Sunday, October 26, 2008

Review of The Predator State



Here is my review on "The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too" by James K. Galbraith.

What an interesting book. The American Economy was in a much different state when I began reading this book than when I finished it (last night). I think what I learned from this book has helped me think about possible solutions for our economic meltdown.

Here are some points from Galbraith's (yes, Kenneth's son) book. I'll give indication of my opinions on his ideas as well.

I had no idea how long this post was going to be (even though my notes while reading the book were copious.) Maybe I should summarize my summary as well. Here goes:

Galbraith says that liberals who are for the following things should reverse their thinking: balanced budgets, free trade, open markets / monetary policy, tax cuts and the importance of savings.

He attacks each idea with an obvious depth of economic prowess and an even more obvious bias towards big government thinking.

His argument against balanced federal government budgets is perhaps his most compelling. He provides a simple equation that shows that the U.S. federal government (unlike all other countries) is positively incapable of balancing its budget and should not even try. To do so results in pain for consumers and business in the U.S. Galbraith actually won me over on this point. (See below for details.)

Galbraith isn't exactly against free trade itself, but against the unfettered access we seem to have as a goal where environmental and labor regulations aren't part of our agreements. He seems to have a fairly typical liberal view on this point, and I agree as well. He aggressively debunks the notion that the free trade agreements are remotely linked to job loss in the U.S. Instead, he blames deregulation and union-busting for the job losses.

Galbraith deftly points out the failures of the "open market" and, in many ways, foreshadows what happened in the weeks and months after his book was published in August 2008. He was right on almost every account on this point. Just this past week we saw Alan Greenspan admitting to the "flaw" in his own thinking about markets and monetary policy. Galbraith must have had a giggle about that. He points out that the countries where open markets were most vigorously applied were dramatic failures (Argentina, Brazil, Chile). He says that Milton Friedman's motto of "freedom to choose" is actually just "freedom to shop." He shows how the big industrial companies lost their brain trusts in finance and technology to Wall Street and Silicon Valley respectively, and the damage this has caused. He shows how extravagant CEO pay has been a destructive force in the economy. He says that government "planning" is needed because "markets cannot think ahead."

I didn't take many notes about tax cuts. He saw the George W. Bush tax cuts as irresponsible and, in general, the trickle-down economics as a joke. I think most people would agree, including me. On financial inequality in general, he says that we must use government controls to close the gap between the rich and the poor, and if we do so, we will experience a better and better economy. He uses Denmark as an example of high equality and low unemployment.

With the importance of savings, I think Galbraith is of two minds. It seems that he is opposed to supply-side economics, which emphasizes the importance of savings, but he also, later in the book, says that he is in favor of the government having some control or influence over how/when people save money, so I ended up a little confused on this point. I, personally, am a crazy saver and I think Americans need to have more of a saving/investment mindset than we currently do.

When I first picked up this book, I did so because the title and sub-title was threatening and abusive to my own thinking. I had to find out what an accomplished economist knew that I didn't know about my deeply held beliefs about capitalism and economics.

I found out a lot of things. Perhaps only a handful of books I've read in my life have forced a bigger shift in my thinking than this book. I cannot say that I am a far-left liberal like Galbraith himself, even after reading this book. However, I can say that I've shifted left-ward knowing what I know now, and I'm sure my opinions have also been drastically impacted by the lurchings of the American economy this fall of 2008.

With that said, here now are my detailed notes on Galbraith's book.


