Saturday, October 25, 2008

Greenspan now agrees with Soros; Galbraith interview and a calculation

Bill Moyers' Journal is usually pretty boring, but of late he's been quite good. Two weeks ago he interviewed George Soros, who said the following:

GEORGE SOROS: ...this belief that everybody pursuing his self-interests will maximize the common interests or will take care of the common interests is a false idea. It's a suitable idea for those who are rich, who are successful, who are powerful. It suits them to justify you know, enjoying the fruits without paying taxes.

Yesterday he interviewed (thanks to Mark Thoma for the link) heterodox economist James Galbraith (UT Austin; son of John Kenneth Galbraith). Moyers led into the Galbraith interview by first quoting from Alan Greenspan's recent congressional testimony.

ALAN GREENSPAN: I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.

CHAIRMAN WAXMAN: In other words, you found that your view of the world, your ideology, was not right, it was not working.

ALAN GREENSPAN: Absolutely, precisely. You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.

Now on to the heterodoxy:

BILL MOYERS: With his ideological blinders stripped away by reality, Alan Greenspan might well do penance by curling up this weekend not with THE FOUNTAINHEAD and ATLAS SHRUGGED but with James K. Galbraith's new book THE PREDATOR STATE: HOW CONSERVATIVES ABANDONED THE FREE MARKET AND WHY LIBERALS SHOULD TOO. In it, the author asks: "Why not build a new economic policy based on what is really happening?" ...

BILL MOYERS: What scares you most right now?

JAMES GALBRAITH: Well, a week ago or two weeks ago I would have said the possibility that [McCain economic advisor] Phil Gramm might become Secretary of the Treasury. ...Gramm himself was the architect, a deep architect of the speculative markets that have just collapsed. ...

BILL MOYERS: You call your book THE PREDATOR STATE, what do you mean predator?

JAMES GALBRAITH: What I mean is the people who took over the government were not interested in reducing the government and having a small government, the conservative principle. They were interested in using these great institutions for private benefit, to place them in the control of their friends and to put them to the use of their clients. They wanted to privatize Social Security. They created a Medicare drug benefit in such a way as to create the maximum profit for pharmaceutical companies.

They used trade agreements to extend patent protections for various interests or to promote the expansion of the corporate agriculture's markets in the third world. A whole range of things that were basically political and clientelistic. That's the predator state.

BILL MOYERS: You call it a corporate republic.

JAMES GALBRAITH: It is a corporate republic.

BILL MOYERS: Which means that the purpose of government is to divert funds from the public sector to the private sector?

JAMES GALBRAITH: I think it's very clear. They also turned over the regulatory apparatus to the regulated industries. They turned over the henhouse to the foxes in every single case. And that is the source of the decline in, the abandonment of environmental responsibility, the source of the collapse of consumer protection, and the source of the collapse of the financial system, all trace back to a common root, which is the failure to maintain a public sector that works in the public interest, that provides discipline and standards, a framework within which the private sector can operate and compete. That's been abandoned.

BILL MOYERS: We saw what Alan Greenspan said yesterday. But did you see what the chairman of the Securities and Exchange Commission, Christopher Cox, said? I mean, it was one of the great recantings in modern American history. Quote, "The last six months have made it abundantly clear that voluntary regulation does not work."
Now to my heterodox heterodoxy: always estimate costs and benefits when making a decision. A little calculation is in order: suppose unfettered markets lead to systemic crises every 20 years that cost 15% of GDP to clean up. I think that's an upper bound: a $2 trillion (current dollars) crisis every 20 years.

Easy Question: What growth rate advantage (additional GDP growth rate per annum) would savage, unfettered markets need to generate to justify these occasional disasters?

Answer: an additional 0.1 percent annual GDP growth would be more than enough. That is, an unregulated economy whose growth rate was 0.1 percent higher would, even after paying for each 20 year crisis, be richer than the heavily regulated comparator which avoided the crises but had a lower growth rate.

Hard Question: would additional regulation decrease economic growth rates by that amount or more?

Unless you think you can evaluate the relative GDP growth effects of two different policy regimes with accuracy of better than 0.1 percent, then the intellectually honest answer to the policy question is: I don't know. No shouting, no shaking your fist, no lecturing other people, no writing op eds, just I don't know. Correct the things that are obviously stupid, but don't overstate your confidence level about additional policy changes.

(Note I'm aware that distributional issues are also important. In the most recent era gains went mostly to a small number of top earners whereas the cost of the bailout will be spread over the whole tax base.)


Seven Star Hand said...

