Ian Bremmer

I den här Charlie Rose intervjun från den 4 maj 2012, utvecklar Ian Bremmer sina tankar. Väl värt att titta på för den som vill förstå varför länder som Kanada och Turkiet och regioner som Sub-Sahara Africa sitter med starka kort i en G-Zero World. Jag tolkar Bremmer så att länder/grupper av länder som är tillräckligt stora för att göra skillnad, som är politiskt självständiga och därmed flexibla, och som har resurser eller produkter som är attraktiva på den globala marknaden, blir vinnarna i denna nya värld.

Titta på intervjun här (27 minuter)

Vad kan vi då se? Ja, för det första att vi efter kriget och ett par decennier framåt, i praktiken 1950- och 1960-talen, hade goda tider. Och så vet vi att det var. Dessa båda decennier kallades i USA för ”the golden years”. Det fanns fog för uttrycket. Det var inte bara företagen som tjänade mycket pengar, och aktieägarna som blev rikare. I det amerikanska samhället fick också medelklassen det mycket bättre, och politiskt var det en progressiv era med bland annat medborgarrättsrörelsen, och allt vad den åstadkom.

För det andra ser vi en femtonårsperiod, grovt sett från mitten av 1960-talet och fram till 1980, med sjunkande kurser. Det vi vet är att det rådde villrådighet vad gäller den ekonomiska politiken under de här åren. Keynesianismen, som hade fungerat så väl under den föregående perioden, blev mer och mer ifrågasatt. Det var under 1970-talet som vi fick stagflation (hög inflation + stagnation samtidigt) som inte stämde alls med Keynes. Samtidigt var det oklart vad som skulle komma istället. Låg tillväxt, hög inflation, lägre vinster, förstelnade marknader, bland annat till följd av mycket regleringar, var kännetecken under dessa två decennier.

För det tredje ser vi att från 1980-talet början fick vi en vändning uppåt. Under två decennier, 1980-talet och 1990-talet, utvecklades de amerikanska S&P 500 företagen mycket  bra. Det är egentligen inte särskilt förvånande att det ser ut som det gör. Inflationen hade kommit under kontroll, tack vare bland annat Paul Volcker’s hårdhänta ingrepp via Federal Reserve. Parallellt slutfördes avregleringarna av de finansiella marknaderna (som hade börjat redan under 1970-talet) och i real sektor privatiserades mer och mer av det som tidigare sköts av politikerna. Sammantaget var det en marknadsorientering av ekonomin över hela linjen, både i finansiell och real sektor. Med Ronald Reagan och Margaret Thatcher som politiska fanbärare hade ett nytt ekonomiskt politiskt paradigm fått fäste, det som jag i annat sammanhang har kallat ”den postmodernistiska klassiska ekonomin” (eftersom paradigmet är en slags utveckling av neo-klassisk ekonomi). Det skapade optimism och tillväxt. Föga förvånande gick vinsterna, och därmed aktiekurserna upp.

Det mest intressanta som diagrammet berättar är kanske ändå att det tycks som om vi återigen – räknat från sekelskiftet – är inne i en period med trendmässigt sjunkande kurser. Och vad mera är, det tycks som om volatiliteten på aktiemarknaden är större än den någonsin tidigare varit sedan andra världskriget. I själva verket har vi under det första decenniet på det nya seklet haft två rejäla djupdykningar i amerikansk ekonomi, dels IT-debaclet 2000-2003, dels subprime-krisen 2008/2009. Min hypotes är att dessa två djupa kriser på kort tid hänger samman med att finanssektorn har kommit att spela en större roll än tidigare. Om vi mäter finanssektorns storlek i hur stor andel av de totala vinsterna som finanssektorn svarar för ser vi att det skett något anmärkningsvärt under de senaste 15-20 åren. Det gäller särskilt efter 1995. Finanssektorns vinster har exploderat, de har lämnat den koppling till BNP som historiskt har funnits, och lever mer och mer sitt eget liv frikopplade från hur vinsterna i real sektor utvecklas.  Idag, 2012, (liksom åren närmast före krisen) svarar finanssektorns vinster för i runda tal en tredjedel av alla amerikanska vinster vilket är långt utöver vad som gällt historiskt. Det är högst sannolikt, i varje fall en rimlig hypotes, att de höga vinsterna har uppstått genom högt risktagande. Eller uttryckt på annat sätt, de stora hacken i S&P 500 indexet under första decenniet av 2000-talet, är ett uttryck för att banker och andra finansinstitut har tagit alltför stora risker, som lett till  bubblor som spruckit

En annan sak man kan misstänka är att precis som under 1970-talet lever vi mitt upp i en villrådighetsperiod vad gäller det ekonomisk-politiska paradigmet. Den postmodernistiska klassiska ekonomin lever idag på övertid, precis som Keynesianismen gjorde under 1970-talet. Just det är emellertid inte en fråga för den här artikeln (men jag har skrivit om det här).

A few weeks ago, on April 1st, my book, Dagbok från USA, came out in Sweden. It will also, around May 15th, be published in English (as an e-book for Kindle and for other readers with the title: “Diary from the United States – Notes on a society in crisis“). As an appetizer for English speaking readers, I will the coming week publish three essays, excerpts from the book (chapter 4). The first essay you can read here, the second here.

This is the third, and last, essay. A political challenge the U.S. shares with all other countries, and it’s unavoidable in all discussions about the future,  is to address climate and environmental threats. It’s just that this particular challenge seems to also become a challenge to the ideologies that govern the Western world, ranging from libertarianism to social democracy. It will no doubt require rethinking in depth of current political ideas and political practice. It’s likely that the libertarians, and they dominate U.S. politics today, will have the biggest step to take if we want to effectively tackle global warming and other environmental threats. If that is true, and I think it’s, it concerns the U.S. fundamentally. I write about it in this essay.

Essay 3: About the need for the United States (and the world at large) to address the environmental threat

The fact that George W. Bush chose not to sign the Kyoto protocol was an important event. It confirmed what many non-American sensed, that the U.S. has decided to go their own way and disconnect itself from multilateral cooperation efforts. The Kyoto Protocol had its shortcomings, no doubt. Nonetheless, the fact that the world’s largest economy and foremost political power decided to stand on the sidelines of a joint effort by many countries to an agreement codifying their willingness to tackle climate change, was a big disappointment for many.

Since the Kyoto Protocol was about global environmental and climate change, it was surprising that the U.S. did not want to join in. It must have been as obvious to the Bush administration as it’s for everyone else that environmental and climate issues need to be resolved jointly by the countries of the world. Yet they chose to accept the political costs of stepping aside. It says something about “American exceptionalism”. It’s worth noting that Condoleezza Rice, according to an article in the New York Times in connection with her recently published memoir, considers the decision to abstain from signing the protocol, as a mistake, “a self-inflicted wound”.

In this essay, I will discuss environmental and climate change as a global political challenge, but do so with special emphasis on what is required of U.S. politicians. My hypothesis is that environmental and climate change is a political challenge of special distinction compared to what we have become accustomed to during the centuries of industrialism. It transcends that. The world will apparently not be able to cope with environmental and climate issues without “big government”, more joint investments, and more political involvement than we have today in the OECD countries, perhaps more than we ever had during the last century. This vision must look provocative to today’s American politicians. It runs counter to individual freedom and libertarianism that holds so much sway in contemporary American politics. Yet climate change is a threat that no responsible politician can ignore.

Let me start with the big picture

One could argue that Western man in modern times, say from the 1600s until the 1900s, on the whole has acted rationally, and has refrained from a too short-sighted behavior. This took place with the support of constitutional liberalism, capitalism and democracy, the three basic elements of Western civilization.

Constitutional liberalism came first in the late 1600s and was in many ways the most crucial element. As citizens, we gradually became free from monarchs and various institutions of unquestioned authority, and we acquired rights to control our lives and property: freedom of speech, freedom of religion, property rights, and so on. From the mid-1700s on, economic liberalism developed. It intellectually killed mercantilism and saw to it that government regulation and intervention in the markets were removed. Other obstacles to an efficient economy, such as guilds, were abolished. Furthermore, we as citizens acquired democratic rights, the right to vote, even if it took a long time as in the case of women’s suffrage. In the mid 1800s we had in the front-line countries, mainly Britain and Germany, an emerging democracy and a dynamic capitalism with large production capacity. But also many abuses and social problems, like child labor and extreme poverty. Those social problems led to political counter-movements, primarily socialism and communism. The Communist Manifesto was published in 1848. Conservatism, which was conceptually developed by Edmund Burke in the late 1700s as a reaction to the French Revolution, was also a kind of counterpoint. As ideologies evolved, we in the Western world achieved slowly but surely, at least in practical politics, a kind of consensus between liberalism and socialism (even though we speak of social democracy, the reformist variant of socialism). One of the reasons was that the economic and political model that has emerged during this process provided people in general with a materially better life, and eventually access to welfare resources such as health care, education, and social security.