  • Galbraith says that this book is for the liberal who today says they are for a) balanced budgets, b) free trade, c) open markets and monetary policy, d) tax cuts and e) the importance of savings. (Hey, that's me.)
  • It all started with Ronald Reagan and Paul Volcker.
  • Together, they gave the American economy a type of "shock therapy" when the Fed raised the interest rates extremely high in the early 1980s. They thought that this would encourage savings (supply-side economics) and all the market to work most efficiently. It failed. America fell into a recession immediately and they abandoned the supply-side theory very quickly thereafter.
  • He says that the combination of open, perfectly efficient markets and supply-side economics is incompatible. If we need to encourage savings, the markets must not be perfectly efficient. (This seems very academic to me, kind of objecting to it based on purely theoretical terms. The question for me is if they work together in reality or not).
  • He says there are no economic conservative academics left, and certainly none in the Bush administration.
  • One of the problems is that the only people who benefit from encouragement to save are the very rich. Tools for encouraging savings are things like IRAs and 401(k)'s. (I don't really see how these things only benefit the super rich.)
  • A good point that he brings up is that the countries who followed the Washington Consensus, like Argentina, Chile and some African countries, failed economically, while the countries who followed other paths, like China, did much better.
  • As a result, no countries trust the International Monetary Fund (IMF) to work with them anymore.
  • Liberals need to create their post-Reagan economic policy (this is so true. In fact, it needs to be neither socialistic nor Reaganistic, but something really different.)
  • Hurricane Katrina was to conservative government what Chernobyl was to communism
  • Milton Freidman's "freedom to choose" is nothing more than just "freedom to shop"
  • What is a free market anyway? It is a negation. "Not" government.
  • The only beneficiaries of a free market are the largest corporations (as a former small business owner, I can say this is very true).
  • To the free market proponent, there is simply something offensive about the redistribution of wealth from a moral point of view, since it robs a person of property to which the market has assigned a natural claim.
  • Supply-side causes companies to move capital out of their retaining earnings and into executive salaries. As a result, society gets mansions and yachts instead of factories and office buildings.
  • Galbraith actually advocates wage and price controls. (Yecch.)
  • He says that "deficit spending works." (More on this later. It isn't as ridiculous as it sounds.)
  • Macroeconomic principle --- A country's internal deficit - public deficit plus private deficit - equals its international deficit. (This was a big realization for me.)
  • Very interesting how, in the 1990s, consumer and business deficit (credit cards, loans, mortgages) drove economic growth even as the federal government cut their deficit to zero.
  • The surplus of the late 1990s did what government surpluses always do: a government running a surplus necessarily subtracts in taxes from private spending more than it injects in payments to private incomes. This forced the private economy to finance the expansion with a buildup of debt. (My comments: 1) This makes sense except, b) why doesn't he mention the cost of maintaining a debt (public or private), c) why does he advocate consistently using deficits, never surpluses, and therefore going into a neverending abyss of red ink for the U.S.?)
  • The budget deficit no longer depends on the federal budget policy decisions, but rather on international trade and the financial position of the private sector. So long as American foreign trade remains in a permanent state of deficit (an overall trade deficit with all countries), which the U.S. has to do, actually, so long as a growing and unstable world economy requires U.S. dollar reserves, then the federal budget deficit is basically permanent!! (This is huge. We have to run a federal budget deficit otherwise we force consumers and businesses to run up their debt. The non-U.S. countries use U.S. dollars as their reserves, and those dollars have to come from somewhere - that's us.)
  • Eventually, we may change the global financial system to alleviate this. This would be a very dangerous change, however, because the reason everyone uses the U.S. dollar for its reserves is because everyone else is using the U.S. dollar as their reserves.
  • (This is my own thought.) It is possible to look at George W. Bush's presidency as a resounding success. Remember when he claimed he would be the first CEO President? Well, if you look at what corporations do, they try to get value from a market in whatever way possible, and give value back to their shareholders. If you look at Bush's campaign as the corporation, as America as the marketplace, and at his contributors as the shareholders, he did everything he should have. He took money from the market (America) into his corporation (his campaign) and gave it to the shareholders (his contributors in energy, pharmaceuticals, insurance industries, etc.).
  • Back to Galbraith's ideas, NAFTA did nothing as far as job loss or gain. It simply made permanent the maquiladora system in place since 1965.
  • China's success has to do with their lack of mature capital markets. When a Chinese company does not turn a profit, their management is not automatically fired. (I don't get this. I guess he is saying that managers aren't worried about the super-short term like here in the U.S., but to me you would want some type of accountability and not just losses year after year, which is what he's implying.)
  • Labor markets do affect people's paychecks, but income inequity is only partly due to differences in pay. Other factors, such as capital gains, interest, dividends and proprietor's income have a large effect as well. So it is somewhat incorrect to say that the market forces of the labor market are solely the cause of income inequity. And further, to say that we will cause massive disruption in the labor market if we institute minimum wage increases or wage controls doesn't make sense. (It is a good point when he says that differences in pay are just part of the picture. But I do think that raising the minimum wage causes disruption, the question is just whether we are willing to live with the disruption.)
  • When California and New Jersey increased their minimum wages, unemployment dropped. (Yeah, okay, but what about other states?) The U.S. tends to have increasing pay inequality during bad times and decreasing pay inequality during good times. (That's an interesting statistic if true.) And, of course, unemployment rises during bad times and drops during good times.
  • In Denmark, there is high equality and low unemployment. (And what are their productivity numbers??)
  • Inequality means a few "good" jobs and a lot of "bad" jobs by definition. So a lot of people queue up for the good jobs, causing inefficiency, unemployment and market disruption.
  • It seems like Galbraith is against people donating to their alma maters and using it as a tax deduction. (I really don't get this.)
