In Defense of Dodd-Frank

It’s been nearly a decade since we first felt effects of the Great Recession. While the recession officially ended, its consequences still affect us. Some are beneficial, others (like sluggish growth and the number of people leaving the labor market) not so much. One of the better side effects of the 2007-2008 crash, however, is likely to disappear rather soon: the Dodd-Frank act. The newly inaugurated White House is eager to scrap that set of financial regulations.

My goal with this post is to present a very simple explanation of what Dodd-Frank is, why some people want it gone, and why we should fight to keep it and strengthen it. Hopefully, this accessible explanation will motivate more people to join the fight. Maybe then we can have our voices heard. With this objective in mind, I am aware that some details will not be pursued to their full extent, but the overall message should still be whole.

Let me start with a very simplified analogy. Think of the financial system as a system of highways. In a modern highway, there are usually a few lanes on each side, separated by a median. There are many regulations put in place to make sure that the people zooming past each other inside two tons of metal–all the while sitting inches away from gallons of gasoline–do it safely. In this analogy, your average American with their savings, retirement account, mortgage, student debt and credit cards is driving north on the “commercial” lanes in their Peel P-50 (click the link, it will help you understand where I am going with this). Besides them are other entities such as big banks, hedge funds, insurance companies and the like. Those are heavy 18-wheelers and tanker trucks, so the massive gusts of wind that they create will shake smaller cars as they pass by. Of course, whenever a P-50 gets into a crash (like when a head of household goes bankrupt) it is tragic, but it does little to the overall flow of traffic. However, when one of those big vehicles crashes, it often leads to a chain reaction of other accidents, which affects all other drivers and overall makes everyone’s day a lot worse.  

After the great crash of 1929 (the financial crash, I’m unaware of any major vehicular crashes from back then), a set of fairly stiff regulations were designed to keep the drivers of that industry–namely the banks and other financial institutions–from getting in other accidents of similar magnitude. Those regulations were known as the Glass-Steagall Act of 1933, enacted as an answer to the failure of almost 5,000 banks. The legislation was put in place to strengthen the public’s opinion towards the financial sector, to curb the use of bank credit speculation, and to direct credit towards more “real economy” uses. In our analogy, Glass-Steagall introduced a number of norms to the ‘financial highway’. Most notably, it created a solid median between the financial and the commercial banking lanes. Now, commercial banks could not use their clients’ funds to engage in risky investments in the financial markets. In our analogy, it means that before Glass-Steagall those big trucks were free to go across the road to the “wrong way” whenever they felt like doing so would be beneficial for them. In addition, Glass-Steagall also created the FDIC, which insures bank deposits; think of it as the weight-per-axis limitations that help preserve the roads from the damage caused by overloaded trucks.

Fast forward to the Clinton presidency, 1999 to be exact. By then, the broad belief that separation between financial and commercial banking was necessary had lost force, even though it had kept the American economy away from any significantly serious recession/depression for over 70 years. That year the barrier between the financial and commercial lanes was brought down. Now, banks and other financial players were free to drive on whatever side of the highway they wanted; banks (and others) are now able to use their clients savings and retirements accounts to buy and sell toxic financial assets such as CDOs. As a result, they were able to take bigger risks, which brought–in many cases–good rewards. This is the era of leveraging, or what Minsky called “Money Manager Capitalism.” To some, it was clear that such an environment would eventually lead to a big crash; a few smaller ones serving as a warning. Indeed, with 2007 came the worst financial and economic ‘accident’ in almost 80 years.

Financial regulations are naturally reactionary. As Minsky stated, the economy is inherently unstable, and in good part that is due to the financial sector’s insatiable thirst for financial innovation. Regulators need to remain attentive to the markets and introduce rules to curb too-risky behaviors as they surface. This is especially true in the days and weeks following a crisis. Once the dust has settled we can look into the causes for the downturn, and put in place measures that are supposed to keep it from happening again, not unlike the way traffic regulations are designed. As such, the Dodd-Frank Act was drafted to put a stop to some of the recklessness that drove us to the Great Recession.

In short, Dodd-Frank ended Too Big to Fail Bailouts, created a council that identifies and addresses systemic risks within the industry’s most complex members, targeted loopholes that allowed for abusive financial practices to go unnoticed, and gave shareholders a say on executive pay. It aims to increase transparency and ethical behavior within the financial sector, both of which are good things.

In no way is the Act perfect. Some, like me, would have advocated for much stiffer regulatory practices like rebuilding the division between financial and commercial banks, or taking a more definitive approach to dissolving Too-Big-To-Fail institutions. Therefore, during its somewhat short existence, Dodd-Frank has received much criticism. While some of those critiques were fair and well founded, the loudest critics were the ones coming at a wrong angle. As it happens the loudest critics now have the opportunity to scrap those safeguarding regulations altogether.