So in summary, if we talk about the West’s development during the Industrial Revolution up until today, we have managed to find a workable balance between the short-term and long-term. The success of the Western model of society has in fact been so great that the political scientist and philosopher Francis Fukuyama some twenty years ago wrote the book The End of History. He said that now that the Cold War has ended with the fall of the Berlin Wall and the Soviet Union in shambles, it was time to ask whether constitutional liberalism, combined with democracy and modern capitalism, is the ultimate model of society. Not that it couldn’t be further developed politically and economically, but it would be difficult, Fukuyama said, to find any real alternative to constitutional liberalism, democracy, and capitalism. The question is whether Fukuyama is right. I would say that he is only partly right.

“Land is considered the inexhaustible gift of nature”

It’s thought-provoking that political ideologies, and that goes for everything from libertarianism to socialism, are based on a more or less implicit condition – that there are no limits to the possible and thus no limits to our prosperity. The resources we need to extract from nature are limitless. As it was declared in an old textbook, “Land is considered the original and inexhaustible gift of nature.” Classical economics does not see this as a problem: to the extent that we are using up more of limited resources, the market will ensure that the problem is addressed. Prices will go up, it will be more profitable to open new mines or whatever is required, and build new refining facilities. More goods go on the market, prices fall, and supply and demand eventually balance. But only for a short time. When the next disturbance occurs, the same process repeats itself. And so it continues.

If it’s finite resources we are talking about, such as certain metals or oil, there will sooner or later come a time when it’s economically and physically impossible to increase their extraction. We have probably reached the limit for some resources today. “Peak oil” has already occurred, or is about to occur, according to qualified observers. Besides, it’s far from the most severe part of the problem of limited resources. It’s rather that during the centuries of industrial development we have used nature as a garbage can, as a place where we, without thinking and at virtually no cost, can emit various wastes and substances that we do not need. The air, the land, and the seas have become developed Western society’s dumping ground. We have been doing it for so long and so widely that a majority of the scientific community with expertise in this area today have recognized, most clearly expressed in IPPCs reports, that the planet is getting overburdened, and that there’s an urgent need to address the problem. The global temperature increase is very likely a result of society’s emissions of greenhouse gases. Sea levels will continue to rise as the temperature in the Arctic increases.

At this point I think we no longer have the conventions and institutions and ideologies that are powerful enough to ensure that we humans do not act selfishly. Perhaps the evolutionary biologist Richard Dawkins was right when he concluded that sustainability is not something that humans have, as he puts it, “a natural talent for”. It’s another way of saying that humans are acting shortsightedly when it comes to the planet. To be sure, we are improving. We understand that natural resources are finite and that we must not pollute the environment. Ecological awareness is high, especially in children and young adults. And businesses and politicians make lots of gestures to improve the environment and to avoid additional stresses on nature.

However, it’s done a little with the left hand, gently, with the tacit understanding that Western democracies have historically shown an incredible ability to cope with major challenges, that capitalism is extremely adaptable, and good at developing new, more efficient technology. So probably things will work out in this case, too.

Can we count on what carried us through in the past?

Can our political system take care of the threat to the planet? The policy measures needed to save the planet, defined as the measures proposed by the IPCC, are so extensive that the current political system may not be able to handle them. Let’s look at what is almost certainly required, and let us observe it from an American perspective.

(1) We need to create high awareness among people in general about environmental and climate change. It may seem like a task that is already done in the West, but it’s not. As the reader knows, I spent much of the autumn of 2009 in the United States, just before the climate summit in Copenhagen. In Europe, the Copenhagen meeting was all over the media. In the U.S., you had to search for information about it. Furthermore, any broad environmental debate like the one in Europe did not exist. A year later, in autumn 2010, I was in Australia and New Zealand. Both of these countries, particularly Australia, are doing financially very well on the export of finite natural resources. Australia also burdens nature heavily through emissions. Almost all of Australia’s energy production is based on black and brown coal. All in all, it set the tone of the Australian and New Zealand environmental debates. There are few politicians in these countries who strongly pursue environmental and climate issues, and if there are some (for example, former Australian Prime minister Kevin Rudd who wanted to tax the mining industry), the risk of political backlash for that politician is apparently high.

(2) Economic growth is a must. At least for an economist, it seems self-evident that the market needs to work at full speed, and the economy needs to grow if the ecological challenges are to be dealt with. This is not, for example, self-evident to Tim Jackson, author of the highly praised book, Prosperity without Growth. He calls economists “ecologically illiterate”. They do not understand, he argues, that growth, the constant quest for higher productivity, and creative destruction, is a threat to environmental efforts and something that must be eliminated. For me, this is, to respond in kind, “ecological bullshit”. Tim Jackson, and all others who think that in order to save the planet we must strive for prosperity without growth, is simply wrong. How could we have any chance in the world to meet the planet’s sustainability challenges without having our economic system, the market economy, working at full speed? Economic growth is a must. On this particular point, I have a hard time seeing any Western country being better positioned than the U.S. where politicians are focused on creating the best possible conditions for economic growth.

(3) There must be financial incentives for structural change that enhances the environment and climate. This process is ongoing. The market simply sees to it that the incentives change. People and companies increasingly demand products and services that are good for the environment and ecological balance. From the supply side, it’s scarcity that pushes up prices. The problem is that the market left to itself apparently does not do enough. There’s a need for even stronger incentives for increased economy of energy and finite raw materials, for reducing harmful emissions and other sources of environmental degradation, and for even more rapid structural change in the way we travel, build, warm up and cool down, produce food etc. The problem with the market is that it’s rather myopic. Through the price signal, the market is really good at meeting demands in the short term. But for needs that are farther away than 3-5 years, the market operates poorly, if at all. This is the problem for the issue we are discussing here because the time horizon for the environmental and climate issues is much longer than 3-5 years.

Only through a political process can incentives for long-term behavior be created and implemented. Subsidies to enterprises for sustainable energy, waste management, and technological development are concrete examples. And there could be incentives for households to save energy and otherwise to behave in an environmentally friendly manner: in other words, much of what already exists but on a much larger scale. On this point the challenge for the United States is bigger. By American standards, it means “big government”. To intervene in markets to change the incentives, is as far from today’s dominant economic policy paradigm in the Western world, the post-modern classical economics, as one can imagine, and especially for the American version of the paradigm, the small-government approach, the libertarian policies we’ve had in the U.S. since the 1980s. Moreover, it’s not the only challenge brought on by environmental and climate threats. There is one further point.

(4) Investment’s share of what we produce must increase. This is basically the same as saying that consumption must be reduced. It’s most obvious for those countries that already have high consumption and at the same time have borrowed heavily. The United States is such a country. As we know, over 70% of what’s produced (GDP) in the U.S. goes to private consumption. This is 10-15 percentage points more than what other OECD countries consume and it suggests that the transition for the United States would be more profound. There’s another disturbing factor. Left to itself, the market cannot cope with many of these environmental and climate-related investments. The amounts are too large, the time horizon too long, and the risk too high. These investments can be realized only through political initiatives and public financing. Since the U.S. already has a significant national debt, and everyone agrees that it must be reduced, it follows that these investments cannot be realized without major tax levy – again, an expression of “big government”.

Cutting back on consumption and increasing investment for the purpose of protecting exhaustible natural resources and reducing emissions, and doing it in a relatively short time, perhaps in a few decades, is a huge political challenge for all countries. Politicians will try to protect themselves, perhaps making light of the challenge, and that probably goes for all the big, traditional parties regardless of ideology. The above four-point program goes much further than what Western politicians are used to. Not least, it extends further than what American politicians have been accustomed to.

PS. It may require a fifth point for the politicians to take environmental and climate change seriously enough.

(5) Everyone needs to be shocked. In the summer of 2011, Nobel Laureate Paul Krugman participated in a TV debate on the U.S. economy (Charlie Rose, Bloomberg, June 3, 2011). He argued, as the Keynesian he is, that much more vigorous political actions were needed to revive the U.S. economy and bring down unemployment. And then he added something like: “Think about the idea that we unexpectedly find out that there’s a threat to the planet by an invasion from outer space, of aliens. We would immediately take action with a very ambitious program. One thing we can be sure of, the current unemployment rate of 9% would be gone, at least very much reduced, in no time.”

This is probably correct. There are even real examples, such as what occurred in many Western countries when the Second World War broke out. From that, one can speculate about what the world today would need to “get on its feet”, to seriously address the climate and environmental threat. What would provide a sufficient shock, parallel to the threat of an invasion of aliens or a world war, for the planet’s vulnerability to become clear to everyone? One can only guess. Maybe an event that temporarily made global agricultural yields fall dramatically, and made it clear that the next time would be worse. Or maybe something entirely different.

