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James K. Galbraith and the End of Normal
The years since the Great Crisis of 2008 have seen slow growth, high unemployment, falling home values, chronic deficits, a deepening disaster in Europe—and a stale argument between two false solutions, “austerity” on one side and “stimulus” on the other.
Both sides and practically all analyses of the crisis so far take for granted that the economic growth from the early 1950s until 2000—interrupted only by the troubled 1970s—represented a normal performance. From this perspective the crisis was an interruption, caused by bad policy or bad people, and full recovery is to be expected if the cause is corrected.
The End of Normal challenges this view. Placing the crisis in perspective, Galbraith argues that the 1970s already ended the age of easy growth. The 1980s and 1990s saw only uneven growth, with rising inequality within and between countries. And the 2000s saw the end even of that—despite frantic efforts to keep growth going with tax cuts, war spending, and financial deregulation. When the crisis finally came, stimulus and automatic stabilization were able to place a floor under economic collapse. But they are not able to bring about a return to high growth and full employment.
Today, four factors impede a return to normal. They are the rising costs of real resources, the now-evident futility of military power, the labor-saving consequences of the digital revolution, and the breakdown of law and ethics in the financial sector. The Great Crisis should be seen as a turning point, a barometer of the rise of unstable economic conditions, which should be regarded as the new normal. Policies and institutions going forward should be designed, above all, modestly, to cope with this fact, maintaining conditions for a good life in difficult times.
A governing myth hides an underlying reality, and any attempt to govern through the myth is bound to be short-lived. So it was with Reagan. But what is the essence of … reality in the American case? If we do not actually live in a world made by Reagan, just as the Soviets did not actually live in a world made by Marx, what is the true nature of our actual existing world?
An evolutionary economist knows where to look for the answer to such a question: at institutions…. The fundamental public institutions of American economic life were those created by public action in an earlier generation — by Franklin D. Roosevelt in the new Deal and World War II, by Lyndon Johnson in the Great Society, and to a degree by Richard Nixon…. These institutions have, to a large extent, survived to the present day.
But if they have survived, obviously they have not survived undamaged.
James K. Galbraith
The son of and direct intellectual heir to John Kenneth Galbraith is James K. Galbraith. The younger Galbraith carried forward his father’s interest in institutional structures, his respect for the work of the New Deal and perhaps most importantly his keen ability to take a direct look at economic events and build an interpretation of the economy quite at odds with the Neoclassical and market fundamentalist orthodoxy, but quite useful in unlocking actual economic events. His book, The Predator State examined how corporate capture of government allowed an exploitation of the institutions of the New Deal for private gain. The legitimate social agenda and public policy objectives of these institutions became distorted to divide profitable from unprofitable. The costly elements were assigned to government and the profitable diverted into private hands.
Galbraith came to Washington in the 1970s as a Congressional staffer and rose to the position of chief of staff to the Joint Economic Committee of the U.S. Congress, a function created by the 1946 Full Employment Act. With the triumph of the Reagan Revolution in the early 1980s and the defeat of the liberal Demand Side agenda, Galbraith moved to the University of Texas, where he has taught for several decades.
Having worked on financial crises from the time of the rescue of New York City in 1975, Galbraith saw the events of 2008 as the biggest threat to the system as a whole since the late 1920s. Galbraith’s analysis of the breakdown of the economy during the Bush presidency was early and accurate. “This is the big one,” he told Bill Moyers. (Galbraith J. K., 2008) But he also saw the great advantage in 2008 over 1929, the fact that the New Deal had happened. The institutions of the New Deal, although they had been badly damaged, were still extant: deposit insurance, Social Security, a government capable of acting as lender of last resort, and with the capacity to borrow and spend as needed to deal with the crisis.
The wherewithal to handle the crisis existed in 2008. Lacking was a government willing to use that capacity. The way was open, with the collapse of the old objectivism of Alan Greenspan, for thinking afresh and ...
how to solve them. Absent was the intellectual integrity to face the facts and deal with them. This failure has perhaps been the greatest for economics as a discipline and for the modern version of representative democracy as a governing regime. Orthodox thinkers clung to policy prescriptions long after the intellectual premises had crumbled under the weight of evidence. They did so either from a lack of imagination, or more likely, for the need to preserve decades of professional capital built on the failed paradigms. The Great Financial Crisis was, according to Galbraith, the breakdown of an entire system — the failure of financial regulation and of supervision of the banking system. It had caused a collapse of trust between banks, who no longer knew whether their counter-parties (their partners in the web of interlocking financial arrangements) were solvent, of trust with customers, who no longer trusted the banking system, and of trust with potential commercial borrowers.
In the midst of the maelstrom Galbraith presciently worried about the periphery of Europe and accurately prescribed the need to move quickly from rescuing the financial sector to rebuilding the real economy. Deficits were sure to rise to another level, he said. They would rise either because nations supported employment by public spending or they would rise because tax revenues would collapse with the collapse in that spending and employment.
