Coconut Grove
A variety of people I know – from a tech industry face guy to a leading neo-liberal former Senator – have sent me the same article, with reactions ranging from enthusiastic support to reserved intrigue. The article is called “How To Make an American Job Before It’s Too Late,” by former Intel CEO and Chairman Andy Grove. In it, Grove argues that we need a “job centric” policy that encourages the scaling of start-up companies and that preserves industries that otherwise can’t cut it because, for example, we don’t produce lithium-ion batteries (which are to electric vehicles “what microprocessors are to computing”) because we stopped producing consumer electronics.
If a wide swath of intelligent people are considering or even proselytizing for what Grove has to say, it’s worth plumbing his thinking for a bit. And it’s even more important insofar as he has linked his theorizing to the driving question of the moment, namely, where there hell are the jobs?
First, Grove. At the risk of representing the thinking of someone with whom I profoundly disagree, it comes down to this. First, invention has to be accompanied by investment – “scaling” start-ups – in order to create jobs. No argument there —I direct you to an essay I wrote for the Committee for Economic Development a few years ago – chapter 2 talks about how growth and jobs happen in as simple a set of terms as I can muster. Second, planned economies such as China’s are beating us to the future by maintaining a manufacturing base that gives them a base camp for scaling the summits of tomorrow’s industries.
Third, giving up “old” industries “can lock you out of tomorrow’s emerging industry” – Grove takes a moment to dissent from former Fed Vice-Chair (and Smart Guy) Alan Blinder, who regards our getting out of low-wage TV manufacture as a positive thing. Not only should we keep these industries (which account for “an untold number of jobs”), but we should “rebuild our industrial commons” by taxing “the product of offshore labor” and using the proceeds to subsidize companies that “will scale their American operations…If what I’m suggesting sounds protectionist, so be it.” Businesses that outsource cheap work abroad are like the engineer who repaired he guillotine that was used to behead him.
Now, first, Grove and Intel have never been free markets’ best friend. Back in the late 1980s, when I was Chief Economist Unisys, a (then, mainframe) computer manufacturer, Grove waved the bloody shirt about Japanese memory chips, leading to “voluntary” limits on Japanese chip exports. These added something like $100 or so to the average price of an American laptop that went directly to Intel’s pocket. And when, as a representative for chip users, I would advocate for an alternative approach at industry meetings, the Intel flak told me that I didn’t get it. “It’s like dominoes,” he told me. “Once they get memory chips, they’ll go after microprocessors, and then it’ll be low end machines, and then mainframes.” The most interesting problem with that argument – which is like saying vegetable farmers end up high-end chefs – was that Intel was already producing microprocessors and low-end machines. “If I believed that,” I told him, “I’d be more worried about you.”
The many problems I have with Grove’s argument can be broadly grouped into two. The first and most immediate is that job creation is weak right now not because the Chinese are taking jobs from us or because we failed to keep low-paying work like television assembly. It’s because we had a housing bubble and ensuing financial crash that devastated demand (as I argued here). We could be doing everything Grove would like us to do and we’d still have the same problems that are plaguing us at this moment – an economy full of “After you, Alphonse/After you, Gaston” businesses and lenders, the product of pervasive uncertainty.
But even more fundamental is Grove’s view of the economy. The idea that we need to preserve the activities of the past in order to have a future defies one of the basic precepts of the economy –that growth and change are inseparable. The economy doesn’t grow by adding new activities to a roster of old ones – by producing horseless carriages alongside buggies and buggy whips. The very essence of economic growth is displacement – new activities and new productive techniques displace old ones, and those who master them supplant those who don’t.
Twenty years ago, the Census Bureau began a landmark project in which they lined up all of the information provided to them regarding specific manufacturing plants – how much they produced, how many people they employed, and so on – and tracked what happened to these plants over time. The result was the first statistical movie of the economy, and the results were in many ways remarkable.
Perhaps two findings best summarize what the economists working on this project discovered. The first was that productivity in the U.S. doesn’t grow because everybody gets more productive, as in the rising tide that lifts all boats. Instead, two-thirds of the measured productivity gains occurred because plants and establishments with higher productivity took market share away from competitors with lower productivity – our productivity grows because the more productive among us displace the less so.
And the second finding was that there’s a similar pattern to job creation. Two-thirds of the jobs created come from plants or establishments – and “establishment” means a specific plant or other center in a company, not the entire company itself – that were newly established or growing by more than 25 percent in that year, and that two-thirds of the jobs lost were lost at places going out of business or shrinking by a like amount.
Perhaps that sounds like a validation of Grove’s viewpoint – that we ought to subsidize the “scaling up” of start-up companies – but I don’t think it does. In fact, it argues that this underlying churn takes place all the time. For example, the Bureau of Labor Statistics, which started making this data accessible once the Census had taken hold of economists’ thinking, tells us that around 6.5 million jobs were created in each quarter through the recession. The problem is that in the years leading up to the recession, 7.5 million jobs were being created each quarter. Gross job losses rose from about 7-and-a-quarter million jobs each quarter in the boom years to a peak of 8.5 million at the end of 2008, and then returned to their previous level.