In any case, politicians all over the world would immediately initiate a wide range of “green” investments and other measures to save the planet. There would be coordinated action across borders, much like what happened when the global financial crisis was at its worst in the fall of 2008. The funding wouldn’t be an issue (or rather, it would be resolved by printing money or via high-growth, or more likely a combination of both). Besides, the market would immediately raise the price of scarce natural resources like food, oil, metals, and forest products, which in turn would have profound structural consequences with less use of these resources in absolute terms as one effect. People would save more and consume less. Presumably, the public interest, and what we collectively produce and consume, would have more space in people’s minds. That has been true historically – when human beings meet a grave threat to society, the collective and communal get more of their attention and thoughtfulness.

Literature:

Fukuyama, F., 1992. The end of history and the last man, Hamish Hamilton, London;

Jackson, T., 2009, Prosperity without growth: economics for a finite planet, Earthscan, London;

A few weeks ago, on April 1st, my book, Dagbok från USA, came out in Sweden. It will also, around May 15th, be published in English (as an e-book for Kindle and for other readers with the title: “Diary from the United States – Notes on a society in crisis“). As an appetizer for English speaking readers, I will the coming week publish three essays, excerpts from the book (chapter 4). The first essay you can read here.

This is the second essay. It concerns the ability to create stability in the economy, stability in income and jobs. In the coming decades, there is hardly a more important responsibility for U.S. politicians (other than possibly national security and defense issues). Stability in income and jobs may be threatened. It appears that the financial sector in the United States, and particularly the TBTF banks, only a few years after the subprime crisis, has again entered a speculative phase. There is a risk that we may have another financial crisis with its epicenter in the U.S.

Essay 2: Is it God-given that the financial sector growth follows GDP?

It’s hard not to think of a bubble when, as in this chart, click for bigger picture  (Source: Jones, 2008), one can see how the U.S. financial sector’s profits in the last decade are completely disconnected from GDP, and from profits in the rest of the economy (“Non-Financial Profits”). The chart was made by Jim Reid, an economist at Deutsche Bank, probably around 2008. What he saw in the graph was an abnormality. It shouldn’t look like this, and he coined the phrase “a trillion dollar mean reversion”. By this he meant that while the financial sector’s profits in the long term reasonably should track GDP growth – sometimes above GDP growth and sometimes below – sooner or later there should be a correction, a return to “normality”. And the correction, as he calculated it, was at the time on the order of a trillion dollar.

A correction did come with the financial crisis of 2008-2009. The financial sector’s profits plummeted, and when they reached their lowest point in the fourth quarter of 2008, the profit curve was below the GDP curve. The correction Jim Reid thought was  inevitable had been achieved – but only for a moment. From the lowest point in late 2008, financial profits began to bounce back. Banks and other financial institutions’ profits again developed after a completely different pattern that didn’t correspond with how the profits in the economy in general developed. It seemed as if the old order with the financial sector in a unique position, the one that applied before the financial crisis, was back. Could it be that the financial sector itself had become a bubble? Could it be that the subprime crisis for a short time led us to believe that the financial sector returned to normal in the sense that it would continue to develop in line with the broader economy? In this paper, I examine the question: Is the financial sector a bubble? By “bubble” I then mean unsustainable increases in the financial sector’s volume and profits. Could it be that the subprime crisis was just a temporary setback, certainly dramatic, in an upward trend for the financial sector that began long ago, in the late 1990s, and continues today at this writing (May 2011)? The financial sector is defined as companies whose main task is to work with financial instruments and the trading of financial instruments: banks, investment banks, hedge funds, mutual funds, brokers, etc. I discuss the conditions in the United States. This means that the financial sector more specifically is defined in the way the Federal Reserve and other U.S. authorities are doing. The time horizon is the period after 1990 with emphasis on conditions between 2000 and 2010.

Why has the U.S. financial sector profits exploded?

There are at least five profound explanations, none of them necessarily more important than the other, of why the financial sector profits have exploded over the last 10-15 years, why the curve of “Financial Profits” in Jim Reid’s chart looks the way it does.

First, deregulation. During the past twenty years there has been significant deregulation in the financial markets in the U.S., as in all OECD countries. Admittedly, when talking about interest rates and credit volume controls (which, incidentally, never had the same significance in the U.S. as in Europe), deregulation of financial markets began much earlier, at the end of the 1970s. It was also a deregulation that allowed for modern money and capital markets. But this occurred before deregulation had a real impact in the sense that banks and other institutions could make big money given more freedom. However, during the 1990s, we got a number of important new deregulatory measures in the U.S., which opened up more profitable markets. The Glass-Steagall Act, which expired in 1999, is probably the most important. It meant that now U.S. banks, just as in Europe, could conduct both conventional banking and investment banking in the same firm. This has accelerated development in some areas, such as proprietary trading. It’s in turn part of the background to the explosion of profits. More generally, one need not doubt that deregulation has contributed to earnings growth in the U.S. financial sector over the past 15-20 years. Expressed differently, financial institutions have step by step through deregulation acquired new markets to operate in, and they have done so successfully in the sense that, all else being equal, the profits have risen.

Second, there has been plenty of cheap money and cheap capital available in the economy, and occasionally there have been very good times. Especially in the last decade, from 2002 until 2007, monetary policy in the U.S. has been very lax. The Federal Reserve, with Alan Greenspan as chairman, held short-term rates low, at the level of 1%, for long periods. And America’s large financial imbalances, especially the current account deficit, meant that there was plenty of money in the system. After 2003 and up to the crisis, there was a boom. Times were good, and the mood in the stock and housing markets was excited, sometimes euphoric. Credit expansion was very strong. All are factors that have contributed to the financial sector’s earnings explosion.

Third, the housing bubble. The extreme price increases for single-family housing in the United States after 2000, and the increasingly hectic mortgage carousel, favored banks’ profits. In practice, this meant very strong volume increases in mortgages, which rose in a few years, from 2000 to 2008, from 15% of GDP to 25%. In absolute figures, the mortgage loan portfolio in the U.S. increased from $1,500 billion in 2000 to $3,500 billion in 2008. This is an almost incomprehensibly large increase – compare Sweden’s GDP in 2009 of about $400 billion. In parallel, the financial sector developed other, primarily commission-based methods to make money on the housing bubble. Housing loans were often made for the short term, which meant they had to be renegotiated now and then. Every such transaction incurred new charges for the borrowers.

Fourth, securitization. In simple terms, securitization means that if a bank has a large portfolio of a particular type of credit on its balance sheet, let’s say home loans, it can sell off the portfolio as a package to another company, which in turn converts the portfolio into new securities. Individual loans in the portfolio that the bank sold – where differences in size, maturity and interest rates from one loan to another, of course, are large – reconstituted in this way into securities with more precise contours, precise duration, exact interest rate, and, above all, a rating. It means that these securities become tradable. It opens up a huge market where those with money to invest, such as pension fund or hedge fund companies, can find high-yielding and, or so everybody thought, safe securities to invest in. And this was done on a massive scale. When the securitization in the United States was most extensive in the final months of 2006 and first half of 2007, about $100 billion per quarter was brought into the market in new securities. Not only mortgages for housing and commercial properties but also portfolios of credit card loans, car loans and many other types of credit, were securitized. With the crisis, not surprisingly, the interest in securitization turned radically downward. During the first half of 2008, there was only $5 billion per quarter in the form of new securitized assets. The subprime crisis had struck.

It’s no coincidence that the period when the securitization in the United States grew and became significant for the financial sector, from the early 1990s until 2007, coincides with the period when the financial sector’s relative earnings exploded. Securitization developed into a formidable profit machine for financial firms, not the least for the major U.S. banks. Fifth, proprietary trading. Banks’ freedom to conduct business against their own balance sheets used to be highly regulated in virtually all OECD countries. In view of the principal-agent problems that might arise, legislators typically were critical of, and therefore limited, a bank taking risks on its own account through non-hedged investing in securities such as stocks or bonds, or currencies. There simply is, regulators argued, a potential conflict of interest between the bank’s customers and the bank itself. There has been an important exception to this basic rule. American investment banks did not have these restrictions. They have been able to speculate in securities by taking the risk on their own account. Little by little, an increasing proportion of the large U.S. investment banks’ profits came from proprietary trading. When the boundaries between banks and investment banks disappeared with the end of the Glass-Steagall Act in 1999, there were in practice even greater opportunities for proprietary trading and even greater opportunities for more institutions to make money that way.

More proprietary trading – together with intensive product development, in which lots of new financial products, like credit default swaps (CDS) and other derivatives, arrived on the market and became key instruments – is an important reason why the financial sector’s profits since the mid-1990s have risen faster than GDP, and faster than the profits in non-financial firms. One could more generally say that the U.S. financial sector during this period successfully developed new ways to make money. An increasingly large proprietary trading business is thus one example. That traditional banking became more and more commission-based is another. It became more common to make such lending arrangements that the number of transactions, and thus the opportunity to charge fees, would increase. In his book Freefall, Joseph Stiglitz argues that banks’ increased focus on making money, has meant that they moved away from their social mission to help households and businesses to easily, and at the lowest possible cost, borrow the money they need. The balance, says Stiglitz, seems to swing more and more over to the banks’ self-interest to make as much money as possible. The banks’ social mission has taken a back seat. We need not doubt that these five factors weigh heavily when it comes to explaining why the U.S. financial sector’s profits increased faster than GDP since the mid-1990s. The question is whether it also has meant increased risk-taking.

