Ages of American Capitalism (part 5)

July 13, 2021

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Continuing with the last of Jonathan Levy’s four ages, the “Age of Chaos,” I turn now to the present century and the period including the Great Recession of 2007-2009, the worst economic crisis since the Great Depression. Someday, Americans may look back and see it as the start of a new era in economy and government. So far, however, Levy observes mostly continuity since 2009, and not the new “democratic politics of capital” he would like to see. More on that later.

The “Great Moderation”

In 2004, Ben Bernanke, a governor of the Federal Reserve who would later become its Chair, used this term to describe the economic stability he believed had been achieved. (If this sounds familiar, I recently described Binyamin Appelbaum’s take on the “Great Moderation” in my third post about The Economists’ Hour.) At the time Bernanke was speaking, there had been only 16 months of recession in the previous 21 years. He credited this achievement especially to sound monetary policy, tight enough to control inflation but flexible enough to alleviate recessions by lowering interest rates as needed. Bernanke’s views expressed the capitalist confidence of the time—not only in the stability of the currency, but in the continued growth of economic demand and corporate profits.

Profits were growing rapidly in the 2000s; the bad news was that few of the economic benefits were reaching the average worker. Labor’s share of the national income was plummeting. Levy attributes that to another “credit-fueled and asset-priced” expansion, “which distributed, logically enough, more money to the property owners of assets, rather than to working people.”

Levy then provides a global perspective on this uneven expansion. Much of the world was experiencing an economic boom, but with some noteworthy imbalances. Manufacturing was booming in developing countries with historically low wages, led by China. Other developing economies prospered by meeting the increasing global demand for commodities like oil or iron. Countries of the new European monetary union were expanding their global financial services. The United States contributed a boom in housing and consumption heavily fueled by debt.

The relationship between the U.S. and China was pivotal. China’s communist leaders chose to save and invest much of the revenue from manufacturing exports. While holding down wages and consumption at home, they invested heavily in the United States, in effect financing the soaring U.S. trade deficit. (The federal budget also went from surplus to deficit as the George W. Bush administration cut taxes but increased military spending after 9/11)

The Federal Reserve had lowered interest rates as the economy slowed in 2000-2001. Now the combination of lower-cost loans in the U.S. and capital reinvested by the Chinese produced a “liquidity glut.” That fueled a speculative bubble in U.S. assets, especially housing. The moderation described by Bernanke gave way to a period of speculation and volatility, leading in a few years to financial breakdown.

Sources of profit

Levy does not claim that the American economy of the new millennium was based on speculation alone. Real businesses produced real goods and services and earned real revenue. Internet companies—so many of which had failed in the dot-com bust of 2000—were finding ways to become profitable. One way was to collect massive amounts of user data and sell it to marketers, as Google and Facebook did. Another was to gain a huge advantage over the competition by developing an especially powerful marketing platform, as Amazon did. Levy notes that such business concentrations challenge the thinking of the Law and Economics movement, which had weakened antitrust enforcement on “the assumption that short-term, rational profit maximization among firms would always increase competition to the benefit of all consumers.” One reason why labor’s share of national income declined was that big companies in highly consolidated industries had more power to set wages.

The benefits of the new economy were distributed unevenly, not only because of the growing power imbalance between business and labor, but because of the increasing premium placed on education and skills. The wage gap between college-educated and non-college-educated workers widened. Geographical disparities were also evident, as centers of technological innovation like Silicon Valley flourished, while old manufacturing cities and many rural areas declined. Unemployment remained stubbornly high in what was called a “jobless recovery,” since high-tech industries didn’t employ enough people to compensate for the decline in manufacturing employment. What job growth did occur was more in low-wage services.

A serious underlying problem was that the growth in profits was outrunning the growth in investment and productivity. Levy says that “productivity growth in general disappointed because few potentially productivity-enhancing innovations appeared.” Economic rewards flowed to the owners of intellectual capital (“Big Data”) and human capital (education), but not to enough workers. The investments that might have enhanced the productivity of ordinary workers were not, for the most part, forthcoming. But consumption could still grow if those with stagnant wages could compensate by assuming more debt. That’s where the liquidity glut came in, making it easier to extend debt to people at many income levels. That’s how the expansion of the 2000s turned into the great housing boom of 2003-2006.

U.S. housing prices shot up. Through a “wealth effect,” capital gains on leveraged property ownership could translate into new incomes for American homeowners. The housing stock thus became a new personal income flow. The age’s capitalism of asset price appreciation had found a new asset class to concentrate on, as many ordinary homeowners were given the chance to participate in the game of credit-fueled asset price appreciation. As in credit cycles before, it only worked so long as confidence was maintained, and prices kept going up. That was what the Great Moderation had come to depend on.