So, again, the problem is not that there aren’t start-ups and scaling and new, dynamic enterprises in the economy. The problem is not that the activities that are leaving the U.S. for low-wage locations really belong here and would stay were it not for managerial greed and myopia. The problem is not that poverty abroad is an unfair trade advantage that’s being used to steal the future. If Grove is really worried about our losing our competitive position in lithium-ion batteries, it must be because he thinks that climate change is a legitimate problem. And if he does think that, then he should be pushing for a carbon tax or cap-and-trade system that lets battery start-ups and other producers get the right economic signal. That would do more for the nascent industries with which he’s concerned than any protectionist, industrial policy experiments – although the term “experiment” suggests that we don’t know how it will end, and here , I think, we do.
The “jobs problem” is that post-crash economic conditions haven’t abated. We could turn here to whether there should be a new round of stimulus and in what form, but I’ll postpone that for now. The point is that Grove’s solutions to the “where are the jobs?” question is to pull the economy into a protectionist regime that favors the status quo over the future, even if, in Grove’s construct, we preserve the present in order to create the future. It doesn’t work that way. So long as you favor today’s activities over tomorrow’s, you’ll get less of the latter.
The World Cup, the Crash, and the Nature of Urban Life
As I warned in my last post, Nancy and I went to see Carl in Valencia and Madrid for ten days at the end of July, and if the definition of meaningful is that which changes you, the most meaningful part of the trip was The World Cup.
I am not a soccer guy. Let’s be brutal, OK? – it’s not a good sport for Americans, least of which, me. It’s clock-heavy, has no offense, it rewards players for whining, and it eats up ballfields that our kids could be using doing throwing drills and learning fundamentals. And I say this knowing that friends such as Andrew Keszler and Nora Mann who have done right by soccer and vice versa, let alone my high regard for Bob Foose and the way he’s been the steward of players and fans’ interests.
But watching futbol in Spain is like hearing organ music in a chapel, or seeing The Dead at the Fillmore. Because futbol belongs in countries such as Spain, where sports haven’t been stripped out of the public sphere of life.
Part of it, of course, is that the World Cup is about national teams. We don’t have nationals teams here because a) we don’t give a shit what foreigners do so why have a national team? – for Chrissake, it’s the World Series, b) we’re roughly the size of all of Europe already, and c) our professional sports were built on the then-prevailing model of vaudeville that gave rise to baseball – play as often and as in many place as possible -- which set a pattern for football, basketball and the one with guys on skates.
It’s hard to talk about the public sphere of life in America, because of the astonishing affluence markets have created here. This puts the burden of proof, both rightly and wrongly, on those who would argue for communal consumption through the public sector.
But everything can’t be privatized. The economy – even the market economy – is a way to act out social norms and preferences. Nothing wrong with that – lots is right about that – so long as we know what it costs to do so and we go into it with our eyes open. We put aside wilderness and subsidize the expansion of broadband Internet because we think there’s a good reason to do so and have made the costs transparent. Those are our preferences.
It always strikes me that laissez-faire guys don’t get that they do see a role for communality in their vision – they think we all ought to have the same values about the right of property.
Back to futbol. Sitting in bars and restaurants to watch Spain advance in the Mundial is regarded as an aspect of the role of the “public sphere” of life in Spanish – and continental European -- “culture,” which is [part of the communal understanding about how you live there. But that “culture” both reflects and is mirrored in economic policies.
And that’s what takes us back to the Crash. It started – let’s not always see the same hands – because our policy was to encourage housing and homeownership, and also not to second-guess banks and other financial institutions, whether lending for housing or trading and speculating for their own accounts no matter how aggressive their risk-taking, because greed is good.
Let’s put the latter aside for a moment. The crash of the housing side of the problem was the end of a policy crescendo that has been underway in America throughout the postwar period. By using federal institutions to develop and standardize the mortgage market, creating a class of banks with not much else to do but lend to housing (the savings and loans), building ring roads around cities that encouraged suburban development and, unsurprisingly, dispersed “ring cities,” and making mortgage interest tax deductable, we’ve made home ownership a leading objective of economic policy.
Other nations do that, too. For all the talk of home ownership being a distinct feature of American life, there are many countries with higher rates of home ownership than ours – some data are here and here. In fact, the countries with the highest home ownership rates – Greece, Italy, Ireland, and Spain – are those in the deepest financial Dutch right now, as they relied even more than did we on ever-expanding housing prices to promote lending which fueled speculation and so on.
But the difference is that these countries didn’t encourage the gutting of their urban centers as part of the promotion of home ownership. In fact, it’s quite the opposite. By taxing motor fuels, maintaining urban public services, regulating land use, and more generally seeing the long-term benefits of viable urban areas, Europe and much of the rest of the developed world has allowed home ownership to co-exist with viable urban centers instead of the risk of hollowed-out inner cities.
As a result, the primary difference between ourselves and these other nations is not the rate of home ownership, but the way in which it has occurred. Our homes are bigger and built in suburbs. More people in Europe own an apartment or an otherwise smaller residence. They rely on public services and become a political force for maintaining them and for urban policy in general. And their homes are smaller. The average newly built home in America has abut 2,300 square feet (214 square meters) of floor space. Spain and Ireland, in contrast, may have higher home ownership, but the average new home is a little over (Spain) or a little under (Ireland) 1,000 square feet.