The most common criticism of the Act (and the main reason the administration has given to overrule it) is that it has made it harder for people and businesses to borrow. That criticism is untrue. For example, Fed Chair Janet Yellen showed in her latest address to the senate that “lending has expanded overall by the banking system, and also to small businesses.” A survey from the National Federation of Independent Businesses, cited by Yellen, shows that only 2 percent of businesses that responded cited access to capital as a great obstacle to their activities. Furthermore, to claim that Dodd-Frank has a macro impact on lending is, at least, sketchy. As Yves Smith puts it:

“For starters, big corporations use bank loans only for limited purposes, such as revolving lines of credit (which banks hate to give but have to for relationship reasons because they aren’t profitable) and acquisition finance for highly leveraged transactions (and the robust multiples being paid for private equity transactions says there is no shortage of that). Banks lay off nearly all of the principal value of these loans in syndications or via packaging them in collateralized loan obligation. They are facing increased competition from the private equity firm’s own credit funds, which have become a major force in their own right. Otherwise, big companies rely on commercial paper and the bond markets for borrowing. And with rates so low and investors desperate for yield, many have been borrowing, for sure….but not to invest, but to a large degree to buy back their own stock.”

In fact, the amount of cash held by American corporations reached an all-time high in 2013. This shows that companies are sitting in liquidity without investing in the real economy. The hoarding of liquidity could even be considered an actual fail of Dodd-Frank; unlike the stiffer Glass-Steagall act it did not focus on pushing investment into the production of real goods and services.

The publicized reasoning behind repealing Dodd-Frank is untrue, so what is the motivation for lobbying against the regulations? In my opinion, there are two main arguments. The less malicious one is that there is still people out there who believe than an unregulated, free-for-all financial sector is effective, benevolent, and will serve the greater good. It is almost a dogmatic position based mostly on circular logic, and unrealistic economics modeling (which often does not even take the financial sector into account!), and lack of supporting evidence. It should be put aside. The second argument seems to be popular among lobbyists and government officials: reducing regulations will allow (at least in the short run) for immense profits.

Without Dodd-Frank, Wall Street will most likely revert to the risky and reckless practices that led to the Great Recession. The repeal of the act would, in Minskian terms, act as a catapult launching us towards the Ponzi state of finance, in which risky borrowing and lending end in a financial crisis. Doomsday predictions aside, repealing Dodd-Frank would hurt the common folk like you and I. For example, the Fiduciary Rule is likely to also be erased, and it requires that investment advisers put their clients’ interests above their own. This puts people’s retirement savings at great risk. If money managers do not have to act in their clients’ best interest, they will make decisions that allow them to maximize their commission even if it means losing money for their clients. Additionally, to some extent, the repeal would kill thousands of jobs across the nation; because of Dodd-Frank, financial institutions had to create and staff entire departments focused on quality assurance and compliance, without the rules these employees are not longer needed. Finally, without the rules, banks can go right back to targeting the most vulnerable and financially illiterate among us, offering them loans, mortgages, and other predatory instruments they cannot possibly afford; it would be disastrous.

Reverting back to our simplified analogy. Since the repeal of the Glass-Steagall Act, the highways of the financial systems do not have a median, separating investment traffic from going the ‘wrong way’ into the commercial lanes. Further repealing rules such as the Dodd-Frank Act, without substituting with a set of better regulations, is like removing the usage of turning signals, the requirement for turning the lights on at night, and speed limits – all the while releasing the Bull from Wall Street right in the middle of heavy traffic. Accidents will happen, and in the case of our financial highway it does not matter if we are inside the vehicles involved, we are all going to become casualties of the crash.

The Borrowed Science of Neoclassical Economics

Another “Econ 101” story we hear in microeconomics classes is that, as consumers, individuals are always involved in a rational, hedonistic competition trying to maximize their own utility. The utility principle was brought to the forefront of the economics profession with the Marginal Revolution of the 1870s. The Marginal Revolution, the story goes, was a response to the rise in prominence of the theories of Karl Marx. While this might be true, it is only part of the story. The rest has been conveniently left out of the intro courses because it reveals that the foundations of neoclassical economics were essentially plagiarized from the natural sciences.

Modern orthodox economists frequently theorize and propose their models wrapped in algebraic expressions and econometrics symbols that make their theories incomprehensible to anyone without a significant training in mathematics. These complicated mathematical models rely on sets of assumptions about human behavior, institutional frameworks, and the way society works as whole; i.e. theoretical underpinnings developed through history. Yet, more frequently than not, their assumptions go to such great lengths that the models turn out utterly detached from reality.

