The Future of the Economy

The untold story of the financial crisis is the transition from manufacturing to services. This won’t mean the death of the economy – as some skeptics proclaim - and it shouldn’t even come as a surprise.

Historical View

To gain some perspective, the Great Depression had a similar underlying theme as the country transitioned from farming to manufacturing. Agricultural products were considered tangible necessitates; the rugged American farmer was seen as a cornerstone of the economy; and, it was argued, the country’s best interest lay in keeping the farmer alive. Supporting the farmer was considered patriotic – the same sort of pathos which, ironically, we currently see in the manufacturing sector.

The sequence of events was remarkably similar to that of America’s car companies – a former leading industry begins to falter during an economic boom, depression hits, and it suddenly implodes.

Looking back, we can at least feel some comfort that, as useless as our current attempts to bail out the Big 3 have been, they pale in comparison to the damage caused by trying to salvage the farming industry. Leading the way was the Federal Farm Board (FFB), which was setup before the crash.

The FFB began with $500 million dollars dedicated for loans to farmers. After the Great Crash, prices for agricultural products, like most consumer goods, took a nose-dive. Farmers complained that they couldn’t turn a profit. The FFB was then placed in the awkward position of trying to keep farmers alive while raising the prices of their goods. In order to accomplish the latter, they tried to limit farmers’ output by buying and storing huge quantities of agriculture goods, encouraging farmers not to farm, and going so far as to encourage the destruction of farmland. In 1930 it even tried to raise cotton prices by seizing 1.25 million bales of cotton for 1 year; this had no effect on the price.

Tangibility of Services

I imagine that before the Great Depression, one could make the same argument against the foreseeable manufacturing revolution as one can make today against the upcoming service-based economy: Services are non-essential and an economy cannot be built on such intangibles.

On the contrary, the only tangibles in any economy are supply and demand. This holds regardless of how concrete a given product is.

Part of the confusion has to do with what, exactly, we mean by services. At times its distinction from manufacturing is blurry. People are also quick to point to failing service sectors – advertising can be lucrative, but its success is strongly tied to that of the overall economy; journalism, another quintessentially American industry, has received a heavy blow; and IT support is overly prone to outsourcing.

These smaller service sectors may reveal some clues, but the central veins of a service-based economy – as key today as auto making became after the Great Depression – are healthcare and education. As intangible as services may seem, the modern American cannot live without these 2 services. They are the bread-and-butter of a service economy.

Healthcare & Education

The rising cost of healthcare and education is heavily debated. Regardless of where you side, it can be agreed upon that a large portion of the cost resides in systematic inefficiencies linked to public policy. At the same time, the mere fact that Americans continue to pay such high costs for healthcare and education is testament to their growing importance.

The importance of these services is forgotten when pundits speak only of the rising “costs” of healthcare and education, although it is forgotten for a good reason. In the final quarter of 2007, for instance, Apple reported revenues of $3.4 billion from iPod sales; and yet you wouldn’t say that during those 3 months the iPod cost the nation $3.4 billion. Yet by means of contrast, what remains alarming about healthcare and education is that, however you look at it, we haven't found a way to let them thrive. Some sectors do flourish, but on the whole the industries really do “cost” the economy quite a lot of money.

Our current problem is that we haven’t figured out a way to integrate these areas into the economy. The question is not “how do we minimize the costs health care and education upon the economy?”, it’s “how do we make them a part of the economy?” Lots of government regulation and subsidies, I suspect, aren’t the answer. But either way the debate is too focused on minimizing their negative impact.

The success of the automobile industry hinged on not only better cars, but on cheaper cars as well – this was the famous recipe to Ford’s success, that he was able to tap an economy of scale. In contrast, healthcare and education in the US are, by any measure, diseconomies of scale. And yet as national employment continues to decline - with manufacturing taking the biggest hit - service-based employment is growing substantially, and projections suggest that it will continue to accelerate with healthcare and education leading the way. Looking forward, it’s hard to imagine a successful future economy without these 2 industries on board.

-KJ

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Media (in order of appearance)

Photos: (1)CROP CIRCLE MAKER - Matthew Williams, 06/07/2007, Mark Berry; (2)USA 2005 (October 1st) Nevada, Reno, National Automobile Museum, 02/25/2008, by Paraflyer; (3)The Causes of the Great Depression/FDR Memorial Site, 09/15/2008, Tony the Misfit; (4)2008AUG121654, 08/12/2009, bootload; (5)Gesundheit, 04/01/2009, by Gunnar Ries; (6)iPod Family, 02/09/2007, by CokeeOrg; (7)Class, 12/04/2007, by Nik Lee. Sphere: Related Content

Honing Capitalism - BAC vs. Fed

Political rhetoric has moved beyond socialism vs. capitalism. Instead, it centers on how to best hone capitalism for the common good. This insight comes directly from Barrack Obama’s autobiography. And in that context, it might just be semantics, replacing the term “socialism” with “honing capitalism for the common good”. The main difference, however, is that people will often have a definitive stance on socialism; but no one quite knows how to hone capitalism for the common good. This is why the Bank of America / Federal Bank scandal has emerged as bar none the most fascinating subplot of the financial collapse.