And the difference shows up in the way of life. Street cafes and bars and the other aspects of viable urban life aren’t just quaint aspects of “culture.” They’re an important aspect of a way of life that relies less on living in a larger, fortress-like home and more on using a more communal “public sphere” to supplement what their abodes offer.
So Americans watch the Superbowl with their friends in rec room parties, while Spaniards watch the Mundial with their friends in street settings that allow them more comfort and space than many of their homes. Or, as Carl said in his own blog: Super Bowl parties consist of 15 people watching a 60-inch screen, World Cup celebrations host 60 people watching a 15-inch TV. There’s a little literary license there, but not much.
I’m not touting this way of life as being distinctly superior to ours, mind you. It has its costs. For one, a greater reliance on public services means a larger public sector. Carl told me that some Spaniards say the civic employees of Spain do “less work than Tarzan’s tailor.” There’s a far greater level and tolerance of inefficiency (and sloth) that comes with the territory. And while my instinctive left wing twitched sympathetically for the striking subway workers in Madrid during our visit, I was still surprised by the incredibly low level of grumbling on the street about the resulting inconvenience. Would Ihave been as tolerant?
But respect for the public sphere is a good value to recall as The Crisis acts itself out. We’re facing reductions of municipal services as state and local governments make draconian cuts. The debate over whether some kind of revenue sharing should support these local governments and the services they provide is being played out as whether another round of stimulus is merited. But we would do well to remember the value of what’s lost and what we prefer when the hollowing out of public services spreads.
Sketches of Spain
Sorry, couldn't resist using the name of a great Miles Davis-Gil Evans record as my title, given that I'm on my way there.
Nancy and I leave today for a week and a half in Spain to visit our son, Carl, whose two blogs about the Spanish football experience you’ve been reading, I’m sure. His team, the Valencia FIrebats, lost the Spanish championship last week – lost it by five scores, truth be told – and that well could be the last game of his football career, win or lose .
But beyond an exciting trip and a chance to see my kid, who’s been gone since January, I’m also very excited about the Euro being down to $1.23, making our timing excellent. I’ve had some exciting economic adventures in Europe, starting with being in London on August 15, 1971, when the convertability of gold was ended and the dollar set loose from the fixed exchange rate regime. I spent the evening in a pub watching the local TV commentators bemoaning how the Americans were solving their problem off of British backs, and was impressed that my classroom training has not prepared me for the real experience of markets. Nor could imagine that I would get married exactly ten years later to the day, making ours one of the few weddings where the phrase "closing of the gold window" was heard in the toasts.
Which brings me around to events in Europe. It will be interesting to see what 20 percent unemployment looks like in Spain – they’re about there right now. As I hear it from Carl, it hits the ground as an extended adolescence – young people can’t find work, can’t move out, can’t start families, and so on, and you can see how an economic crisis such as theirs ends up having demographic and cultural echoes that reverberate for a generation.
And I wonder what people there think about staying in the Eurozone. I wouldn’t be surprised if “el hombre sur la calle” thought of the disciplines demanded by the Euro as a tyranny and wanted to bolt. After all, countries in Spain’s kind of trouble – high unemployment, big debts, and so on – traditionally let their currencies depreciate which solves the problem in rough-and-ready fashion. Prices rise, real wages fall, and exports increase, all of which act together to lower the standard of living, which solves the problem, however brutally.
Being in the Eurozone, however, makes that impossible. The value of the currency Spain uses isn’t determined by events in Spain, that’s really the central problem.
Think of it this way. Spain and Ireland and Belgium and all them-there countries use the same currency. So do Alabama and Maine and Wyoming. And when Alabama, Maine, and Wyoming have problems, they can’t manipulate their currencies, either. But, unlike Spain, and like most, but not all, Americans, people in Alabama, Maine, and all the other states agree and accept that they will share the costs of economic adjustment with each other, which is what allows the 50 states to use the same currency.
This was not an easy decision for the 50 states. When you get right down to it, the Civil war was fought to create those conditions. Because when entities agree to use the same currency, they essentially agree to one of two conditions – either their productivity levels will all grow at similar rates, or they will allow their populations to migrate from low-productivity to high-productivity areas.
When economic conditions get bad, people move – it’s a fundamental but often overlooked fact of economic life. The “Massachusetts Miracle” that was alleged to occur under Governor Mike Dukakis has much to do with hundreds of thousands of their citizens leaving the state in the 1970s. More Californians left their home state for the other 49 in the early 1990s than left East Germany for West Germany where, again, unification with productivity differentials meant migration. The migration of millions of Black workers from the South to the North in the first part of the twentieth century – “Exodus with pork chops instead of matzoh,” as Dick Gregory said – was a similar experience. So was the depopulation of the Dust Bowl.
But Europe is not there. In-migration from the Third World is part of Europe’s economy, but cross-border migration is not, certainly not on the American scale. And freer trade in goods and services and easier movement of capital has not closed up productivity differentials. So any one country in the Eurozone – starting with Greece, Spain, Portugal, and Ireland – has to tough it out.