This approach was promoted during the 1870s, in an effort to emulate the success of the natural sciences in explaining the world around us, and so transform Political Economy into the “exact” science of Economics. The new discipline, born with a scientific aura, would provide a legitimate doctrine to rationalize the existing system and state of affairs as universal, natural, and harmonious. It is understandable that economists wanted their field to be more like the natural sciences. At the time, great advances in physics, biology, chemistry, and astronomy had unraveled many mysteries of the universe. Those discoveries had yielded rapid development around the world. The Second Industrial Revolution was well underway, causing a transition from rudimentary techniques of production to the extensive uses of machines. Physics and mathematics were validated to a great extent with the construction of large bridges, transcontinental railroads, and the telephone.There exists extensive evidence to establish that this success of the natural sciences and the scientific method had a big influence on the mathematization of what had been the field of Political Economy. Early neoclassical theorists misappropriated the mathematical formalism of physics, boldly copied their models, and mostly admitted so. Particularly guilty of this method were W.S. Jevons and Léon Walras; credited with having arrived at the principle of marginal utility independently.

Jevons’ Theory of Political Economy shows this very clearly. He explicitly says he wants to “treat Economy as a Calculus of Pleasure and Pain, the form which the science, as it seems to, must ultimately take.” Here Jevons has abandoned the term “Political Economy,” and instead he is talking about the science of “Economy;” a science that would become “as exact as many of the physical sciences; as exact, for instance, as Meteorology is likely to be for a very long time to come.” Moreover, the concern of this new exact science would be limited to “the mode of employing their [referring to the population] labour which will maximise [sic] the utility of the produce,” and taking as “given” institutions like the property of land.

Walras showed many of the same intentions, claiming that “pure theory of economics is a science which resembles the physic-mathematical sciences in every respect.” Walras wanted that the pure theory of economics would deal with the relation between men and things (what he called “industry”) in a scientific way, while relations among men (termed, “institutions”) would be the object of study of social economics employing non-scientific techniques. This way, Walras removed property rights and class conflicts from the set of issues with which economics should be concerned. He abstracted the pure Economics theory from reality, and created an imaginary, utopian world: “an ideal market . . . [with] ideal prices which stand in an exact relation to an ideal demand and supply.”

American economist Irving Fisher furthered the work of Jevons and Walras in even less subtle ways. By the end of the 19th century, Fisher was openly copying physics models, term by term and symbol by symbol! Fisher’s Mathematical Investigations shows how he takes physics concepts and translates them to economics jargon:

Figure 1. Correspondence between the terms taken from mechanics and their economics counterpart in Mathematical Investigations

Source: Fisher, I. Mathematical investigations in the theory of value and prices, and appreciation and interest (p. 85).

Of course, none of this would be problematic if the adapted physics theories could be applied as Jevons and Walras proposed. But humans are not particles! In order for their scientific approach to work, Jevons and Walras had to assume a utility theory of value, which implied that people’s individual preferences were perfectly quantifiable, and that the amount of pleasure they obtained from the consumption of a certain good could always be measured. With these tools, Jevons and Walras assumed people to make rational decisions with the intention to maximize their utility.

This way, the Marginal Revolution transformed Political Economy into the pure science of Economics. Their methods, however, reveal that this  formalization was more of a scam than an actual process of discoveries through scientific methods. Those who followed, however, took it to be a solid foundation. The founders of neoclassical economics used it to build theories that portray the existing order as rational, natural, and just. The social setting of the individual, institutions, and social relations of production continued to be exempt from examination, in the name of impartiality and objectivity. Economic “laws” continued to be devised—not discovered. The economy came to be portrayed as a system that operates autonomously and independently of human will, and comes to harmonious fruition under a free-market capitalist system of production. These conclusions, however, are built into the assumptions.

The urgency with which these theories were invented can be understood against the backdrop of Marx’s rise in popularity.  Marx explained capitalism in the way a mechanic would open the hood of a car and explain the function of each part. His theories talked of conflicts of classes and exploitation as the inevitable consequence of private property, and the reduction of labor to another factor of production. With the intention to develop a counterargument, neoclassical thinkers decided to exempt those exact elements from their examination, and their models would show a capitalist society where there exists no exploitation, but rather a harmony of interests among classes and where the income created is divided according to the marginal productivity of each factor of production. No wonder neoclassical economists, like Robert Lucas, consider issues of distribution as “harmful” and “poisonous” to the economics profession; even in the face of staggering inequality. Maybe Piero Sraffa was right when he suggested that we should toss out these faulty theories.

 

Written by Oscar Valdes-Viera
Illustration by Heske van Doornen

The Tragedy of “The Tragedy of the Commons”

How should society manage its common-pool resources like fisheries, forests, and grasslands?

The problem, as presented in an Econ 101 course, is that these systems lack the proper incentives for sustainable use. Without private property or government regulation, people inevitably overuse and exploit them. This is the “tragedy of the commons” —famously formulated in a seminal 1968 paper by ecologist Garrett Hardin, and taught to thousands of economics undergraduates every year. There’s just one problem: Tragedy of the commons fails to explain real-world behavior.