Hey Steve,

So, why should all of humanity be forced to suffer and struggle any longer now that the entire global financial system has been exposed as a mind-boggling deception within many other deceptions? No one in their right mind would continue to be enslaved by a proven deception, which is also proven to be undeniable slavery-by-proxy !!!

Understand clearly, that these leaders have, once again, been caught red-handed, with their pants down around their ankles, and their hands in the cookie-jar/till, colluding to exploit and deceive everyone and at a scale and scope that is absolutely mind-boggling. Furthermore, this model of civilization (money, politics, and religion) has repeatedly failed. Unlike past failures though, this one is global in scope and greatly compounded by massive international deception and rampant greed in the form of derivatives, other smoke and mirrors financial schemes (scams), and several layers of speculation. The same out-of-control "betting schemes" were also behind the skyrocketing oil prices of recent years.

Here is Wisdom...

Anonymous said...

It's not an either/or question. One may enact pinpoint regulation to exclude each specific type of crisis while simultaneously enjoying the private interests-driven growth.

Regulation governing financial markets is as essential as civil law to social interactions. (Think of the financial markets as a nuclear reactor... hire good personnel who understand every facet, monitor, administer, and never turn your back...)

Steve Hsu said...

> One may enact pinpoint regulation to exclude each
> specific type of crisis while simultaneously enjoying
> the private interests-driven growth.

I wish that were true. Markets overshoot on the way up and down, as do policy and social sentiment.

Anonymous said...


The current financial crisis would not have happened, were:

1. The 11:1 leverage ratio limit upon IBs retained (rather changed to 33:1 in year 2005). The higher ratio set up IBs for a deleverage collapse in a bear market.

2. Mortgage downpayments of X percent required, as per tradition. This (a) tends to kill out speculation, dampening bubble formation; (b) decreases risk of mortagee going "underwater" and walking away - the house value must now drop X percent rather than 0 percent, etc.

3. "Liar's loans" cracked down upon the moment regulators got ear of it. The repackaging of LL as safe products to unsuspecting third parties was simply fraud.

4. Money supply growth kept in check. The Bubbles could not form but for excess money created by artificially low interest rates set by the central bank.

The reactor *does not* have to go Ka-Boom.

Anonymous said...

Perhaps systemic crises are infrequent precisely because, in their aftermath, people get serious about regulation!

Raymond Luxury Yacht said...

A different perspective on the easy question:

Easy Question: What growth rate advantage (additional GDP growth rate per annum) would savage, unfettered markets need to generate to justify these occasional disasters?

Answer: Any growth rate at all in an unfettered market would justify these occasional disasters.

As we know, for total production to be maintained there has to be enough saving to offset capital wear and tear. For total production to grow, an increase in saving is needed. In an unfettered market changes in the ratio of consumption to investment would dictate the amount savings, and later total production, would grow or shrink by.

In any case, a man's decision to save more or less or the same amount would be his own. Such a system is justified not because it would lead to greater GDP growth, but because it would lead to the GDP growth that people would choose voluntarily.

Anonymous said...

I think one can distinguish between responsible risk-taking, with a constructive aim, which if nothing else may consist of exploring unknown territory to see what might be learned from it, versus gambling or predatory risk-taking in pure pursuit of self-enrichment and/or self-aggrandizement.

Both personally and collectively we need to be willing to take some risks and make mistakes in order to learn and grow. What I find so despicable and unnecessary about what has happened recently is that old lessons were ignored—in many (perhaps most) cases willfully ignored—and deliberate efforts were made by people who should have known better to facilitate this disaster. Galbraith's characterization of the predator state is on target. One might say the same about Christopher Hitchens' (!) use of the term "banana republic" in this piece.

PS: I second Hcl's comments.

Anonymous said...


just a brief remark.

Greenspan did not talk about the 'common interests', but was surprised that banks did not better protect the interests of their own shareholders.
So your headline that Greenspan agrees with Soros is not really correct.

Anonymous said...

Hi Steve,

Its not obvious to me that unfettered markets in principle have any advantage in growth rate - why can't a little extra regulation thrown into the mix result in better growth rates? We have a mixture between a completely free market and a completely planned economy currently. Taken to extremes in _either_ direction you will devastate the economy. People need incentives to achieve their full productive potential, but on the other hand they also rely on rules so they can make simplifying assumptions that allow them to do productive work (otherwise we would still all be hunter-gatherers!).

We need to match regulation dynamically to the issues of the day, based on quantitative metrics, not to some preconceived ideas about right and wrong. And governments should get elected based on those quantitative targets. That way we will at least get what we asked for! The metrics were available... Perhaps we ought to insist on minimum educational standards for government representatives :)

Anonymous said...