Deficits were to be welcomed for filling the gulf created by the financial collapse. Deficits were even a good deal so long as interest rates were low. The move Galbraith contemplated — a quick, clean rescue of the financial sector, then a robust rebuilding of the real economy — did not occur. In the aftermath of the crisis the rescue of the financial sector was enthusiastically executed in the U.S. by the Treasury and the Fed, under both presidents George W. Bush and Barack Obama. The chosen approach was instead a muddy "muddle through" strategy — not restructuring and reform, but bailout and backstopping. Bad practices survived. “Too big to fail” banks became larger. Smaller banks were allowed to fail. Unregulated securities, including private contracts such as credit default swaps, were made good by public interventions.
A financial reform measure, the Dodd–Frank Wall Street Reform and Consumer Protection Act, made changes around the edges, but substantially failed to alter practices in the casino markets or significantly amend incentive structures. Even these modest reforms were eroded in the back offices of regulators after the fact by an army of financial sector lobbyists. A consumer protection office, the Bureau of Consumer Financial Protection, was delayed by unprecedented Congressional maneuvering, again sponsored and abetted by financial sector money.
Meanwhile, the real (non-financial) economy received ill-designed stimulus. Under George W. Bush, the Economic Stimulus Act of 2008 attempted to deal with the recessionary pressures using tax cuts and rebates. A 2009 measure under Barack Obama, the American Recovery and Reinvestment Act (ARRA) was much larger, but its $700 billion was divided roughly in thirds: (1) effective public works programs and supports to states, (2) relatively ineffective middle class tax reductions, and (3) the politically necessary but entirely ineffective tax concessions to businesses. The Bush 2008 measure followed largely on the “timely, targeted and temporary” template advocated by former Clinton aide Lawrence Summers. Summers became Obama’s chief economic adviser in time to form the size and style of the 2009 ARRA.
The New Deal had established unemployment insurance, which was a large part of the effective federal support to the declining economy. But direct government jobs programs and the direct write-down of mortgage debt were examples from the New Deal that were ignored. Massive foreclosures beset the American household sector, but despite early signals by federal authorities that renegotiation of principle would be facilitated (as was the model set in the 1930s by the New Deal’s Home Owners Loan Corporation), the sequence of measures trotted out by the Treasury and supported by the Administration failed to address principle. For both households and the holders of their mortgages, the chosen method was "extend and pretend." Extend terms and pretend the loans were good. The paper solvency of the big banks depended on their ability to carry bad loans on their books at full value. Nor were the homeowners most in need able to take advantage of falling mortgage rates to refinance. As their houses fell in value, loan terms became more strict. Their equity had been wiped out, and equity was required to secure new mortgages. Housing and employment continued in deep recession, even as a nominal recovery occurred.
In his work outlining the capture and exploitation of government institutions by the corporate oligarchy, Galbraith identified a set of motives:
“[The] people who took over the government were not interested in reducing the government and having a small government, the conservative principle. They were interested in using these great institutions for private benefit, to place them in the control of their friends and to put them to the use of their clients. They wanted to privatize Social Security. They created a Medicare drug benefit in such a way as to create the maximum profit for pharmaceutical companies.
“They used trade agreements to extend patent protections for various interests or to promote the expansion of the corporate agriculture's markets in the third world. A whole range of things that were basically political and clientelistic. That's the predator state.”
The governing regime, Galbraith said, had become a “corporate republic,” the purpose of which was to divert wealth from the public to the private sector.
“They … turned over the regulatory apparatus to the regulated industries. They turned over the henhouse to the foxes in every single case. That is the source of the decline in and the abandonment of environmental responsibility, the source of the collapse of consumer protection, and the source of the collapse of the financial system, all trace back to a common root, which is the failure to maintain a public sector that works in the public interest, that provides discipline and standards, a framework within which the private sector can operate and compete. That's been abandoned.”
The aftermath of the Great Financial Crisis was not a return to rational regulation and the enactment of New Deal style support to the real economy. The model of the New Deal would have led to straightforward programs: direct employment projects, mortgage principle renegotiation, clear and simple reregulation and federal support to states and municipalities. Instead, the financial and economic collapse was absorbed by the public sector, with the idea that relieving the financial sector of the weight of its error would allow it to turn to normal credit creation. Support to the banks, it was thought, would be multiplied by its lending. The government money would be amplified by a rejuvenated financial sector.
Bailouts and supply side tax concessions multiplied corporate profits, but did not increase employment. The deficits which followed from absorbing a recession brought on by private market excess were cited as evidence of government profligacy, even as those massive deficits stemmed the freefall and allowed a weak and halting recovery. And amazingly, out of the stagnation arose calls for precisely the deregulation policies that had led to the crisis. Thomas Palley was to call it the “Neoliberal Two-Step,” where conservative, market fundamentalism led to a breakdown that was itself the excuse for more conservative, market fundamentalist policy.