What’s going on in Europe brings to mind one of my many public mistakes – I’m famous among many friends for a lifetime of bad calls, from Fed Chairman Preston Martin to Presidents John Glenn and Gary Hart. One of the more esoteric ones concerned the imminent success of the Eurozone and the growing trend towards dollarization – smaller countries such as Ecuador abandoning their own currencies and using the dollar, simply to force themselves to grow their productivity as quickly as does the United States.
Ten years ago, I did an NPR commentary on the topic, which I’ve printed elsewhere on this blog. It argued, in essence, that as the Euro succeeded and more economic functions moved from European capitals to Brussels, Europe’s countries would have “less to do,” and were ripe for dissolution. And as I said then:
As global economic integration unavoidably leads countries to become part of currency blocs and free trade areas, countries will find it harder to define their purpose. Belgium, for example, once had its own currency and its own economic policies. As those functions rapidly shift towards the European Union, Belgium will become less a country than a bunch of Flemings and Walloons who don’t like each other. Spain, with its unhappy Catalans and Basques, is also a candidate for dissolution. And if these disaffected areas don’t print their own money, don’t restrict trade, and don’t run Soviet-style border checkpoints, who’s really going to care?
And so, Ecuador's dollar policy leads to a paradox: global economic integration, with its common money and shared rules, will leave us with a world of more countries, not fewer, ethnic ministates that subscribe to basic global economic etiquette and can then go about doing the important business of dancing their national dance and taking their national hero's birthday off.
Hail, hail Fredonia, land of the brave and free.
Well, it’s brilliant writing and high-altitude theorizing, but it has the collateral disadvantage of being dead-ass wrong. What I missed was that all the integration going on around us demands that we either reach some convergence of growth rates or accept mass migration as part of the adjustment. Spaniards apparently have no interest in leaving – they’d rather sit home with Mom and Dad and postpone life for a while. I can’t say I blame them. But absent migration and currency revaluations, the only thing that will fix places like Spain is an awfully long amount of time.
Under No Management
Here's an interesting clip. Steve Jobs is introducing the high-resolution, video-conferencing iPhone 4 on June 7. It's a heck of a phone. Watch the clip. He's trying to demonstrate his prodigious device, but he can't get a connection because of all the Wi-Fi activity in the audience. So he asks everyone to turn off their Wi-Fi connections.
The point isn't to rag on Jobs. The point is that this moment captures the issue that underlies the entirety of the broadband debate. Jobs' suffering -- I couldn't resist that one -- is a modern parable about net neutrality. It captures why "neutrality" won't work, and how little it will gain us in exchange for what we're going to give up to get it.
Last March, when the FCC presented their Broadband Plan for America, they presetned creating a universal broadband network as the highest priority in Internet policy. And I thought they did a reasonable job of showing us a way to get there.
But the FCC's decision to reintroduce the regulatory authority that they were given eighty years ago to regulate the nation's phone system throws that plan out the window. You can dress it up all you want -- call it a "Third Way," argue that you're only going to use the authority for specific, limited purposes, whatever -- in essence, the FCC is telling the providers of broadband connections -- cable, fiber, and wireless -- that it retains the ability to regulate their business. And that’s going to put a pall over broadband infrastructure investment.
I was on a press call for Broadband For America this week and a reporter asked a reasonable question -- when you talk about this kind of regulatory authority leading to reduced investment in broadband infrastructure, he said, it sounds like some kind of all-or-nothing proposition, like the companies are going on strike, or are holding the Internet hostage -- you expect to get Patty Hearst's ear in the mail any day now.
But that’s not it. The companies in this business are gambling tens of billions of dollars by creating this infrastructure and are going to amortize it over decades. Which means that they have to have some idea as to the environment in which it will exist over that period of time. The FCC taking unto itself a full complement of regulatory authority -- whatever their intentions are at the moment -- turns that investment into a hostage. The assurances of today's FCC chairman are worth very little over this larger time frame.
Another reporter asked, in essence, so is the FCC stupid, or what? Good question. And I told them, I don’t think the FCC thinks it can assert all this authority without some repercussions. We can say with some certainty that it's going to be much harder for companies to put tens of billions of dollars into an effort that will take decades to repay and that could at any time be subject to a significant regulatory burden. But I think the FCC thinks that this sacrifice is worth it because, if it had the regulatory authority it seeks, something would be gained.
Neutrality advocates argue that what's gained is innovation at the "edge of the network." They argue that, unless we guarantee that all traffic on the network operates under the same terms and speeds, the "Googles of tomorrow" will die a-borning, unable to compete with the superior connections the Big Websites are able to buy for themselves.
I see three things wrong with this argument. First, the Big Websites already have compelling advantages. Through caching, they can make their connections faster and stronger than can newer competitors. When it's all said and done, the cost of an improved connection to the user will probably go down once we abandon the "one speed fits all" rule that the neutrality proponents want to enshrine in law. That's true because websites won't want to buy an uninterruptable connection from broadband providers unless it's cheaper than their next best alternative (that's Econ 101, right?), and caching is probably that alternative. So dropping the "neutral" framework should make competing easier for new entrants, not harder.
The second problem I have is with the idea that, if it weren't for the competitive "periphery," the Internet would be a stagnant morass. In fact, I could argue that the great onrush of innovation from the periphery of the net -- the place where Google and EBays and so on came from -- was historically specific, that it was the equivalent of a "land rush" -- if you were first to get there, you won. Now that the real estate of the net has been divvied up, the periphery is probably less important than before.