  • He sees universities most important contribution as a way to keep young people busy and diverted while they are at their least employable. (What???) Keeping young people occupied and away from the streets is more important than the skills they gain while in class. (What???) Schools provide a similar function in society to prisons and the military, all three of which keep our young people from causing disruption. (I guess I can see a glimmer of logic here, but I do think that universities - the good ones anyway - provide skills that help us when we go into the workforce, as well as business connections and social skills on top of the technical skills we may learn. This point is a bit crazy, I think, or maybe just overstated for effect.)
  • He says that when you add up the heavily government-influenced sectors of the economy - military, schools, universities, social security, healthcare (Medicare, Medicaid), and housing (HUD I guess?) - it makes up more than half the economy. And it has been a stabilizing force which has kept us from falling into another Great Depression. (I am willing to acknowledge this point, although he is very loose in defining what is "government-influenced. But I will agree that the private sector is not as large and as independent of government-influence as we might think it is.)
  • It was not our social institutions that had been damaged during the Republican presidencies in the 1980s and 2000s. It is the corporation that has been decimated (This is super interesting. Read on...)
  • The best financial people used to work inside the large corporations (Ford, GE, Sears, AT&T, etc.). But in the 1980s, 90s, and 00s, they all left the large companies and went to work for Wall Street. (Interesting point - I had never considered this.)
  • The best technical people used to work inside the large corporations. But they, too, left to join Silicon Valley startups like Microsoft, Cisco and now, of course, Google. (I would also say consulting companies too, because it is often noticeable that consulting staff seem to be more technically advanced than the staff of the client companies they serve. Maybe that's just my bias as a consultant!)
  • As a result of losing all this talent, the big corporations switched from being producers to consumers of financial knowledge and technical knowledge. They had to acquire the expertise of how to run their business financially from Wall Street and consulting firms, and they had to rely on technology solutions from custom software and packaged software from outside entities like Microsoft or IBM. (So they've had their heart and lungs removed and are on a kind of life support to these outside service providers.)
  • The big industrial companies have to rely heavily on Wall Street for their finances and therefore Wall Street is able to dictate how a corporation should perform without ANY ACTUAL UNDERSTANDING of how the corporation works. This causes the "short termism" we can all see in the stock market that is killing the long-term viability of all public companies.
  • The crooked goings-on at Enron, Tyco and WorldCom were not only not understood by Wall Street firms, but actually encouraged. The dual inability of Wall Street to understand the various industries (energy trading, telecom, etc.) and their singular focus on "the numbers helped to destroy these firms. (Remember that Galbraith is writing all this months before the economic meltdown of late 2008.)
  • CEOs, instead of being specialists in a particular industry, have become specialists in cutting costs and raising stock prices for Wall Street's approval. This new breed of CEOs often not have the slightest clue to the long-term implications of their decisions. And the capital markets, not understanding business needs for investment, do things like overinvestment in fiber optics installations by sixty-fold that happened in the late 1990s.
  • Galbraith explains the sub-prime mortgage crisis (this had already begun in early 2008 when he was still writing this book). Interest rates were set extremely low, which made T-bills unattractive. Big investment banks bought packages of home mortgages from traditional mortgage lenders as investments. These mortgages were on ultra-low teaser rates set up during the low interest period after 9/11. Once these teaser rates expired, homeowners could not pay the adjusted mortgage payments, as they had often been poorly qualified by the mortgage lenders, and the investment banks (Bear Stearns, Lehman Brothers, etc.) were left holding the bag.
  • The Reagan, Bush I and Bush II administrations have not actually destroyed the public institutions of social security, Medicare, etc. What they have destroyed is the modern corporation. By pulling back on all types of regulation, they have encouraged the Enrons, WorldComs, Tycos, Bear Stearns and Lehman Brothers of the world. They've allowed transient, unaccountable CEOs to deplete the corporate coffers for their own personal gain. And by giving control of government to a subset of industry - the worst polluters, the flagrant monopolists, the technological footdraggers - they've made life worse for the businesses that have played by the rules. (I have to agree.)
  • Galbraith says that job training doesn't help! (He doesn't mention how many firms are searching for qualified people during times of high unemployment, but my own experience is that this is constantly happening. Employers cannot find the qualified people they need and simultaneously we have millions of unqualified or wrongly qualified people out of work.)
  • Galbraith quotes Keynes as saying "A supply curve for labor doesn't exist." (I don't understand this. All my experience says that there is definitely a supply-and-demand relationship with labor like anything else. Galbraith does a very poor job of explaining this point.)
  • He states that preschool isn't a help to anyone. (Really?)
  • He says, overall, he isn't advocating "abandoning the free market." He is really saying that "government planning" shouldn't be considered an evil thing and some relic of communism, but instead should be combined with the free market and used as a counterbalance to the problems of the free market.
  • He advocates planning a number of things: a) how much to save/invest, b) directions for new technology, c) how to deal with environmental issues, d) scientific knowledge, e) and culture.
  • Government planning is needed because markets cannot think ahead. (I have to agree here.)
  • Markets have two big flaws. Markets convey their signals only in proportion to the purchasing power of the individual, so the rich guy gets a thousand times more votes in the marketplace than the middle class guy. (Yeah, but there are a thousand times more middle class guys though. He doesn't mention this fact.)
  • The second flaw is that markets don't have a way to represent the next generation, the not-yet-born. (Very true.)
  • Galbraith argues in favor of certain wage regulations. In Norway, you are free to import, export and outsource as you like. But you are not free to cut your employees' wages. You can't go after cut-rate workers, whether native or immigrant. You cannot undercut the union rate. The effect of this on business discipline is quite wonderful. Businesses must find ways to compete that do not involve running down the wage standards of their workforces.
  • The middle class in America was built by unions, regulations and wage standards and it will be rebuilt the same way. (You know, this is kind of a good argument.)
  • Galbraith actually aggressively debunks the notion that free trade (NAFTA, CAFTA, etc.) has caused a loss of jobs. Instead, he blames deregulation for those issues in America.