Hardin’s argument runs something like this. First, he invites us to “picture a pasture open to all.” In this scenario, herdsmen of the pasture, if they are rational, self-interested agents, will figure that the benefits they receive from adding one additional cattle to the pasture outweigh the costs from overgrazing that are shared by all the other users. Each herdsman continues to add cattle to the pasture, but in this way, the resource is inevitably depleted.

For this reason, Hardin argued that “Ruin is the destination toward which all men rush.”

Scholars—many outside the economics discipline—have attacked this argument for its unrealistic assumptions and lack of evidence. One prominent critic is Elinor Ostrom. Elinor Ostrom is a lifelong researcher of the commons and Nobel Laureate in economics. Ostrom said that Hardin confused a joint property commons with an “open-access regime,” where restrictions on use are completely absent. Open-access regimes sometimes do exist (e.g., fishing on the high seas). However, in the real world, common-pool resources are often governed by rules and norms that their users develop. This means Hardin’s “pasture open to all” does not accurately map how the commons operate in practice.

There is ample empirical evidence for the sustainability of commons regimes—as defined by Ostrom.

The very existence of the commons, particularly where resources are scarce, proves neither private property nor state coercion is a prerequisite for their viability. In the words of Ostrom and her colleagues: “although tragedies have undoubtedly occurred, it is also obvious that for thousands of years people have self-organized to manage common-pool resources, and users often do devise long-term, sustainable institutions for governing these resources.” Commons are not always successful, but they are far from doomed to a tragic fate.

Take, for instance, the grasslands in northern China, Mongolia, and Southern Siberia. State-run and private methods of resource management implemented in Russia and China are not nearly as effective in conservation as the traditional Mongolian group-property institutions. Around three-fourths of grassland in Russia, and more than one-third in China has shown signs of degradation, compared to just one-tenth of grasslands in Mongolia.

The water commons in Bali provide another example.

Subak, the traditional institution for irrigation management, has been sustainable for centuries without state regulation or private ownership. With water flowing downhill, the position of upstream farmers seemingly puts them in a prime position to free-ride. It is diverting more water for their own crops, but in reality, the opposite occurs. Farmers, upstream and downstream, are able to create a synchronized cropping arrangement in which damage from pests is minimized and downstream farmers retain access to water. In the end, crop yields are increased while water is used sustainably by all.

The voluminous literature on the commons documents countless similar examples. In the West, these include the cod fishery in Newfoundland (before it collapsed due to government mismanagement) and the lobster fishery in Maine. Digital and intellectual domains can fall under commons management as well. Wikipedia and the Creative Commons license exist only because people are able to cooperate and discourage free-riding.

Policymakers, unfortunately, sometimes fail to see the nuances of these sustainable systems.

Under “tragedy of the commons” assumptions (no communication, self-interested, rational agents, etc.), arrangements like those found in Mongolia and Bali simply can’t exist. As a result, technocrats, looking to promote sustainability and growth. It has often designed policies that backfire because they fail to take into account the complexity of local conditions.

Case in point:

Bali in the 1970s. On advice from the Asian Development Bank, the Indonesian government, in an attempt to boost crop yields, instructed farmers to plant rice as often as they could—disrupting the synchronized cropping schedule. Pest populations exploded as a result, and crop losses were massive. In this example, simplistic and detached development policy had disastrous consequences for the Balinese farmers.

Thus we see a genuine understanding of the commons is imperative for coherent policymaking. Scholars have long shown that Hardin’s “tragedy of the commons” is an inaccurate representation of reality. Policymakers ought to adopt a more realistic view of the commons, and professors should jettison this fallacious model from their Econ 101 courses. A failure to do this and embrace the real world would, indeed, be the real tragedy.

Written by Jimmy Chin
Jimmy is an undergraduate studying economics and Asian studies at UNC-Chapel Hill. He hopes to continue his studies in graduate school and has interests in economic development, political economy, and China. Other sources of enjoyment for him include reading philosophy, writing, and hiking.

Economics: An Illustrated Timeline

Do you keep getting confused about the different schools of thought in economics? Do you always forget what Walras was about, and when Marx was around?

This timeline has your back. It provides an overview of historic events, schools of thought, and the people involved.

About the author: Heske van Doornen holds an MSc in Economic Theory and Policy from the Levy Economics Institute and a BA in Economics from Bard College.

Sources: The Economics Book, Economie!, www.preceden.com, www.econlib.org, www.whistlinginthewind.org, www.hetwebsite.net

Hidden in Plain Sight: Illicit Financial Flows

The importance of Illicit Financial Flows (IFFs) in the context of economic development has slowly come to grasp people’s attention. The World Bank defines IFFs as “money illegally earned, transferred, or used that crosses borders.” Since 2006, the Global Financial Integrity (GFI), a Washington, DC-based think tank, has done extensive research on IFFs. Their studies emphasize that the developing world lost $7.8 trillion in IFFs between 2004-2013—whereby $1.1 trillion was lost in 2013 alone. Studies have shown there is a strong correlation between IFFs and higher levels of poverty and economic inequality. The United Nations just passed its first resolution on combatting IFFs, as it is pertinent to achieving the Sustainable Development Goals. This article explores further how IFFs occur, their role in keeping economies from developing—especially in the African continent, and some suggestions to tackle them.