Have financial firms increased their risk-taking?

The risk-return relationship, i.e., high yield implies increased risk, is well known and well documented both in finance theory and empirically. If in any part of the economy, it’s in the financial sector that the risk-return relationship should be particularly strong. In other words, it’s a reasonable hypothesis that the relative profit explosion that occurred in the financial sector, especially during the first half of the last decade, can largely be explained by increased risk-taking.

The symptoms of increased risks are many. First, the financial sector debt has increased rapidly. As a rule of thumb, rapid debt growth is almost always an indication of increased risk, and the development of the U.S. financial sector debt has been dramatic. This FRED chart, click for bigger picture  (from the Federal Reserve Bank of St. Louis) shows that clearly. Since 1990, borrowing by the U.S. financial sector has increased from 40% of GDP to just under 100% of GDP today. And even more interesting is that this expansion is much more rapid than in any of the other three sectors in the U.S. economy: non-financial enterprises, households, and the public sector. The indebtedness of non-financial companies followed household debt up to about year 2000. Thereafter, one cannot find anything equivalent to the mortgage bubble’s impact on household debt, which increased dramatically. Non-financial enterprises’ debts have largely been following GDP during the last decade. Furthermore, the liabilities of the public sector have remained fairly constant as a share of GDP up to the financial crisis. Of course, the big federal stimulus programs changed that, but the fact remains that during the period we are discussing here, from 1990 until today, it seems that the U.S. financial sector’s debt growth has been in a class by itself.

This development is thought provoking. Stated in other terms, it means that the financial sector has, to a large extent, “taken on a life of its own”. The debts in the financial sector have increased significantly because of internal deals that required credits, deals between different financial institutions. Polemically, one can say that the rapid increase in financial sector debt in the new millennium is essentially explained by either the subprime mortgage bubble, or by “change-money-with-each-other” activities. Both definitely have the character of speculation.

The high relative growth of debt is the most important sign that the financial sector has assumed increased risk, but there are also other signs. New financial products, particularly derivatives of various kinds, and all the tools and instruments used in the securitization process, have created the conditions for greater risk-taking. It’s reasonable to argue that the net effect has meant increased risk, and it’s also likely that the corporate culture of banks and other financial institutions has become more risk inclined, not least as proprietary trading activities have widened. The degree of speculation also correlates positively with the general mood in the economy. When times are good, and they were for much of the last decade in the U.S., banks are willing to take on more risk. My conclusion is that increased risk-taking significantly contributed to the financial sector’s relative earnings explosion. A bubble was built, but whether the bubble burst once and for all with the subprime crisis, is another matter. I will return to that question. A short digression. Could it not also be argued that large banks lending to states, which turned into a nightmare last year, especially for the large European banks, with sovereign debt crises in the PIIGS countries, is another sign of financial sector speculation? I would say no. Under the so-called Basel rules government bonds have been regarded as safe investments. They do not require any additional capital. It’s not the banks that decided that bonds issued by, say, the Greek state are without risk (which is the implicit assumption behind zero capital requirements for sovereign bonds). It was a political decision based on what regulators and other bureaucrats proposed. For this reason I would argue that sovereign bonds on banks’ balance sheets should not be considered as speculative investments.

Is it God-given that financial sector growth follows GDP?

No, it’s not “God-given” that financial sector growth follows GDP growth. But one could say it’s logical when looking at the financial sector’s three classical tasks:

• To allocate credits
• To handle savings and liquidity for households, corporations, and other legal entities
• To be responsible for the payment system in the economy

The fact that the U.S. financial sector has broken the relationship with GDP suggests that it has taken on new tasks besides these three. These new tasks must in principle involve one of two areas: 1) they must successfully offer households or businesses, or both, valuable financial products that are not related to credit, savings, and payments. It’s difficult to see what it could be; possibly advanced problem solving coupled with sophisticated technology, such as risk management services for businesses. There might also be some new products based on trading. Or 2) it has to do with “inter-bank business”, where the financial sector in itself creates markets for different products. It has apparently been done, especially on the trading side. But since “inter-bank” is a market where professionals do business with each other, and a market where it’s difficult to find a temporary monopoly through product development, it should essentially be a zero-sum game in terms of profit. In any case, the risk-adjusted profits should in the long term be very limited. This is related to that the level of risk in such transactions, by definition, is high. Besides arbitrage, it’s all about speculation.

Parenthetically, what is meant by speculation? The concept is not crystal clear, but in the financial context, it means that someone makes a short-term investment in a security of some kind. “Short-termism” is the main characteristic of speculation. The investment is made because one believes it will be profitable. The opposite, to know anything with certainty, is of course not possible. A long-term investment grounded in fundamental analysis has a high probability of becoming a good deal, but the outcome is never certain. Speculation is thus tantamount to taking a high risk with a short-term investment. Speculators often increase risk intentionally, for example through leveraging via borrowing or through large volumes.

My conclusion is therefore that these “inter-bank” trades are mainly about speculation so defined. The financial sector’s large relative profits, which particularly in the last decade disconnected from the other corporate sectors of society, are thus a reflection of considerable risk taking. This would mean that the profit explosion is an anomaly. The level of profit will in one way or another be returned to normal. Put another way. Jim Reid was right when he talked about “a trillion dollar mean reversion”. It also means that it’s reasonable that the financial sector growth on the whole, and in the long term, is following growth in the real sector, roughly equivalent to GDP growth. If it does not, it may be a bubble that is being built up.

Is the financial sector a bubble?

Academic research knows almost everything about how financial bubbles arise and develop. The setting in the country in which a bubble might occur is almost always the same. The times are good. There’s an expansionary monetary policy, which means that there is plenty of money in the economy. Surprisingly often, the country also has financial imbalances, such as a large external debt that is growing (current account deficit). Businesses and households have easy access to credit. Interest rates are low. The bubble develops in two stages. The first stage is characterized by a general expansion of credit. For a particular asset class, such as family homes as in the subprime crisis, credit growth is exceptionally strong. Consequently the price of this asset rises very quickly. As the asset is often used as collateral for loans, it means that price increases will widen the supply of credit. And that space is taken. In other words, we get a self-reinforcing process and credit expands even faster. It’s so rapid that usually no bank or other creditor understands how quickly increasing risks are building up on their balance sheets.

Suddenly something happens that creates uncertainty. It can be almost anything, seemingly trivial or random, but the consequences are immediate. The prices of the asset suddenly turn downward. The most risk-prone lenders run into trouble. In the Swedish financial crisis of the 1990s (considered “one of the big five” global financial crises by Reinhart and Rogoff in their book This Time is Different), it was the finance companies that were first, they had taken the high risk credits that banks didn’t want to have on their balance sheets, and one by one, they went bankrupt in the autumn of 1990. Pretty soon the crisis hit the entire financial system. The bubble had burst.

The U.S. subprime crisis followed exactly the same pattern. Like all other bubbles in history. It’s one thing that financial bubbles historically have followed this pattern. But how can one say that the financial sector itself is a bubble? Financial bubbles normally are about, as I just said, a particular asset class (such as railroad bonds in the 1870s, shares after the First World War, family homes during the current crisis, etc.) whose prices run amok and leave reality, largely due to generous lending, that in turn makes speculation possible. The financial sector as a lender is the very condition for a bubble to emerge. How then can the financial sector itself be a bubble? Not surprisingly, the financial sector per se can be a bubble. All financial sector companies considered as a single portfolio are an asset class that should be studied if one wants to demonstrate that what occurred in the last decade is about a financial bubble. Two issues are relevant. Has the aggregate market value of banks and other financial institutions, that is, financial firms collectively, some time in the last decade risen quickly and a lot? And thereafter turned down as quickly and as much? The answers are yes and yes. The market value of the U.S. financial sector (defined as the Dow Financial Sector) grew almost 90% in just over four years, from March 2003 to June 2007 when the downturn began. It was significantly faster growth than for non-financial firms during the same period, and the decline was dramatic when it occurred. From top to bottom, the financial sector’s market value sank by 80% in a very short time.

The second relevant question is whether the financial sector’s borrowing during the period has increased significantly, more than the real sector borrowing. Again, the answer is yes as I have already noted. The U.S. financial sector borrowing increased between 1998 and 2008 by 51%. During the same period, real sector borrowing increased by 18%.

What is the conclusion? It’s difficult not to argue that the U.S. financial sector in the past decade was in a bubble, and that bubble burst in 2007, triggered by the subprime crisis. However, the really interesting question is whether the subprime crisis was just a notch in the curve showing the financial sector’s profits. We can say that it probably was just a notch because we observe that the sector continues its speculation, perhaps more carefully, and after the Dodd-Frank Act a little more reined in by the authorities, but with the same instruments, with basically the same organization and, in fact, with much the same top management people as before the subprime crisis, at least if we talk about the TBTF banks. This leads to the question of the politicians’ handling of the crisis.