3 comments:

Zack said...

Interesting review. Since I haven't read the book, I can't say too much.

Based on your summary, I have great concern that the liberal economic philosophy is gaining a lot of intellectual traction and the it is fundamentally flawed. I suppose I like to think of myself as a principled conservative.

My biggest concern with the liberal rejection of free markets is the lack of any critical analysis of the alternatives. The notion that businesses care only about profit, but government genuinely cares about the future of the country is absurd. Political incentives are every bit as strong in determining how government will behave as profit incentives are for business.

So do political motivations cause better decisions to be made than profit motivations? I think the answer is a resounding "sometimes maybe". Unfortunately it seems like 90% of the people seem to think that government would make really great decisions if only "my guy" were elected. That guy from the other party is obviously stupid, evil, and corrupt.

My only first hand dealings with politicians has left me with a sense that reality is actually much worse than perception. They seem to spend most of their day trading favors for money, and are surprisingly open about it. Small amounts of money are given as campaign contributions. For larger amounts, the favor seeker is referred to a lobyist who takes the money and gets the favor done. I don't know where the money given to lobyists goes, but I know the favors do get done, or else multiple billions would not have been payed.

> Government planning is
> needed because markets
> cannot think ahead.

Politicians get relected or voted out of office based on how well the economy does the year before the election. The correlation is disturbingly high.

Businesses have usually far more freedom to do long term planning. Speculative markets are a mechanism by which future supply and demand projections affect current price levels. They are hardly perfect, but have a much better record than government planning efforts.

Daryl Kulak said...

Thanks for the insightful comments Zack. I need to think more about what you've said and come back with my response in a few days.

I appreciate what you've said very much.

Anna said...

It would be interesting to hear your opinion now in 2010. Clenbuterol