Illicit financial flows are often mistaken as capital flight. This assumption is false because capital flight could be entirely licit. We can group the IFFs in three categories: commercial activities, which account for 65% of IFFs; criminal activities, estimated to be about 30%; and corruption, amounting to around 5%. Trade mis-invoicing is the most common way illicit funds leave developing nations, averaging 83.4%. Trade mis-invoicing means moving money illicitly across borders by misreporting the value of a commercial transaction on an invoice that is submitted to customs. It is carried out by under-invoicing exports and over-invoicing imports. Under-invoicing the value of exports means writing the price of a good as being less than the price actually paid, in order to show reduced profits and then pay less in taxes. Once the good is exported, it will be sold at full price and the excess money will be put in an offshore account. Over-invoicing the value of imports is when the price of a good is listed as being higher than the seller actually intends to charge the client. The excess money is deposited in the importer’s offshore bank account. There is the misconception that IFFs are largely due to corruption when in fact they account only for 5%, as mentioned above. With invoice manipulation of prices, there is no need for bribing anymore.

Another scheme used in IFFs is misreporting the quality or quantity of the traded products and services. According to a report by the United Nations Economic Commission for Africa and the African Union Commission, in 2012, Mozambican records showed a total export of 260,385 cubic meters of timber, while Chinese records alone show an import of 450,000 cubic meters of the same timber from Mozambique. Other strategies consist of creating fictitious transactions (which consists of making payments on goods or services that never materialize), transfer mispricing (which involves the manipulation of prices), and profit shifting (which is popular among corporations looking for favorable tax rates).

 

Role of IFFs in Keeping Economies from Developing

Illicit Financial Flows act as a barrier to economies from developing and achieving the UN Sustainable Development Goals. Illicit financial outflows—facilitated by secrecy in the global financial system—are bleeding developing countries dry. UNCTAD emphasizes that developing countries will need $2.5 trillion every year until 2030 to achieve their goals on health, nutrition, education and the rest. But pledged capital inflows are only around $1.2 trillion. Preventing or even reducing IFFs can fill this funding gap. Seven out of the past 10 years, IFFs were greater than Official Development Assistance (ODA) and Foreign Direct Investment (FDI) given to poor nations.

The IMF estimates that developing nations lose $200 billion from tax revenues per year due to IFFs, while OECD countries lose $500 billion. Specifically, the United States (US) loses $100 billion annually. Tackling IFFs is in the interest of the US. Even though both developed and developing countries are victims of IFFs, developing countries suffer greater losses.

When it comes to most significant volume of IFFs, Asia is leading by 38.8% of the developing world over the ten years of this study. However, when IFFs are scaled as a percentage of gross domestic product (GDP), Sub-Saharan Africa tops the list averaging 6.1% of the region’s GDP.

At the Seventh Joint  Annual Meetings of the ECA Conference of African Ministers of Finance, Planning and  Economic  Development  and  African  Union  Conference  of  Ministers of  Economy  and  Finance  in  March  2014  in  Abuja,  Nigeria, a Ministerial Statement was issued, which states that:

“Africa loses $50 billion a year in illicit financial flows. These flows relate principally to commercial transactions, tax evasion, criminal activities (money laundering, and drug, arms and human trafficking), bribery, corruption and abuse of office. Countries that are rich in natural resources and countries with inadequate or non-existent institutional architecture are the most at risk of falling victim to illicit financial flows. These illicit flows have a negative impact on Africa’s development efforts: the most serious consequences are the loss of investment capital and revenue that could have been used to finance development programmes, the undermining of State institutions and a weakening of the rule of law.”

Former South African president Thabo Mbeki stated at a High-Level Panel on IFFs “Africa is a net creditor to the rest of the world.” The amount of IFFs out of Africa were between $854 billion and $1.8 trillion over the period 1970-2008, according to estimates by GFI. There is a campaign to end IFFs, “Stop the Bleeding”, led by Trust Africa Foundation. Mr. Mbeki stressed that Africa can no longer afford to have its resources depleted through IFFs. On the other hand, illicit financial transfers by African elites paint a different picture. It shows that African elites lack confidence in their own economies. Because they have the privilege to go abroad for education and healthcare, they are less likely to invest in their own countries.