Ummm Isn't your calculation out? I may be being dense but 1.001^20 = 1.02 in my book.

Steve Hsu said...

wolfgang: technically you are right, but if banks can't even optimize for their shareholders, how can firms optimize the well being for all of society?

g: yes, technically we don't even know the sign of the effect, but I was willing to accept for sake of argument that the conventional wisdom holds.

g: .1 percent additional growth means that after 10 years the unfettered economy is already larger by 1% and by 20 years is up by 2%. For simplicity, you can imagine the differential is put in the bank and saved to pay for a crisis. Over 20 years the unfettered economy has *accumulated* more than enough advantage to pay out 15% of a single year's GDP (e.g., $2 trillion today) and still be ahead of the more regulated economy. It can also take a 2% reduction in its GDP in the wake of the crisis (recession) and still be even.

Anonymous said...

woops I was being dense. Perhaps you should insist on minimum educational standards for commenters on your blog...

Anonymous said...

>> but if banks can't even optimize

Currently they do e.g. more to prevent 'global warming' than anybody else.
So they help the 'common interests'.
Like I said, it all depends on how you define 'common interests'.

Anonymous said...

I agree there is a danger of going too far in reaction to failures of "free" markets.

IMO, one should recognize the distinction between "free" markets and "competitive" markets. There are many ways to use regulation to maintain, manage, or increase competition -- and many ways to reduce competition. To me, the virtues economists extol of "free" markets are essentially consequences of competition.

To give an example, we could find alternative sustainable energy resources by huge government investments. This requires a lot of foresight and intelligent management of public funds. Or, we could impose a huge tax on fossil fuel energies. The allows the market to select for the most promising ideas (and privatizes the costs) -- the role of regulation is simply to tilt the rules of competition in the favor of what we want it to accomplish.

Unknown said...


For a long time I have admired your mathematical prowess and the systematic rigor you bring to your thinking. However, I would suggest that it is getting in your way on this particular point.

The problem with statistical analysis of this kind (how much GDP growth would you need to offset a bubble crash) misses the point. Growth for growth's sake is not valuable. See, the problem I have with numbers in this case is that they don't get sick, eat, and raise families.

Bubbles cause a MISallocation of capital...real estate bubbles especially illustrate this point, because after all that investment and growth, what society basically has to show for it is a bunch of houses that nobody wants. Sure, some people got wealthy, which can have trickle down effects, etc. But in the end, there was a clear misallocation of resources directed toward both the real estate and finance sectors, which was an overall negative for human welfare.

Also, the sinking of GDP does not capture the pain of crashing bubbles. The social and political strains that massive economic swings put on a society is hard to quantify, but creates quite a bit of human suffering. This is why moderate and steady growth, with regulation to check the excesses in both directions, is a good good thing.

Having said that, I want to restate that I enjoy your work immensely. Keep it up.

Steve Hsu said...

Well, I agree that this bubble and the last misallocated resources tremendously. That should be factored into any analysis. But it is tricky to argue how that would compare to under allocation of resources to worthy projects that might result from highly regulated financial markets. (I know, you will claim you can regulate without those negative impacts, but I am skeptical.)

My overall point is that anyone who claims to know the optimal balance with high confidence is probably talking their bias / priors rather than doing a careful analysis.

I agree with comment about the social strain arising due to collapsed bubbles.

Anonymous said...

But it is tricky to argue how that would compare to under allocation of resources to worthy projects that might result from highly regulated financial markets.

Conceive of "regulation" as *discrete* laws/rules/diktat and not as an indivisble lump.

Decompose to component laws/rules/diktat, and examine each per partial effect.

It is impossible to "fine-tune" or do "careful analysis" otherwise.

Seth said...

One of the things you should admit you don't know is: how to attribute "extra growth" to a policy choice. Quite the hypothetical, virtually evidence-free conversation you're starting there ;)

Anonymous said...

One of the things you should admit you don't know is: how to attribute "extra growth" to a policy choice.

Good law-making (or regulation-making, etc) isn't easy and requires true expertise. That's where mere theorizing about the regulatory regime ends and the "rubber hits the road".

But it's possible to try to estimate partial effect in the various ways it's done in any other area.

Steve Hsu said...

STS: I admitted that already!

"g: yes, technically we don't even know the sign of the effect, but I was willing to accept for sake of argument that the conventional wisdom holds."

Thanks for the Sims ref. on the other thread -- I will have a look.

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