The basics of the scandal have been unfolding for some time: In September, BAC announced plans to acquire Merrill Lynch (ML). As the crisis worsened in the winter, BAC considered backing out based on ML’s projected 4th quarter losses. Paulson (previous US Treasury Secretary) and Bernanke (current Fed Chairman) pressured BAC to go through with the deal, threatening to withhold bailout should the economy worsen. BAC complied completing the deal around New Years. 2 weeks later, ML announced astronomical quarterly losses of about $20 billion. This outraged BAC shareholders who blamed CEO Ken Lewis, and Lewis in turn blamed Paulson and Bernanke. On top of all this, recently uncovered emails from the Fed show that they applied much more pressure to BAC than was previously thought, going so far as to threaten to remove Lewis. In the meanwhile, BAC, unsurprisingly, has received upwards of $50 billion in bailout funds, along with guarantees of twice that should they face future losses.

Bernanke and Pualson justified their actions as necessary to avoid widescale financial collapse. Afterall the failure of The Bank of the United States catalyzed the Great Depression in 1930. And it is thought that in order to avoid another Great Depression, we must prevent such large scale failures.

There is one view of history that says it’s determined by large-scale historical events. If you could’ve prevented the event, this line of thought goes, you’d have prevented its consequences. A more subtle view sees large historical events as the effect, rather than cause, of underlying social movement. Going by the latter, it doesn’t matter which large scale events you might prevent, because the underlying problem stays the same.

The BAC/ML merger didn't benefit the greater good at BAC's expense. In some ways, it has made the whole system worse. Going into the crisis, BAC was not only the healthiest bank in America, it belonged to a rare breed of successful commercial banks doing business with tens of millions of everyday people. Loading it up with ML's debt was the equivalent of further dragging down our banking system's best fruits with its worst apples. (Ironically, in 1933 the Glass Stegal act attempted to hone capitalism by doing the opposite, forcing the separation of commercial and investment banking.)

The underlying story of the financial crisis is that institutions which were too big to fail misread their risks and were too interconnected to each other. Fair enough. But to the degree that separate institutions are indeed separate, forcing BAC to merge with ML is simply perpetuating the original problem (of interrelated systemic risk) albeit to the nth degree. Instead of cutting our losses with ML and maintaining one great bank, we have a formerly great bank forced to remain on life-support from the government.

Public bewilderment towards the financial crisis stems partly from the fact that no one quite knows what to do. It makes one nostalgic for the 1980’s when things were as simple – at least in retrospect - as Reaganism and Thatcherism vs. Socialsim. Current economic debate - in contrast to the public’s partisan divide on Obama approval ratings - has become less polarized and ideological, more ambiguous and murky, and more important all at the same time. As Greenspan – a self-described Republican-libertarian - pointed out, his job was similar to those of communist central planners, only he was controlling a relatively smaller piece of the economy.

It’s a point worth repeating that the current depression is more complex than most of us can wrap our minds around. And it reveals one of democracy’s flaws, which is that running a country requires more detailed knowledge than is commonly held by the public. Our successful economic recovery - similar to the post-WWII recovery following the Great Depression - is likely to leave the public with few lasting insights about the economy or how the world works. It’s in this panicked context that we see such strange behavior as the Fed’s pressure to force the BAC/ML merger – a scandal occurring at the main nerve of the crisis, the lasting effects of which are unlikely to be well known by the public and experts alike.

What makes this scandal unique is that it's not quite a financial one, and it is a political scandal but not in the regular sense. What, in the end, did Paulson and Bernanke have to gain by forcing the merger? It wasn't money, votes, or even popularity. It didn't spark public outrage like the Madoff or AIG bonus scandals. And the perpetrators weren't guided by partisan or ideological grounds as in the case of Acorn's voter fraud. Unlike any of the previous examples, the perpetrators' motives are not immediately obvious; you have to sit back and think about it before understanding why Paulson and Bernanke felt the need pressure BAC into the merger. And you also have to sit back and think about it before understanding why Paulson and Bernanke's actions were wrong.

-KJ

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Media (in order of appearance)

Photo: (1)Obama at the Texas book festival, 10/28/2006, by Mr. Wright; (2)Bank of America Logo, 08/19/2007, by Neubie; (3)fail, 09/29/2008, by rin3y; (4)Joan of Arc, 08/23/2006, by dbking;(5)Aghast, 08/28/2008, by Daveness98. Sphere: Related Content