Curbing IFFs

When searching the literature on IFFs, the focus seems to be on developing nations, which are the source. However, there is little focus on the destination countries like Switzerland, Ireland, United Kingdom, etc. A paper by GFI titled “The Absorption of Illicit Financial Flows from Developing Countries: 2000-2006”, discusses that there are two types of destinations for money leaving the developing world. These are offshore financial centers and non-offshore developed country banks. The greatest challenge is getting the money back from the destination countries.

The OECD and the Stolen Asset Recovery Initiative (StAR) surveyed frozen assets held by OECD countries and how much of them were returned to the countries of origin . Between 2010 and June 2012, $1.4 billion of corruption-related assets were frozen and only $147 million was returned.

During the Arab Spring, banks and governments froze billions of dollars held by previous leaders along with their associates from Tunisia, Egypt, and Libya. However, following the Arab Spring, only few assets have been returned and the process of recovering stolen assets is very cumbersome. In order to recover stolen assets, there needs to be solid enough proof that these assets were in fact gained through corruption to begin with.

Illicit financial flows is an issue that plagues the developing world. Nations are denied tax revenues that could be geared towards providing necessities, employment, and economic growth. Nations should hold their financial institutions accountable if they participate in tax evasion activities. There is a need for the creation of financial supervision agencies focused on IFFs. Another suggestion would be the development of a global trade-pricing database so that customs officials are not tricked by false prices. Lastly, the Bank of International Settlement should publish data on international banking assets by country of origin and country of destination in order to better comprehend where IFFs are headed.

Written by Mariamawit F. Tadesse

Germany Does Have Unfair Trade Advantages

In one of Donald Trump’s rants, he claimed the reason why there are so many German cars in the U.S. is that their automakers do not behave fairly. The German economy’s prompt response was that “the U.S. just needs to build better cars.” However, this time, probably without even realizing it, Donald Trump was on to something – Germany’s currency setup does give it unfair trade advantages.

While China is commonly accused of currency manipulation to provide cheap exports, the IMF has recently decided the renminbi (RMB) is no longer undervalued and added it in its reserve currency basket, along with other major currencies. However, an IMF analysis of Germany’s currency found “an undervaluation of 5-15 percent” for the Euro in the case of Germany. Thus for Germany, the Euro has a significantly lower value than a solely German currency would have.

Since the Euro was introduced, Germany has become an export powerhouse. This is not because after 2000 the quality of German goods has improved, but rather because as a member of the Eurozone, Germany had the opportunity to boost its exports with policies that allowed it to maintain an undervalued currency.

Germany and France are the largest Eurozone economies. Prior to joining the Eurozone, both countries had modest trade surpluses.

In the above figure we can see how following the implementation of the Euro, the trade balances of Germany and France completely diverged. The French moved to having a persistent trade deficit (importing more than they export), while Germany’s surplus exploded (exporting much more than they import). After a brief decline in the surplus in the immediate aftermath of the crisis, it is now again on the rise.

In the early 2000s Germany undertook several national policies to artificially hold wages down. These measures were seen as a success for Germany globally. By being part of the Eurozone and holding down wages, the Germans could export at extremely competitive prices globally. Had they not been part of the Eurozone, their currency would have appreciated, and they would not have the same advantages.

In the aftermath of the European debt crisis, Germany took a tough stance on struggling debtor countries. Under German leadership, the European Commission imposed draconic austerity measures on countries such as Greece to punish them for spending irresponsibly. Spearheaded by Germany, The EU (along with the IMF) offered a bailout to Greece so that it could pay the German and French banks it owed money to.

This bailout came with strict conditions for the Greek government that was forced to impose harsh austerity. The promise was that if the government cut its spending, the increased market confidence would help the economy recover. As a member of the Eurozone, Greece had very limited monetary policy tools it could use. Currency devaluation was no longer an option, the country was stuck with a currency that was too strong for its economy.

Meanwhile Germany prospered and enjoyed the perks of an undervalued currency. Being able to supply German goods at relatively low prices, Germany’s exports flourished. At the same time, Greeks, and other countries at the periphery of the union, were only left with the choice to face a strong internal devaluation, which meant letting unemployment explode and wages collapse until they become attractive destinations for investment.

Germany consistently broke the rules of the currency area, without ever being punished. When it first broke the deficit limits agreed upon by Eurozone members in 2003, the European Commission turned a blind eye. Germany is often considered to have set an example for other EU nations by practicing sound finance, and having a growing, healthy economy.

Greece, on the other hand is blamed for spending too much on social services, and many of its problems are blamed on being a welfare state. When you compare the actual numbers, however, Greece’s average social spending is much less than that of Germany. Between 1998 and 2005, Greece spent an average of 19 percent of GDP, while Germany spent as much as 26 percent.

To address these vast differences in the trade patterns of the EU nations, the European Commission introduced the so-called “six-pack” in 2011. These regulations introduced procedures to address “Macroeconomic Imbalances.” However, as found in the Commission’s country report “Germany has made limited progress in addressing the 2014 country-specific recommendations.”