And because of that, innovation is probably taking place at the center of the Net just as readily as its edges. And restricting the center through neutrality has the prospect of impeding just as much, if not more, innovation than it encourages at the edges. I've discussed before the illogic of a cardiac monitor's signal travelling at the same speed and under the same terms as a video of a cat playing the xylophone. But think of it this way -- ATT approaches The New Orleans Jazz and Heritage Fetival to put on a live benefit concert for NOLA reconstruction that can only be watched on an iPhone. In order to make it work, it has to make sure that the signal isn't lost in buffering -- who wants to freeze up during a staggering Jeff Beck solo during How High The Moon or Nessun Dorma?
If that happened, the neutrality advocates would raise holy hell and try to stop it, just as they complained about the iPhone's inabiloity to connect to any platform. That's because they would argue that making sure that Jeff Beck's bits stay together until they hit your computer disadvantages all the other bits -- the cats playing the xylophone. So, when you get right down to it, they're making the statement that we're giving up so much that might happen -- "land rush" aside -- that we should prohibit what will happen.
But there's a third, and more down-to-Earth, third reason why neutrality misses the point. Traffic requires management. And management means there are some rules or procedures for determining what goes where, when. Red lights, green lights, variable speed limits, weight limits, HOV lanes and so on – those are the rules of a “non-neutral” traffic grid.
Under neutrality, we do away with that. If the Internet gets congested, we all slow down together. When Comcast, a few years ago, responded to congestion on its network by slowing down users of BitTorrent, there was outrage in some corners. I think Comcast's greatest sin was keeping that practice a secret from their customers. But absent a clear regulatory message that broadband providers can do what they want to optimize their networks' performance and let consumer judge how they did, it's hard to blame them for being reticent to announce what their practices are. Besides, as I've said before, BitTorrent is used for file sharing, and file sharing generally is all a low-value use. It’s like rules that stop you from watering your lawn during draughts. You can argue that some people would rather be thirsty and dirty than have a withered lawn, or that they’d pay any amount to outsod the Joneses. But generally, it’s a simple and easily understood rule that works when the reservoir is low. Slowing down file sharing – as opposed to e-commerce or distance learning or whatever else – is the same kind of rule. It’s not perfect, bit it works.
So here we are with Steve Jobs. He wants to use the network, but too many people are on it for him to get the signal he needs. So his presentation isn’t happening. What he needs is network management, a system that allows infrastructure providers to optimize the productivity of their networks – not just to facilitate the flow of traffic, but to determine how the highest-valued uses get through, using markets to allocate these priorities much as they do everything else.
Jobs shows you what happens we avoid taking this inevitable step. We cannot afford an Internet that is Under No Management.
What the —-?
Although the title of today’s entry wasn’t meant to refer to it, the call at first base on what would have been the final out of Armando Galarraga’s pitching baseball’s 21st perfect game was not the worst call in baseball history. Don Denkinger’s call on Jorge Orta in 1985 was not only far more obviously wrong – it wasn’t even a bang-bang play –but changed the outcome of the World Series, which is far more severe than marring one player’s individual accomplishment. Ken Burkhart’s call in the 1970 World Series was particularly egregious as he ended up in the middle of the play, as well as blowing the call. And Larry Barnett’s failure to call Ed Armbister out for interference in 1975 was not only wrong, but marred perhaps the greatest World Series ever (although I’ll take 1991, thanks, with props to 1960, 1924, and 2001)
So Galarraga now enters baseball history as one of the three guys to have “asterisked” perfect games. He’s really the third of the three. The second is Harvey Haddix’s famed 1959 outing, in which he threw a 12 inning perfecto – 36 up, 36 down – only to lose, 1-0 to Lew Burdette and the Braves in the 13th on an error, a sacrifice, an intentional walk, and a homer by Joe Adcock that ended up being only a double because he passed Henry Aaron on the basepaths. The first great “not perfect” game was in 1917 when Babe Ruth, pitching for the Red Sox, walks the first batter, argues the call, gets thrown out by the umpire, and Ernie Shore, who replaces Ruth, picks the runner off and gets the next 26 in a row. Can you imagine? It’s a different list but Galarraga’s on it, and the beauty of baseball is that its devotees keep and respect both lists.
So much for the sublime. Now, on to the ridiculous.
For the first time in my career as an economist, I’m getting “the question” – friends, colleagues are coming up to me and with the hushed tones usually reserved for intimate conversations in public places and dope deals, ask me; “What the --- is going on out there?” The blanks, of course, vary as do the askers.
I don’t take this as a sign that economists are now climbing up the ranks of respectability, leaving lawyers and other reprobates behind, but rather that the daily stream of news is so confusing, so off-the-map, and creates so much volatility – markets and their underlying sentiment taking giant steps in opposite directions with each passing day – that “what the ---“ becomes the only appropriate response. “What if everybody felt that way, Yossarian?”/”Then I’d be crazy to feel any different.”
So here’s the hyper-condensed version of events that I’ve developed in response to the dominant questions of the moment.