The rescue of TBTF banks became a political half-measure The world’s politicians and central banks intervened in 2008 in the financial sector with a combination of risk capital contribution, increased liquidity, and radical reductions in short-term interest rates. Globally, it was the largest stimulus package ever. The dramatic fall in the financial sector’s market value stopped. The turning point came early in 2009. About the same time the real sector turned up. If measured by the stock market’s behavior, the major stock exchanges began their recovery in mid-March 2009.

Why did politicians intervene so forcefully? The simple answer is that they had no choice. There are systemic risks tied to the financial sector. The risk of a bankruptcy of a large bank is a threat to the entire economy. Consequences in the real sector of a bank failure can be extremely serious. On the other hand, if a large industrial enterprise, even the country’s largest company, goes bankrupt, the contagion effects will be comparatively limited. The financial sector is special in the sense that there is this systemic risk. Banks also provide “the oil in the economic machinery”. Without a well-functioning financial sector enabling households and businesses to get the loans they need and to make their payments, we will immediately see dire effects in the economy as a whole, which is exactly what happened in 2008. When the credit market in a very short time “dried up”, unemployment rose. For example, manufacturing companies that rely on credit to get their products sold, like the automotive industry, ran into trouble right away. Volvo’s sales of heavy trucks fell dramatically after 2008, to take a Swedish example. The crisis quickly spread to other sectors. Politicians felt it was necessary to intervene, and to do so forcefully. Today we can say with certainty that if the U.S. government and Federal Reserve had not gone ahead with these huge stimulus packages and relief efforts, reinforced by the actions of other governments and central banks, the global economy would have entered into a very deep recession, something similar to the Great Depression of the 1930s. As a result of this effort, the major U.S. banks were saved. They were simply TBTF – too big to fail.

Unfortunately, the rescue of the TBTF banks was done in a way that exacerbated the situation, so the systemic risk increased. If anything, the TBTF banks became even more system-critical for the United States than before the crisis and even more politically powerful by virtue of their size and nearly limitless lobbying resources. I think it was a big political mistake by Washington when the possibility existed, not to restructure the TBTF banks and thus reduce systemic risk significantly. It would have been possible, and attempts were made. Many wanted to break up the TBTF banks into two parts – a traditionally regulated banking organization and a deregulated investment banking business, similar to what existed before 1999 and the repeal of the Glass-Steagall Act. This “breaking up”-model became known as the Volcker rule, after former Federal Reserve Chairman Paul Volcker, who suggested just such a division. It would have decreased systemic risk as well as the major banks’ political power. But these ideas came to naught. Arguably this is because it’s inconsistent with American values, certainly not in keeping with the small-government strategy, to replace private ownership with public ownership, much less to allow politicians to control the restructuring of an industry.

Because the TBTF problem is essentially unresolved, I think we can expect a new major financial crisis within a few years with its epicenter in the U.S..

We can expect a new financial crisis in a few years

We know that the U.S. financial sector’s profits today have returned to the same level as before the crisis. In fact, profits in absolute dollars were higher for the full year 2010 than they ever have been, higher than 2006, the best year before the crisis. We know also that the U.S. financial sector’s profits as a percentage of business sector’s total profits today is back to the same figure, around 35%, we had at its highest level a couple of years before the crash. It’s clear from this chart, click for bigger picture. (Source: Madigan, 2011)

That the financial sector’s profits have bounced back is the same as saying – provided the hypothesis that the financial sector is a bubble is proven correct – that it’s likely that something dramatic will happen again. Expressed another way, all the efforts to stabilize the financial system made by the world’s governments and central banks in 2008 and 2009 have been effective in the sense that the financial sector has begun to function again. Real sector companies can get their loans and make their payments. However, what is more disturbing is that the financial sector in the U.S. – to judge from its quarterly reports – has again begun to speculate on a broad scale and may very well be on track to once more lose its link to the GDP. Someone might say that the stock market does not reflect this trend. U.S. financial stocks have not improved in 2010 and 2011 despite soaring profits. I think one can assume that the market has understood exactly the thesis of this paper – large new risks are being built up in the financial sector that will turn into in a new bubble that bursts. Further, European politicians’ “kick-the-can” handling of the sovereign debt crisis and American politicians’ inability to convincingly take hold of America’s own national debt problems, contribute to the fact that bank stocks do not follow bank profits. As I write this, we are also moving into a low growth period, at worst a recession. But underlying that explanation, it seems, it’s at least my view, as if the stock market believes that once again considerable risks are being built up in the U.S. financial sector. For everyone who believes, and I am among them, that the financial sector is not there for its own sake, and should not be allowed to take such huge risks that the stability of the entire world’s economy is threatened on the day the bubble bursts next time, what we now see, is to say the least, frightening. Somewhere in the future, probably within a few years because the financial sector’s revival is going so fast, we will have a new deep financial crisis. And it will almost certainly be worse than the one we thought we had just rescued ourselves from.

Literature:

Acharya, V. V. & Richardson, M. (ed.), 2009, Restoring Financial Stability, John Wiley & Sons, Inc, Hoboken, New Jersey;

Johnson, S. & Kwak, J., 2010, 13 Bankers, The Wall Street Takeover and the Next Financial Meltdown, Pantheon Books, New York;

Jones, S., 2008, “A trillion dollar mean reversion”, ft.com/alphaville, Financial Times, blog, July 15, 2008;

Madigan, K., 2011,“Like The Phoenix, U.S. Finance Profits Soar”, Real Time Economics, WJS Blogs;

Rebonato, R., 2007, Plight of the Fortune Tellers, Why We Need to Manage Financial Risk Differently, Princeton University Press, Princeton;

Stiglitz, J. E., 2009, Freefall, W. W. Norton & Company, New York;

Economist

Sverige finns inte med i Economist graf. Men jag har lagt in värdet (250) för den reala prisutvecklingen för småhus  i  Sverige vid utgången av 2011 (1995=100). Med andra ord har de reala priserna för småhus i Sverige gått upp med 150% sedan 1995, i runda tal med 10% per år. Och hade jag ritat in linjen för ”Sverige” mellan 1995 och 2011 hade den varit ganska rak. Sverige har inte känt av prissänkningar på småhusmarknaden på samma sätt som gäller för de flesta andra länder. De svenska priserna har mer eller mindre konstant gått uppåt.  Det framgår av den andra grafen (som jag hämtat från bloggen flutetankar, läs mer här). Klicka för större bild.

Det finns en mer djupliggande problematik bakom dessa grafer (och andra som jag har visat i andra sammanhang, bland annat här). För den som studerar ett mycket långt tidsperspektiv för USA, låt oss säga perioden från 1900 fram till idag, framstår det som klart att det är de senaste 15-20 åren som är unika.  USA har nu, så skulle man kunna säga, återförts till ordningen. En ständig prisuppgång av det slag som vi haft i många länder under de senaste 2-3 decennierna och som nästan har garanterat fastighetsägaren att bli smått förmögen, och att  i praktiken bo gratis, är inte vad som gällt historiskt, i vart fall inte under de senaste 100 åren om vi talar om USA. Och med den kunskapen ligger det nära tillhands att fråga sig om vi inte kan räkna med att de bubblor i småhus och bostadsrätter som har byggts upp också i Europa, och som uppenbarligen ännu inte spruckit i alla länder (och det inkluderar alltså Sverige), kommer, precis som i USA, att spricka och priserna justeras ner till nivåer som mer följer den långsiktiga trenden (som i västländerna handlar om en real prisökning på kanske 1 procent per år). Egentligen är det om man tänker efter ologiskt att man skall kunna utnyttja en tillgång, sitt boende i det här fallet, och ha ett högre värde i reala termer kvar efter utnyttjandet. Att det kan vara så på vissa delmarknader är en sak. Men att det gäller för ett helt land och som ett genomsnitt för alla småhus (och ganska säkert bostadsrätter) i landet är en helt annan sak. Det borde inte kunna vara så. Alla andra kapitaltillgångar man utnyttjar sjunker i värde i takt med utnyttjandet. Varför skall inte ett småhus eller en bostadsrätt också göra det, låt vara med lite längre avskrivningstider?

Har vi en småhus- och bostadsrättsbubbla i Sverige? Mitt svar blir, förmodligen. Mot den här bakgrunden borde en tillgång som på femton år har gått upp med 150% i fasta priser (och ännu mer i storstadsområdena) befinna sig  i bubbla. Om jag har rätt i det, vad kommer då att ske? Ja, det finns två vägar ut. Antingen en pyspunka, alltså en svag real prisutveckling för svenska småhus och bostadsrätter under lång tid. Eller en dramatisk korrigering som i USA, Irland och Spanien. Den första vägen kan Sverige möjligen klara av om vi som hittills sköter vår ekonomi ansvarsfullt (och slipper stora externa störningar).  Den andra vägen kan komma att bli aktuell nästa gång vi får en finansiell kris med globala dimensioner. Och det senare är inget som kan uteslutas. Tvärtom.