Germany’s trade competitiveness comes at the price of making other members of the Eurozone less competitive. This is something that Germany needs to be aware of when responding to the problems other economies are facing. Currently Germany is demanding punishments for countries whose have few policy tools available to stimulate growth as Eurozone members.

However, Germany should keep in mind that the Euro is preventing the currency adjustments that would take away its trade competitiveness. Without a struggling EU periphery, there wouldn’t be a flourishing Germany.

Ending the Econocracy: The Need for Pluralism in Economics

To understand why economics students around the globe are calling for Rethinking Economics, the book The Econocracy is a thoughtful and accessible place to start. An econocracy, as defined by authors Joe Earle, Cahal Moran, and Zach Ward-Perkins is “a society in which political goals are defined in terms of their effect on the economy, which is believed to be a distinct system with its own logic that requires experts to manage it.” Their work carefully explains why our current system is an econocracy and discusses possible ways to change that. Based on my own experiences so far, I can’t help but agree with them. 

The Econocracy argues that the current definition of economics is limited to a narrow, neoclassical viewpoint. Institutions of higher education have accepted and helped reinforce this tendency, at the expense of the discipline. The neoclassical approach to economics requires an understanding of complex mathematical models, which leaves many citizens feeling unable to engage with it at all. However, they should not be intimidated by those who do possess the necessary quantitative skills. While today’s economic experts hold prestigious positions, their understanding of math is often greater than their understanding of the economy. As the 2008 recession demonstrated, the majority of current experts didn’t get things right. This shows “the perils of leaving economics to the experts.”

The authors’ critique of economics curricula at colleges and universities necessarily extends to a critique of the higher learning system where these curricula are taught. Interestingly enough, they argue neoclassical arguments have helped shape this system to become what it is today. “Human capital” theory has its roots in neoclassical utility maximization. One of the first exercises in standard econometrics classes is to calculate the “returns to education,” which shows that incomes are higher for those who have completed college degrees.

These type of theories are problematic because they frame education as a “financial investment” which encourages students to give “the minimum effort and engagement necessary to get a satisfactory grade.” Such a mentality “undermines many of the core principles of a liberal education.” The authors look through history at the UK’s higher education system, and show how rising tuition costs financed by personal loans also has its roots in neoclassical thinking. This type of change is symbolic of the econocracy’s influence throughout all spheres of civil life.

While studying at UC Berkeley and Bard College, I met many students who thought and acted this way. As long as you put in a minimal effort, there was little chance of failing or being expelled. Second and third chances were given out often. Teachers did not give a lot of room to think critically about what you were learning, and worksheets and one-size-fits-all curricula were the norm. Nearly every class I had was in a lecture/tutorial format, and nowhere was the socratic method used for teaching. Still, there were some great professors and fellow students who shined the light in the right direction for me. I finished school feeling like I missed out on something, but I’m glad I have my entire life to continue learning.

The Econocracy does more than offer a critique—it also puts forth a new direction, albeit one that might be tough to achieve. For the authors, reform should start with the education system. They pose it’s necessary to shift away from “a passive student body—whose only input into their education is a tick-box feedback form—to an “active student co-production of education.” Debate and dialogue should be encouraged.

 A shift needs to happen within economics curricula too. The authors recommend economics departments teach with a pluralist approach, which would place post-Keynesian, classical, Marxist, feminist, Austrian, historical, ecological, and other perspectives front and center next to neoclassical economics. This way, students would be able to see neoclassical views as one of many ways to look at things. They would recognize that scholars have debated alternative points of view for decades, often on the fringes of the institutions they call home.

As Joan Robinson quipped in Marx, Marshall and Keynes: “The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.” It doesn’t have to be this way. The Econocracy offers a different vision for economics. One where it is not only for the experts but for everyone.  They want to “democratise economics because [they] believe at its core economics should be a public discussion about how to organise society.” That’s something we should all get behind.

At The Minskys, we too hope to help advance a jargon free view of the economy that everyone feels empowered to engage with. Economics can’t just be left to the experts, because “the economy” affects us all.

Be sure to grab your own copy of The Econocracy, read it, and comment down below with your thoughts.

A Green Job Program Will Help Workers, the Economy, and the Planet

There’s been much talk about Trump’s plan for jobs and infrastructure that entails over one trillion dollars in new spending (without tax increases) and promises to employ thousands of American workers. Because it looks like this would require significant deficit spending,  it has drawn stiff criticism: even Trump’s the own conservative supporters have expressed concern.

Among advocates of Keynesian spending and Modern Money Theory (MMT), however, some precautionary excitement can be observed. Their perspective is different because they are unafraid of a government deficit, and in favor of direct job creation. They understand that deficit-spending is not inherently bad, and that the US government will never have to default on its debt. When the economy is not at full employment, increasing the deficit would actually be helpful, not harmful.