When we last left the Western economies, they were imploding after the collapse of the housing market. The balance sheet hit created by crashing home values led banks to cut back lending and led consumers to retrench. This spread the pain and failure to the general economy, which ignited a second stage of financial collapse.
The second stage was caused by “credit default swaps.” Over the previous years, banks and other institutions had made bets that many large firms would never go bankrupt. They did this by buying credit default swaps, a device in which they were paid a nominal amount in exchange for the promise to take a bath if a firm went broke and its securities went unserviced. As long as big companies never went broke, there was nothing to lose.
Oh well. It was this second stage that put the ship on the rocks. Many – almost most – major financial institutions had that kind of exposure. And the ones who bet the right way – by recognizing that one day these credit default swaps might take a bath – couldn’t collect what they were owed because it never occurred to them that their counterparty (or as we called them back in North Queens, losers) would be unable to pay. That’s a major oversight -- I don’t lend my neighbor Fitzgerald ten million bucks because I know he’ll never be able to pay it back. So when Goldman tells you it didn’t need the bailout – horsefeathers. They received billions of the money that went into saving Bear Stearns, and they got it because they didn’t think about this point.
Faced with the reality of their major banks shutting down, the major governments had two options – do something, or do nothing. Monday morning quarterbacks on both the left and right are making careers out of critiques of option A, but only a few folks well-removed from reality dispute that Options A was the right move. (For example, Casey Mulligan argued in the New York Times that it was senseless to spend so much money bailing out banks as pension funds and university endowments could match savers and investors just as well. And this guy teaches people? Give me a break.) Other critics thought that the banks ought to be given the kind of rousing reception that greeted Mussolini at Giolino di Mazzegra, others that bailing out Bear but not Lehman was inconsistent.
But the actions taken by the new Obama Administration and the other Western governments brought the world back from the frightening paralysis that would have taken place if the banks were shuttered -- lending would not occur, assets would not be exchanged, liquidity not provided for businesses, and further trillions of dollars would be lost. Time out for an aside – you all owe your asses to the Administration and, yes, Tim Geithner, for keeping themselves focused on the one thing that truly mattered – recreating financial stability. Like comedy, it wasn’t pretty. But it avoided reproducing the very same mistakes that made the Great Depression a catalyst for a decade of great film and theater.
Bailing out the financial system took a lot of money – ultimately, less money than was thought at the time, but that merely means “a lot” of money, as opposed to “psychotropically unfathomable” amounts of money. But, in the world of financial bailouts, if they cost a great deal, it means you haven’t spent enough yet. The real budget hit came from the downturn in the real economy, not the cost of mopping up after the hogs ran through town. The stimulus was big but sorely needed, and again, some credit is due to the Administration – here I see Summers at work – for understanding that the response had to be commensurate with the problem – enormous.
Which takes us to the present, where the economy is stable and beginning to grow anew. As I’ve said elsewhere on these pages, I’m optimistic about that growth, and I’ll double-up on my optimism before this entry is out. But behind the prospects for a meaningful recovery lies the specter of an ocean of government (sovereign) debt. There was a frightening amount of government debt before this mess, and adding on more makes it all the more unnerving. I don’t think it’s beyond the pale to expect some U.S. municipalities or even states to default in whole or part of what they owe – heck, California already issues IOU scrip and when that trades below par, that’s already a form of default.
So the issue now is whether all of these sovereign debts will be repaid. When governments were busy shoveling dollars into the boiler, people put that fear aside, using a variant of what economists call “Tinbergen’s Rule” – that is, one crisis at a time. But once the crisis appeared to abate – as it does now – there was the morning after question – how is all this debt going to be taken down?
And against that backdrop came the startling revelation this Spring that Greece, with enthusiastic support from Goldman Sachs, had set up currency and perhaps other trades in order to hide the true level of their government’s deficit. That Goldman would suggest such a thing to a government is outlandish – that the government would take them up on the offer speaks to Goldman’s uncanny craft. But the news that Greece’s deficit was much larger than previously thought sent a new shock wave through the system. Would Greece be willing to repay all it owed? And what about other European countries with debt levels that, in some fashion, rivaled those of Greece – Spain, Portugal, Ireland, maybe even Italy? Could they, would they, somehow reneg or default?
And so Europe went from a crisis not of their own making – the U.S.-born mortgage/credit default crash – to one entirely of their own doing – the need to stitch together the Eurozone. The framers of the Euro, 20 years ago, understood that once the individual nations of Europe didn’t have their own currency – pesetas, lire, escudos, drachmas -- to degrade (by borrowing like madmen), they had to be prevented from degrading the one they now all shared. They passed rules about limits on deficits, but those rules were impossible to enforce. When confronted with the choice of temporarily bailing out the high-debt nations or watching the European economy founder and the Euro be abandoned by several of its participants, the Germans, Europe’s official embodiment of rectitude, got pragmatic quickly and started dishing out money.
So now the issue has changed. The major industrialized nations all owe staggering amounts of money. Some of it came from the financial bailout, some of it from the Euro-bailout, but most of it is related to the economic conditions that ensued. Some amount of the ongoing deficits we see will fade if the economy, but most of it won’t. And cutting deficits is tough – Greece imagines cutting about 2 percent of GDP each year from its deficit for four years -- that’s going to hurt, hurt badly, and hurt for a long while. Will their per capita income be higher or lower than today’s in 2020? I don’t know. That’s a long time to go nowhere and it requires a population willing to lose that decade because they understand that the alternative is worse. Imagine Glenn Beck – or Jamie Galbraith – chewing on that one.