A few weeks ago, on April 1st, my book, Dagbok från USA, came out in Sweden. It will also, around May 15th, be published in English (as an e-book for Kindle and for other readers with the title: “Diary from the United States – Notes on a society in crisis“). As an appetizer for English speaking readers, I will the coming week publish three essays, excerpts from the book (chapter 4).

This is the first essay. It  deals with  the American model of society, which I in the following will call “the small-government strategy”. It may have reached its limits. By that I mean that this political strategy may have lost its ability to create a society that simultaneously can achieve both high relative GDP growth, and provide all its citizens welfare at the same level as the citizens of other highly developed Western countries. I will show that the northern European welfare state, so often disparaged by Americans, compares quite favorably with the small-government strategy.

Essay 1: Small-government strategy in a dead end (or the renaissance of the European welfare state)

What is a welfare state? The definition I will use here is based on two criteria. The first is that all citizens should have basic social and economical protection of their welfare in case of sickness, accidents, old age, unemployment etc. This can be achieved in different ways. As in Sweden, Norway and Denmark, it can be done by making the public responsible for both the financing and production of welfare. For example, the county councils in Sweden fund and provide the greatest part of the health care system. Gosta Esping-Andersen, Danish sociology professor well known for his typology of welfare models, calls the Nordic model “the social democratic regime”. Or it can be done as on the European continent (“the conservative regime”) with more limited state and local responsibility, supplemented by private efforts, in particular for the provision of health care, and with private insurance.

Whatever the model, the public has two tasks. State and local governments are to assist in different ways so that even the weakest in society get the help they need when confronted with sickness, accidents, unemployment, and old age. This can be done through various types of social security systems, and through for example subsidized medical and social care. The state can also influence the relative income differences through grant schemes, tax deductions or progressive taxation.

The second criteria veer from the typical course of these debates because it isn’t usually discussed in literature about the welfare state. However, I argue that for us to talk about a welfare state, income disparities in the country should be moderate in comparison to other developed countries because research has shown that in Western countries, there is a close correlation between relative income inequality and social conditions. The larger the income disparity, the greater the social problems. Therefore, relative income distribution is a relevant welfare measure. In fact, it’s an indication of whether the welfare model that politicians have chosen (following a social democratic, conservative or liberal model) works for the citizens of the country in question.

According to these two yardsticks, Belgium, France, Holland, Germany, Austria, and the Nordic countries, Denmark, Finland, Norway and Sweden, are European welfare states. Two countries that usually are categorized as welfare states have been left out. The UK because the distribution of income criteria was not met. Income inequality in the UK is, compared to other Western countries, extremely large, almost the same as in the U.S.  Switzerland has also been left out for the simple reason that its successful welfare model is unique. There is no other Western country that has the same characteristics. For example, all the countries I have defined as welfare states here currently have government expenditures taking up around 50% of the GDP (58% in Denmark in 2009 being the highest with Germany as the lowest at 48%). The Swiss public sector in terms of government expenditures was the same year at 34% of the GDP.

A misunderstanding

In the U.S. debates in recent decades, especially after 1980 and the presidency of Ronald Reagan, the European welfare system has been considered an outdated and costly social model. It’s associated with political interference in the market, with income distribution policy, and with economic inertia and lackluster performance, in short, with, in U.S. parlance, “socialist” politics, the most antiquated political system of all. The welfare state has also been a costly social system as its relative growth is weak. Welfare states, it’s argued, have a lower GDP growth than the U.S..

I would argue that today this approach – with an emphasis on today – is wrong. My hypothesis is that it’s in fact the American model that is outdated. It’s my prediction that the European welfare state will have to be relabeled from politically outdated to up-to-date. As it turns out, if one lets markets work freely, over the long term it results in instabilities and misallocations. The financial sector especially is at risk of spiraling out of control. This was the case during the financial crisis of 2008-2009, for example. If the political goal is always to keep taxes low, and thus puts the public sector on a starvation diet, the risk is that one will eventually end up with a society that does not work effectively. The poorly maintained U.S. roads, bridges, and other infrastructure can serve as a prime example.

It’s the purpose of this essay to try to prove this hypothesis. I will systematically compare the European welfare state model with the American model of society (from now on referred to as the small-government strategy). Some may say that such a comparison is impossible because it’s like comparing apples and oranges. However, the U.S. and Europe are culturally, politically and economically part of the same world; the differences are moderate to say the least. The countries are invariably liberal states, democracies, and capitalist economies at a similar level of development. Even the differences in size are moderate. The entire EU-Europe and the U.S. are nearly equivalent measured in terms of GDP. The nine European welfare states as defined above together account for an economy that equals two-thirds of the U.S. economy.

There are three strong reasons why the European welfare state model is likely to undergo a renaissance.

The small-government strategy at the end of the road

The first reason is the most obvious. Judging by the global economy as it looks like today, the small-government strategy will probably turn out to be a political and economic dead end. There are many indications of this.

* Insufficient investment in the public sector, most notably in infrastructure. For a long time the U.S. investment in infrastructure has remained at about half the European level. In Europe, we annually invest roughly 5% of GDP in infrastructure compared to 2.5% in the U.S. The American Society of Civil Engineers (ASCE) regularly publishes a “report card” on the state of American infrastructure – roads, bridges, dams, schools, energy systems, water supply etc. In the latest report, from 2009, the state of the infrastructure did not get a pass.

* Over-investment in some parts of the private sector, especially concerning those having to do with private consumption. One does not need to spend much time in the U.S. to understand that there are, albeit unevenly divided, tremendous resources available for private consumption and for making increased private consumption possible. Corporate spending to facilitate final consumption has been huge in recent decades. This can be seen in everything from new shopping malls to more and more new product showrooms. Seventy-one percent of U.S. GDP in 2009 went to private consumption. In Germany the figure in the same year was 55%. High private consumption may suggest that private and public investment in the U.S. economy is too low compared to other developed countries, and this could eventually affect America’s relative competitiveness.

* The weaker groups in society have very poor protection against sickness, accidents, and unemployment. The U.S. uses just under 10% of GDP for tax-funded social safety nets. Germany and Sweden use more than twice as much. The protection of the economically weak is bad in other ways too. Illness has been the leading cause of personal bankruptcies in the U.S..

* Big income inequities. In practice, the small-government strategy is very stingy regarding measures aimed at mitigating the large income differences.

* Less effective solutions. The small-government strategy has an ideological background that sometimes leads to more costly solutions than is necessary. Politicians, and this goes for both Republicans and Democrats, simply choose a socially and economically more costly approach because they cannot, simply put, imagine that the government should take on greater responsibility. One of the most obvious examples is the private financing of health care.

* An increasingly speculative financial sector contributes to greater instability. Significant deregulation and a generous, almost libertarian, monetary policy, in line with the economic policy paradigm that was introduced at the beginning of the 1980s, has led the U.S. financial sector over the past 10-15 years to increasingly taking on a life of its own, more and more disconnected from the real sector. Historically, growth of the banking sector has followed GDP growth. Logically, one can say that the financial and real sectors should grow at about the same rate. This connection was nevertheless broken during the late 1990s. No matter how one measures it – in credit volume, profits, employee compensation, etc. – the U.S. banks, and shadow banks, have lost the connection to the real sector. This indicates more risk-taking and increased speculation, which will have disastrous consequences if the risks materialize in serious difficulties. This was the case in the crisis of 2008-2009. There is no doubt that there is a close connection between the small-government strategy and increased degrees of freedom for banks and other financial institutions to speculate.

*The  national debt problem. That a government borrows is one thing. All countries with the possible exception of Norway and other states with extraordinary resources or windfall gains do it. But with the small-government strategy, government borrowing tends to function as a substitute for tax increases. There is an imbalance between the demand for public goods on the one hand and the ability to fund it with limited tax revenues on the other hand. It leads to a budget deficit, and increased national dept. The national debt can become a serious problem if and when the financial markets lose confidence, as recently has been the case in Greece and the other heavily indebted countries in Europe. Economic historian Niall Ferguson, and Kenneth Rogoff and Carmen Reinhart in their book This Time is Different, argue that problems will increase when the national debt of a country approaches 100% of the GDP. Rogoff and Reinhart demonstrate that a Western country with a national debt exceeding 90% grows significantly slower in comparison to countries with a lower debt. This insight is part of the background of the intense debate in recent times on the U.S. national debt, which is approaching 100% of GDP.

These seven problem areas can be misleading. It’s not that the market-friendly economic policy paradigm launched by Ronald Reagan and Margaret Thatcher in the early 1980s – which has been so influential in the West and has become the small-government strategy in the U.S. – has been a failure. On the contrary, it has been a success. It was a necessary change. The previous economic policy model in the Western world, the outsized Keynesianism in which the state would actively participate and interfere in the markets, had outlived its usefulness. It was the model found in many European countries during the 1970s. Sweden is a primary example. It was an ossified, social democratic society that was no longer competitive, of which citizens gradually during the 1970s and 1980s became more critical. Sweden’s GDP per capita relative to other Western countries, especially compared to the U.S., declined for 15-20 years until the mid-1990s. From having had virtually the world’s highest GDP per capita in terms of purchasing power in 1970, Sweden fell to place 25-30 in the mid-1990s. There is an explanation for that. Sweden had gone further than almost all other Western countries with its ambitious, and for a time very successful, economic policy. The country paid a high price for it.