The panic period of the Great Financial Crisis was papered over by the facilities of the Fed, above and beyond the official deficits incurred on budget. The Fed absorbed trillions in mortgage-backed securities and backstopped virtually every private financial market. But when the panic ebbed, so did resolve to stabilize and protect the economy from financial markets. No effective reregulation occurred. Criminal prosecution was literally nonexistent, although criminal behavior was rampant at every level of the housing debt bubble. Fraud at mortgage origination extended to fraud at the level of design and sale of mortgage securities. No doubt the fraud was enabled by a near universal mania to buy and to borrow at any price. The panic of the collapse was muted by massive bailouts to banks and securities holders. Assurances were solemnly given that once the troubled ship was righted, the economy would resume.
Those assurances began to fade as soon as they were offered. They then disappeared from memory, as month after month, year after year, the recovery of the real economy — the object of the largesse to the financial sector — did not occur in any meaningful way. By the end of the decade, speculative finance was back in vogue, commodities and equities markets were floating on Fed-sponsored liquidity, banks were cash rich, their balance sheets were as opaque as ever, and the real economy toiled on under an ever-heavier load of debt. Galbraith turned from hopeful advocacy for the rebuilding of a sound public sector to discouraged defense against a new conservative assault on New Deal institutions, particularly Social Security. There would be no new economy engaged in rebuilding its infrastructure base or advancing to meet the challenges of climate change,
At issue was the size of the federal deficit. Although it is difficult to imagine the American economy yielding any positive news without impetus provided by the massive federal deficit, the conservative view was that the deficits that rose in the wake of the financial collapse actually caused the downturn and threatened the future. The prescription was austerity.
Galbraith assessed the economic contraction and its effect on the federal budget deficit and debt from the Demand Side. The deficit would grow, he said, no matter what policy prescription was followed. If government spent on infra-structure, jobs programs, or transfers to state and local government, the deficit would rise in support of economic stabilization and growth. If government reduced spending, cut services and ignored cash-strapped states, deficits would grow because of declining tax revenues and increased payments for unemployment insurance and other safety net programs. The latter process came with sagging employment and increased fragility.
Galbraith saw it to be the duty of government to step into the gap between the economy’s potential and the declining output of the private sector. Borrowing rates had dropped to historic lows in spite of Fed zero rate policy designed to spur investment. Borrowing and investing were suddenly and dramatically out of favor.
Counter to Galbraith’s perspective was alarm over the trajectory of the public debt fomented from many sides. The proposition that increasing deficits would lead to unsustainable economics was given currency by two prominent economists, Kenneth Rogoff and Carmen Reinhardt in the book This Time is Different. The mocking title of the book and its portrayal of a historic pattern of deficits and decline following financial crises suggested that decline might be avoided if only profligate government reduced its borrowing and deficits did not reach a critical level, identified as 90 percent of GDP.
The Rogoff-Reinhardt analysis seemed to give credibility to budget hawks. Immediate crisis was conflated with long-term budget deterioration. Committees such as the Simpson-Bowles Commission, convened by Obama, and the bi-partisan Congressional Joint Commission on Deficit Reduction raised the volume on long-term budget balancing. Virtually all conversation was heavy on spending reductions and light on revenue enhancement. Galbraith’s proposition that deficits would not be avoided, but could be constructive or not, was drowned out and not engaged.
Subsequently, the Rogoff-Reinhardt analysis was undermined by embarrassing and elementary mistakes in their methodology and in basic calculations.
Galbraith has been heavily interested in the Greek crisis in recent years. He teamed with Stuart Holland and Yanis Varoufakis to create “A Modest Proposal,” a policy recommendation to circumvent the austerity prescription imposed on Greece.
The conservative tide was the mileiu in which James practiced. With the 2008 financial crisis and the ever more apparent valildation of his perspective, James has become one of the leading voices espousing a post-Keynesian view. Teaming with Yanis Varoufakis and Stuart Holland, hehas offered the definitive policy solution to the European Crisis -- "A Modest Proposal." Continuing his father's connections with Greece, James has been advisor to the Greek SYRIZA party and its leader Alex Tsipris.
Now posted at the University of Texas Austin, leading its Inequality Project, James is the foremost expert today on geographical analysis of inequality. He and Steve Keen are bookends of a spectrum of economists and explain what has happene coherently and convincingly. He was recently awarded the 2014 Leontief Prize for Advancing the Frontiers of Economic Thought at Tufts University.
The range of his economics is expressed in recent talks:
"Keynes 'in the 21st Century': Tradition, circumstance, fad and pretense in the wake of the Great Crisis"
- Inequality and the Labor Market
- "Inequality: Should We Care?"
- "A Matter of Standards"
[Adapted from Demand Side Economics, by Alan Harvey, 2012.]