But even as sovereign debts have become riskier, investors have raced to buy them, because in the midst of a financial crisis, there’s little else to buy. But when you add the precariousness of government debt to the staggering quantities of it that’s been snapped, you get the ultimate bubble – not a “housing bubble” or a “dot.com bubble” or a “leverage bubble” but a sovereign debt bubble – the possibility that government debt instruments are wildly overvalued because they haven’t been priced to reflect the true probability of default. And like any bubble, when it pops, it’s going to be a bitch; can you imagine the carnage when and if a government announces it’s only going to pay back X percent of the face value of its securities? Or declare an interest-free holiday for itself? People generally walk around thinking “well, that couldn’t happen” until the moment it does. Think of the nanosecond in which Fannie and Freddie turned from makers of orderly markets to oceans of suck. Now apply it to Treasuries. Man.
With that said, and while fully cognizant of all the risks involved, I think that the world economy will most likely escape this trap, when all is said and done. And I base that on a short list of factors. For one, the political processes outside the United States are probably capable of dealing with the unrewarding task of fiscal retrenchment, particularly in Parliamentary systems that have greater continuity and discipline. Second, my earlier remarks to the contrary, markets aren’t being caught by surprise as they were with mortgages and credit default swaps – investors are paying attention to sovereign debts, and the credit rating agencies, which screwed up royally last time, are both chastened and attentive. The spreads among government instruments are responsive to new developments, and we’re probably beyond the point at which such a debt is regarded as “risk free.”
But even more importantly, to me, we live in a world bereft of inflation or inflationary pressure. Pervasive technological change is reorganizing the world economy, and hundreds of millions of people, particularly in Asia and the former Soviet Bloc, are being integrated into it. It is very hard to tell a convincing story about how costs – particularly wages – are going to rise to create overall price pressures, and resources such as oil are now far less important than they used to be in triggering economy-wide price changes – a dollar of GDP now takes about half the oil it did back when OPEC could bring the world to its knees.
This is important because the most rudimentary way to manage too large a stock of government debt is to print money to pay it back. This is frowned on for two, interrelated reasons. First, it causes inflation – you know the old saw, “inflation happens when too much money chases too few goods.” Well, regardless of the universality of the proposition, too much money can lead to higher prices, so it bears watching. Second, when debtors print money, their currency falls in value, which makes its foreign debts harder to pay (since your currency fell in value relative to the currency in which you have to repay), which perpetuates the loop. But inflation is going to be hard to sustain in today’s world – I’m far more bothered by the prospects of deflation than inflation.
And you can’t have a “run” on the dollar, or the Euro, or whatever else unless there’s something to run to, and there isn’t. All of the “advanced” economic areas and their currencies have the same basic problem – too much debt, slow growth, aging populations, and so on. You can’t abandon all of these currencies at once – where do you put the money? Some might argue that it will end up in gold, but gold’s historic role as a way to store value when inflation east away the value of paper money. Are investors really going to flock to gold when there’s no inflation on the horizon? I doubt it.
So we have a historically old problem – governments taking on too much debt – in a radically new historical setting – a deflationary world environment. That means we will have more latitude to manage economic growth and expand the supply of credit while trying to work out the overhang of government bonds around the world. And it means that we can use monetary policy to keep the economy moving while we tighten on the fiscal reins.
But these circumstances also suggest one final economic policy item to me. By next year, with the recovery underway and jobs back in the plus column, it would be very, very wise to raise taxes. A well thought-out tax increase would show global investors that the U.S. was capable of overcoming its own bipolar lunatic fringe and acting responsibly, and that the dollar was still the safest place to be in a scary global economy. Interest rates here would drop and stay low, investment would increase, and we would be better off.
The tax increases that were part of the Clinton budget package in 1993 were greeted with derision by those who claimed they would lead to a recession – and those critics included some in our own Administration. I recall heated conversations in which the other side of the debate mocked the idea of “crowding in” – freeing up resources for better uses by cutting deficits. But they lay the basis for a decade of growth. The 2011 tax increase – and hopefully reform – would do the same. It will be some very heavy lifting. But it’s a better answer to our circumstances than more “what the ---.”
The Sound of One Hand Clapping
Have you ever watched an old movie on television – say, Sorry, Wrong Number, with Barbara Stanwyck – and at a critical moment in the plot said to yourself “Well, if they had cell phones back then...” Cell phones have become a ubiquitous feature of modern life, with rapidly escalating power (so-called “4G” technology, with phone connection speeds in excess of those of DSL, is already on the market) and declining unit cost (the U.S. has the lowest wireless provider revenues per minute used in the developed world).
An essay on the remarkable performance of mobile telephony is hardly worth reading. But that performance has not persuaded the Federal Communications Commission – last week, it released its 2010 “Wireless Competition Report,” which failed to find for the first time in six years that the U.S. cell phone market was “effectively competitive.”