History repeats itself. So I would argue that the American version of the new paradigm, the small-government strategy, which can also be seen as an extreme form of economic policy, has reached its limits.

European welfare states hold up well in the face of competition

The second reason the European welfare state will most likely go through a renaissance is that the economy in terms of growth is as strong as the U.S. economy, and thus, the main political argument for the small government- strategy no longer applies. The main argument has been, and still is, that the relative growth in the United States is better compared to other Western social models, perhaps especially compared to the northern European welfare state countries. Many Americans believe that “big government” inhibits growth. This argument should, I think, no longer be upheld. Growth in the European welfare states is clearly currently not lower than in the U.S.. The dynamics are not worse, and the competitiveness, generally speaking, is the same as for the United States. I will be examining these three claims a little more systematically.

First, concerning growth, it’s correct to say that if we look at the entire period from 1980 until today, the U.S. economy has grown faster than the economy of the welfare states in Europe. While there are no major differences, the U.S. GDP growth, or GDP per capita growth, has been decidedly better during the past three decades. This is a fact whether we measure in current or constant prices. One explanation for this could be that the number of hours worked per year per capita is significantly higher in U.S. than in Europe; all else being equal, this raises the relative growth. Another explanation could be that the public sector is comparatively larger in Europe. The method used to calculate the productivity in the national accounts means that a country with a bigger private sector will gain. A third explanation, and this is definitely the case for Sweden, is that the transition from the old paradigm, the outsized Keynesianism, to a new, more market-oriented economic policy, took longer in Europe than in the U.S. Whatever the explanation, it’s unequivocal that U.S. growth has been better than Europe’s in the period 1980-2010.

It looks slightly different with a shorter time perspective. The GDP growth of the welfare states in Europe over the past fifteen years, 1995-2010, does not differ greatly compared to the U.S. If we measure growth in real terms and after purchasing power, the percentage increase for the entire period for Sweden was 45% against the U.S. growth of 46%. Norway and Belgium developed even better yet. Especially Germany breaks the pattern. During the past 15 years, the country has had significantly slower growth (20%) than the U.S. One explanation might be that the integration of the East German economy slowed growth of the reunited country. Germany has also had to deal with some macroeconomic problems during this period.

The overall picture is that the U.S. is still growing well in line with Europe’s welfare states. But the gap in growth rates has tended to shrink over time. Between 2005 and 2010 the nine welfare states grew by 5.2%, and the U.S. grew by 4.8%. The difference is negligible.

There’s another aspect to this question. Political scientist Uwe Reinhardt, a professor at Princeton, has shown that because households with the highest incomes are taking such a large share of the pie in the U.S. economy, the comparison is misleading. It turns out that if one removes the percentage of households with the highest income, the top percentile, the picture changes dramatically. This is how Reinhardt illustrates the problem (referring to: Atkinson et al, 2011):

Average real income per family in the United States grew by 32.2 percent from 1975 to 2006, while they grew only by 27.1 percent in France during the same period, showing that the macroeconomic performance in the United States was better than the French one during this period. Excluding the top percentile, average United States real incomes grew by only 17.9 percent during the period while average French real incomes – excluding the top percentile – still grew at much the same rate (26.4 percent) as for the whole French population. Therefore, the better macroeconomic performance of the United States and France is reversed when excluding the top 1 percent.

The second claim relates to the dynamics of each model of society. We know that a country with a relatively large influx of new businesses and a high degree of entrepreneurship will manage the jobs and growth better than other countries. Against this background, it would be interesting, not least for politicians, to measure the degree of entrepreneurship in different countries. One of the best and most publicized attempts of this is the Global Entrepreneurship Monitor (GEM). The problem with GEM is that it measures the degree of entrepreneurship indiscriminately. The simplest “enterprise for a living” is mixed up with Facebook, Google, and other corporate gazelles. Now Professors Zoltan Acs and Laszlo Szerb have developed a new index, the Global Entrepreneurship and Development Index (GEDI), which focuses more on measuring the quality part of entrepreneurship, the new “value added heavy” businesses. One could say that GEDI provides an indication of which countries have created favorable conditions for new businesses based on high technology, that is, the kind of company that creates high value added and thus contributes significantly to GDP growth.

Zoltan Acs and Laszlo Szerb analyzed and ranked 71 countries. All European welfare states are found close to the top of the list. Of the welfare states, Austria ranks the lowest, coming in 22nd. Most thought-provoking is that the Nordic countries end up very high: Denmark tops the list, Finland is in thirteenth place, and in between come Sweden and Norway, with Sweden in fourth place. This is interesting because it suggests that the economic policy model that we adhere to in the Nordic countries today is also competitive with regard to entrepreneurship. One can no longer argue that relatively high taxes and a rather generous welfare state are in opposition to growth through new businesses. The United States is also found at the top of the list at number three. This is not unexpected. Everyone knows that the conditions for high-tech growth are better in America than in most other countries.

The third claim concerns the big picture and raises the question, to what extent can the European welfare states compete with the U.S. when the perspective is broadened? The World Economic Forum’s competitiveness study from 2010, The Global Competitiveness Report, which I wrote about earlier, can be used to answer this question.

The following graph (click for bigger picture) from the study shows how U.S. competitiveness holds up when compared to the average of other highly developed countries (“Innovation-driven economies”), which in practice are dominated by the European welfare states. What one sees is what one expects. The U.S. is particularly good at innovation, highly sophisticated in business, with a relatively well-functioning labor market. In addition, the country has a distinct advantage due to the size of its domestic market. The United States has by far the largest and most sophisticated market.

In the ranking showing the best countries, Switzerland comes in first. After Switzerland we find – taking the top ten competitors in the ranking – Sweden, Singapore, the U.S., Germany, Japan, Finland, the Netherlands, Denmark, and Canada. Between positions 11 to 20 we find the rest of the European welfare states, with Belgium coming in last at number 19. It’s no exaggeration to say that the European welfare states truly equal the U.S. when it comes to global competitiveness, at least according to the World Economic Forum’s report.

When these three conditions – the capacity for economic growth, the conditions for entrepreneurship, and overall competitiveness – are put together into a complete picture, the differences between the two social models are not great. The European welfare state model and the U.S. small-government model seem relatively economically comparable.

There is a third factor. By all accounts, people, I would argue, feel better in the European welfare state than in the U.S. small-government society.

People in the welfare state

In their book, The Spirit Level, epidemiologists Richard Wilkinson and Kate Pickett argue that at any given time there is a correlation between income inequality and the social conditions of a country. The wider the income inequity, the more social problems there are when comparisons are made between countries. Infant mortality, life expectancy, obesity, the status of women, mental illness, drug use, people in prison, school performance, the school dropout rate, and teenage pregnancy. For all these factors, the larger the income disparity in a country, the greater the problems.

In the book there are many graphs in which they show the income inequality in different countries along the x-axis and the social parameters along the y-axis. In other words, far to the right of the chart below, click for bigger picture, (Source: Wilkinson & Pickett, 2009, p 20) are the countries that have a high relative income discrimination, high income inequality, and in the upper part of the graph are the countries with major social problems. The U.S. is situated high up in the right corner in all the graphs, that is, for all the social parameters that I just mentioned and a few more. In other words, it’s a position that says that compared to other highly developed countries, the U.S. has greater income inequality and hence greater social problems. The European welfare states (often along with Japan) are without exception positioned in the opposite corner, on the positive side of the graphs so to speak, the side with a relatively low income inequality and low social problems. When I argue that the people of the European welfare states in general “feel better” than people in the American small-government society, it’s this systematic difference in the degree of social problems I’m referring to.

I am not uncritical of The Spirit Level. To be sure, the authors have persuaded me that large income disparities in a country are not good for the people of the country, but they do not show how the relationship operates. What underlying mechanisms, for example, cause infant mortality to be higher in U.S. than in Sweden? Wilkinson and Pickett only assume that there is a causal relationship. Other researchers have also criticized the methodology used, and, of course, there exists a furious criticism of the book from the political right. Still, I think the main message of The Spirit Level, that countries with large income differences on average have more social problems than those with less income inequality, stands up to scrutiny.