A fiscal stimulus aimed at reducing unemployment is timely and necessary. Despite the confidence expressed by the Fed about the latest employment numbers, the situation for those who are jobless is not looking good. One of the reasons for the latest rate hike by the Fed was their positive outlook on unemployment numbers. Chairman Yellen has gone as far as saying that (at 4.6% unemployment rate) we are close to full employment and fiscal stimulus is not necessary to reach that goal.

However, the low official joblessness rate hides the fact that an increasing number of Americans have left the labor force altogether; for example there are currently over 5 million Americans who are not in the labor force but have reported that they want a job. This is where a Job Guarantee program could come in handy. In short, the government would act as an Employer of Last Resort, effectively guaranteeing a job to all of those willing and able to work.

And if Trump uses the deficit-spending towards jobs in infrastructure, it might result in something that resembles the job guarantee policy that America needs**. I argue, however, that the financial feasibility should not be the only criterium for a successful implementation of the job-guarantee. It also has to be sustainable. If we’re going to be at full employment, we have to do it in a way the planet can handle.

The current structure of the economy relies too heavily on fossil fuels, wasteful production methods and non-renewable resources. Unless we change this, sustaining full-employment would result in increasing production, consumption, and waste. My favorite Keynes’ quote is that “In the long run we are all dead.” If we’re talking about a long run of increasing pollution,  he will surely be right. As we know, too much of a good thing can be a bad thing. This applies to jobs too. Unless they are green jobs, too many jobs will be bring us environmental destruction.

The issue of the environmental sustainability of a Job Guarantee program has been on my mind since I first heard of the proposal. Mathew Forstater’s Green Jobs proposal was inspirational to my work. In my Master’s thesis, I tweak its existing framework to target environmentally sustainable outcomes. I find that we can transform the Job Guarantee program to ensure its sustainability without increasing its cost. Here’s how:

I set up the program in a way that promotes social enterprise and community development, following the work of Pavlina Tcherneva et al. With the help of social entrepreneurs, NGOs, and Nonprofit Organizations, local communities should decide what projects will be undertaken. For example, communities along the Hudson river could support a program where workers dealt with invasive species such as the zebra mussel and water chestnut. Other localities could handle neighborhood farming, recycling centers, flood containment structures, bike paths, etc.. It’s been found that if the community is involved in determining what projects are taken on, participation levels are higher.

A more detailed account of my proposal and calculations is available upon request, but this is the gist of it: I used an Input-Output model to establish what would be the cost of employing the official U-3 unemployed population into “green” Job Guarantee jobs. That framework accounts for indirect job creation related to the proposal, but not induced employment. What I find is that the US government can, under conservative assumptions, employ all of those who are officially unemployed for around 1.1% of GDP while paying them a $15hr wage. That is about 17% of the annual military budget. The Green Job Guarantee program is projected to cost just under 200 Billion dollars per year in order to ensure employment for 7.8 million people.

As the world economy quickly transitions into a more sustainable state, a shift in the productive structure will occur, rendering some current occupations useless. Workers who are employed in areas like fossil fuel energy generation (the fabled coal workers of the American Midwest for example) will be left without a job and unlikely to find a new one right away. There is no way to predict how quickly this transition will occur: it could be a gradual–albeit fast–process if led by government initiative, a slower and insufficient movement if guided by profit motives, or even a sudden transition caused by widespread popular response to natural disasters.

Given current trends it is safe to assume that the transition to a renewable energy generation and a sustainable economy will occur before the fossil reserves are depleted. Just as the stone age ended before we ran out of stone, the “oil-age” will end before we run out of oil. As such, fossil fuel workers (and those who depend on their consumption) are at risk of losing their jobs in the near future. A Job Guarantee program would allow those workers to not only find employment readily, but also to acquire the on-the-job skills that will allow them an easier transition into the Green economy.

So as we continue to criticize and investigate the means of job-creation proposed by the President-Elect, let’s look beyond the government deficit, and consider the planet, too. Whether you’re afraid of government debt or not, you should be concerned with the destruction of the earth. If we are going to have a public program that aims a generating new jobs and bringing people back into the workforce, then that program should be a Job Guarantee. But, if we’re going to guarantee jobs, the will have to be green. And we have all the tools we need to make that happen.
*Interested in some good work on how to build a sustainable economy? Check out the publications from PERI and the Binzagr Institute for Sustainable Prosperity. Interested in a non-profit that is already doing some great things in that area? Visit GreenWave‘s website and get involved!

** I must make clear that, although Trump’s infrastructure plan might very loosely look like a Job Guarantee program because of its intent, it differs significantly from it because of how it will will be implemented. The president elect’s plan is based on private spending and making concessions to big corporations; it is basically a big giveaway to developers and not a program to ensure full-employment and financial stability.