I think the facts disagree. The U.S. in one of only four OECD countries with more than four facilities-based wireless operators and more than 140 wireless providers total. Almost three-quarters of consumers can now pick from five or more mobile services, and the percentage of households served by wireless broadband has recently gone from 51 to 76 percent. Perhaps most importantly, the wireless industry continues to invest over $20 billion annually, an investment that reaches well beyond the big urban markets to smaller communities around the country.
Part of the FCC’s complaint appears to be that Verizon and ATT are increasing their share of the market. If they are, it’s unsurprising – they’ve been the biggest investors in cellular infrastructure, and the two most aggressive providers of higher-end, data-friendly handsets. In fact, the way they’ve revolutionized the handset market is important evidence of competition in its own right. Enhanced feature phones and smart phones accounted for 81 percent of total sales last year, and The New York Times recently reported that data (in the form of texts, e-mail messages, streaming video and other services) surpassed voice signals on mobile phone traffic. And, as the Times reported, the burgeoning growth is occurring because “calling is cheaper than ever because of fierce competition among rival wireless networks.”
That the FCC should see this success as problematic is itself problematic given that body’s proclivity to take serious the application of “neutrality” concepts to mobile telephony. “Neutrality’ proponents argue that new devices, such as Apple’s iPhone, should be capable of operating across all mobile systems as opposed to being “tied” to one particular mobile provider. But, leaving aside technical difficulties, the “tied” feature of these new devices has been a spur, not an obstacle, to competition. What if the iPhone quickly monopolized the market and established a choke hold on applications innovation? Instead, confronted with ATT’s growth following their iPhone deal, other vendors have entered deals with such device manufacturers as Google, Blackberry, Palm, Windows Mobile. And all of these handset manufacturers, in turn, now compete to provide applications to run on their devices. Can you imagine an advertisement claiming that a particular phone runs thousands of applications – from recognizing a restaurant across the street to counting the calories in the meal it serves – only five years ago? Three years ago?
Moreover, the trends in competition are moving in the right direction. While ATT and Verizon are the largest providers, pre-paid phones – and area in which neither has a commanding share – are the fastest growing segment of the market. And Sprint, written off by many critics, has recorded the largest industry gain in the past two years in the American Customer Satisfaction Index.
In fact, the U.S. now has the best of all competitive worlds – more active providers than most other nations, rapidly growing penetration, high investment, low prices, and competition that is spreading from line access to devices to applications. And if this track record isn’t enough for the FCC, then we should keep in mind that the solution to the imagined problem is in their own hands – making more spectrum available to the industry.
And all of that suggests to the skeptical that the FCC’s hand-wringing is a prelude to a new regulatory foray. Perhaps it leads to some misapplication of “neutrality” that requires iPhones or Androids to work with every provider’s system, even though that horse appears to have left the barn. Perhaps they intend to cut Verizon and ATT out of future spectrum auctions, in essence subsidizing their competitors at taxpayer expense. But that doesn’t make sense – at least some part of the subsidy would be absorbed by the other firms as higher profits that served no public purpose. (And given the very high proportion of places that offer consumers several viable choices for mobile phone service – and therefore already having a competitive market price – the proportion of the subsidy turned into profits is likely to be substantial.) If the FCC wants to tie spectrum auctions to providing mobile broadband to markets lacking such service, that would be interesting, but you have to be willing to stop worrying about who steps up to take that deal.
But beyond a statement about the FCC’s view of mobile telephony, this recent report is another glimpse into the FCC’s mindset. The FCC has now, within a few short weeks, pronounced both that the wireless telephone market isn’t competitive and that it needs to embrace a risky legal strategy to impose “neutrality” regulation on wireline broadband Internet (as I discussed here). Which means they don’t think the wired market for broadband isn’t very competitive either.
What these findings seem to miss is that not only are these two markets competitive, but that they are rapidly coming to compete with each other. That is, telephony, like broadband, is increasingly available from both wired and wireless sources, and consumers are increasingly seeing one as a substitute for the other.
A recent report by the Center for Disease Control noted that one quarter of American families live in homes with no landline connection – including almost half of adults aged 25–29 years and well over one-third of adults aged 18–24 or 30–34. This growing number of Americans who prefer mobile telephony seem likely to use that connection for broadband access as rapidly as it can be delivered. And when “4G’ phones penetrate the market – this summer’s “big thing” is going to be their introduction -- the interchangeability of the two is going to leap forward. Verizon recently claimed average data rates of 5 to 12 megabits per second on the downlink and 2 to 5 megabits per second on the uplink in “real-world environments.” It’s not enough to watch a high-def live-stream or do telemedicine, but it’s plenty good for most of what we do today, and faster than many if not most home connections. And if that’s true, how can you look at one market – whether wired or wireless – without looking at the other?
The FCC should lose its blinders and focus on this competition. Parts of its national broadband plan, released in March, did exactly that – freeing up more spectrum, expediting the creation of more mobile infrastructure, and so on. The point is to feed that competition, not to deny it. Predicting technological progress is difficult, but it’s hard to bet against the nation’s ultimate broadband infrastructure’s being a mix of wired and wireless provision, and the competition between the two is already underway. By separating the two parts of the market and considering them individually, the FCC is busy contemplating the sound of one hand clapping -- even as the ovation created by two hands is turning into a crescendo.
Part 1: The FCC and Title II
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