A few additional observations in the book are also worth a comment when discussing the United States. In a study of conditions in a number of Western countries including the U.S., researchers at the London School of Economics have demonstrated that there is a correlation between income inequality and social mobility. Social mobility is a term that refers to how easy or difficult it’s for an individual to break free from the income level of his or her parents. The data isn’t extensive, and the results must therefore be handled with care, but what can be seen is astounding. Social mobility in the United States (and Britain) is significantly lower in than the other countries in the survey – Norway, Finland, Sweden, Germany, and Canada. The European vision of the United States, since Alexis de Tocqueville wrote Democracy in America about his visit to the U.S. the 1830s, has been rooted in the myth of the land of opportunity, a place where anyone through hard work and perseverance can achieve anything, the very model of high social mobility. This study drives a wedge into that story. Contrary to what de Tocqueville observed in the 1800s, it seems that it’s more difficult to climb the social ladder in the U.S. today than it’s in Europe.

This second comment is about the relationship between work time and income inequality. It’s well known, and I have touched on these facts earlier, that Americans on average work more hours per year, and take less vacation time than the average Western European. Wilkinson and Pickett discuss the question in their book, and find even here a clear correlation. The wider the income gap between rich and poor in the country, the more hours people tend to work per year when compared to other countries. Hence, one could say that one reason, and perhaps a major reason why Americans work so much, is that they live in a country with relatively large income differences.

The countries with small income gaps in Wilkinson and Pickett’s studies are all European welfare states – with one exception. That exception is Japan. Since Japan’s public sector is one of the smallest among OECD countries if measured as a share of GDP, less than the U.S.’s., this should encourage those American politicians who want to do something about income inequality in their country. It appears that one can achieve a more fair income distribution even without a welfare state of the European type. However, the Japanese model is built on the assumption that there should be small differences in income between all different groups in society, and one can assume that the general public backs this. In other words, it’s the farthest one in the advanced capitalist world can come from the American wage and bonus culture.

If we accept Wilkinson and Pickett’s analysis, and not all do, there is no doubt that the people of the European welfare states on average live a healthier, better life than people in the United States.

Time is on the side of the welfare state model

The first argument in favor of the renaissance of the welfare state model is that the small-government model has serious problems, ranging from shoddy infrastructure to over-investment in the private sector. Further, which I have not discussed here, the political deadlock between Republicans and Democrats in the U.S. has lead such political scientists and commentators as Fareed Zakaria and Francis Fukuyama to be pessimistic about Americans’ ability to address the major issues that urgently need to be addressed in the U.S. society. Some may say that Europe has plenty of its own problems. A bankrupt Greece, difficulties for the other PIIGS countries to affordably finance their public debt, and a high risk that the monetary union, the euro, will collapse all lead one to say that they do have a point. Of course, they are right. But these problems have nothing to do with the welfare state as a social model. The problems only indirectly affect the nine welfare states involved in this discussion.

The second argument is that the European welfare states are no longer economically inferior to the U.S. For a long time it was an unquestioned truth that the welfare states of Europe were if not economically less developed, then at least less dynamic than the U.S. It’s difficult to argue that this is the case now. Although the U.S. remains one of the world’s most competitive countries, and even if no other country in the foreseeable future can compare to the U.S. in terms of domestic market size, on closer inspection it’s proved that the European welfare states are holding up well in everything that determines future economic development.

The third, and decisive, argument has been that people in the welfare states in general live a better life with less social problems.

There is also a fourth point. Time is on the side of the welfare state model. Income inequalities will keep pace with globalization and technological progress, and this will require political measures to mitigate the effects of these developments. Compared to the U.S. small-government strategy, the European welfare state is, I would argue, better equipped to handle them.

Literature:

“2009 Report Card for American Infrastructure”, American Society of Civil Engineers, March 2009;

“The Global Competitiveness Report, 2010-2011”, 2010, World Economic Forum, Genève;

Acs, Z. J. & Szerb, L., 2010, “The Global Entrepreneurship and Development Index”, paper presented at the DRUID Conference, Imperial College Business School, June 2010, London;

Atkinson, A. B. et al , 2011, “Top Incomes in the Long Run of History”, Journal of Economic Literature 2011, 49:1;

Snowdon, C., 2010, The Spirit Level Delusion: Fact-checking the Left’s New Theory of Everything, Democracy Institute;

Ferguson, N., 2008, The ascent of money: a financial history of the world, Penguin Press, New York ;

Reinhart, C. M. & Rogoff, K. S., 2009, This Time is Different, Princeton University Press, Princeton;

Wilkinson, R. & Pickett, K., 2009, The Spirit Level, Penguin Books, London;

Woolhandler, S. et al, 2003, “Costs of Health Care Administration in the United States and Canada”, The New England Journal of Medicine, Vol. 349, No. 8, August 21, 2003, s 768 ff;

Reinhardt, U. E., 2011, “What Does ’Economic Growth’ Mean for Americans?”, Economix, The New York Times, September 2nd, 2011;

 The U.S. has become the fastest-growing oil and natural-gas producing area of the world,” Edward L. Morse, Citigroup’s New York-based head of global commodities research, and half a dozen colleagues wrote in the report. Greater output from Canada and a rebound in Mexico point to bigger increases in North American production “than all of OPEC can sustain.

Det är en ganska anmärkningsvärd utveckling. Den bild vi har av USA som ett oljeslukande land som ständigt måste importera oljeprodukter från Mellanöstern och andra platser måste uppenbarligen omprövas. Om de gynnsamma prognoser över USA:s förväntade oljeproduktion som skrivs fram på sina håll infrias kommer mycket att ändras i USA, både politiskt och ekonomiskt.  Bara skillnaden mellan hur det såg ut för 4-5 år sedan och idag motsvarar, om man får tro grafen, värdet av kanske 4 miljoner fat olja per dag. Lite grovt skulle det med dagens oljepris ($125/fat) betyda storleksordningen $200 miljarder per år i förbättrad amerikansk bytesbalans (allt annat lika). Det är inte småpotatis när man vet att USA:s bytesbalans 2011 låg i storleksordningen minus $500 miljarder.

Det måste vara en grovt felaktig tolkning. Eller bara rakt av fel.  Det är ingen tvekan om att de amerikanska frihetsvärderingarna i högsta grad har påverkat det vårdsystem som finns i USA (ännu så länge har inte ”Obama-care”, det reformpaket som kongressen beslutade om våren 2010 fått praktiskt genomslag). Det gäller i synnerhet tanken att det är upp till var och en som är frisk och arbetsför att ordna sin egen sjukförsäkring. Framförallt skall staten inte blanda sig i. Denna för oss icke-amerikaner obegripliga ståndpunkt är grundad i dessa värderingar.

Det har blivit extra tydligt dessa yttersta dagar när USA:s Högsta Domstol haft en hearing inför sitt ställningstagande till Obama-care, mera precist om reformens konstitutionalitet. Det är i första hand det som kallas ”individual mandate”, alltså den lag som vill tvinga medborgarna att skaffa sjukförsäkring (annars får man böta) som riskerar att bli förklarad som okonstitutionell. I så fall betyder det att inte ens en majoritet av kongressen ledamöter har rätten att tala om för amerikanen att sjukförsäkring är något som alla vuxna medborgare bör skaffa sig.

Den principiellt intressanta frågan blir då naturligtvis gränsdragningen mellan presidentens, och kongressens ansvar å ena sidan, och Högsta Domstolens ansvar å den andra sidan. Skall domstolen ha rätt att överpröva politiska beslut fattade i laga ordning? Om det vore kristallklart vad som är konstitutionellt och inte är det, skulle svaret på den frågan vara ja om Högsta Domstolen dömde oväldigt. Det är den senare förutsättningen, att domstolen dömer oväldigt, som kanske inte gäller. Allt fler hävdar att USA:s Högsta Domstol har ”politiserats”. På allvar menar bedömare idag att när utslaget om konstitutionaliteten hos ”Obama-care” kommer i juni, kommer det att bli ett beslut efter den politiska skiljelinjen mellan konservativa domare och liberala. Det skulle betyda 4:4 (av totalt nio domare). Men  eftersom hearingen häromdagen antydde att den enda “swing vote”-domaren som finns sannolikt kommer att rösta konservativt skulle reformpaketets mest centrala del, ”individual mandate” komma att upphävas. Det skulle vara, försiktigt sagt, en politisk jordbävning.

Kan det verkligen fungera så i världens kanske mest framstående rättsstat? Ja, så här skriver Economist idag (30 mars 2012), och Economist brukar vara så nära sanningen man kan komma när det handlar om ekonomi och politik (läs artikeln här):

Is it fair to apply such crude labels as “liberal” and “conservative” to subtle legal minds whose owners claim to be weighing each case on its merits? Alas, yes. Academic studies confirm that when the court is divided, the liberal or conservative predisposition the judges is a fair indicator of how their votes will go.

Om det är sant, då betyder det att de politiska hårda låsningarna i USA:s kongress har spridit sig också till USA:s Högsta Domstol. Man slutar inte att förvåna sig – och oroa sig – över tillståndet i dagens USA.

Ganska enastående!

PS Det som är något oklart är om “inkomst” här definieras som summan av inkomst av tjänst och inkomst av kapital. Den extrema snedvridningen till de allra rikastes förmån kan möjligen tyda på att båda inkomstslagen finns med.