In booming cities, residential construction and home prices surged because of increased demand and short supply. But they could flourish in more depressed areas too because of riskier subprime mortgage loans (often with initially low but potentially very high rates). President Bush boasted about the “ownership society,” where ownership of a wealth-producing asset was open to all. The financial services industry constructed a $4 trillion pyramid of mortgage-backed securities on shaky ground. The securities became farther and farther removed from the real financial state of the borrowers and the affordability of the loans. Big banks created various classes of mortgage-backed securities, combined them in complicated ways until rating agencies underestimated their true risk, and even had them backed by insurance companies that also misjudged them.

Levy regards the economic expansion of the 2000s as a “wasted opportunity to make broad-based investments in economic life.” Too many dollars flowed into speculative real estate investments, based on the assumption that home prices would continue rising and workers with stagnant wages could make the payments on their subprime, adjustable mortgages. Meanwhile, “the alarm kept sounding that man-made climate change required long-term fixed investments in a new energy system to capture and reduce carbon emissions.” And climate change was not the only pressing national need being neglected.

The Great Recession

I have discussed the 2008 financial crisis and the associated recession many times, most recently in my summary of The Economists’ Hour, part 3. Levy’s interpretation is based on his understanding of the dynamics of capitalism, including the long-term, linear trend of technological advance and the shorter-term cycles of confidence and credit. The crash of 2008 marked the end of a particularly speculative credit cycle, when a liquidity glut suddenly gave way to a liquidity shortage.

The expansion of the 2000s came to depend heavily on the housing boom, which depended in turn on the extension of credit to home buyers whose low incomes limited their ability to repay the kinds of subprime, adjustable-rate mortgages they were getting. The risks were disguised by complex and overrated securities based on those mortgages. As long as buyers kept buying and confidence in rising home values remained high, the boom could continue. When housing prices peaked in 2006 and loan defaults increased, the bubble burst. Mortgage-backed securities suddenly lost value, and investment banks whose balance sheets were loaded with them could no longer raise cash either by selling them or borrowing against them. The collapse of Lehman Brothers in September 2008 triggered a massive contraction of credit.

Nervous, precautionary hoarding among the global owners of capital broke out on a massive scale. Capitalism regressed back to where it was during the Great Depression of the 1930s—mired in a liquidity trap. Across the board, spending of all kinds, whether for investment or for consumption, dropped off. Employment collapsed.

The “ownership society” celebrated by President Bush, in which Americans would prosper together by owning rapidly appreciating assets, had failed. “Due to collapsed housing prices, between 2007 and 2010 median wealth declined 44 percent—back, adjusted for inflation, to where it had been in 1969.” (That large a drop may sound hard to believe, but a family with a $300,000 home and a $250,000 mortgage has only $50,000 in equity, which drops by 44% if the house loses just $22,000 in market value. Many families have little net worth outside of their home.)

What was different in this financial panic was that the federal government quickly intervened to restore liquidity. The standard procedure of cutting interest rates to ease borrowing and expand the money supply was not enough. In addition, the Federal Reserve arranged and subsidized the buyout of investment bank Bear Stearns by JP Morgan. It made a large loan to AIG, the largest insurer of mortgage-backed securities. The Troubled Asset Relief Program (TARP) authorized the Treasury to buy “toxic assets” that companies could not otherwise sell. (Actually, Treasury injected the cash mainly by purchasing non-voting stock in the companies.) In 2009, the new Obama administration got Congress to pass the American Recovery and Reinvestment Act, which stimulated the economy with tax cuts, aid to states, infrastructure projects and government research programs. In 2010. the Federal Reserve adopted its policy of “quantitative easing,” buying up long-term Treasury and mortgage bonds in order to bring down long-term interest rates. (The higher the demand of lenders for bonds, the easier it is for borrowers to borrow at low rates.)

Although these measures alleviated the immediate crisis, economic recovery was slow. Little was done to prevent ten million homeowners from losing their homes to foreclosure. Nevertheless, a new conservative movement, the Tea Party, formed around the complaint that the Obama administration was doing too much to help “freeloaders” and not enough for “hardworking Americans.” Rather than rallying around Obama as earlier generations of Americans had rallied around Roosevelt, a substantial segment of the electorate still wanted less government, not more.

The limits of reform

On the other hand, Barack Obama was no Franklin Roosevelt either. He filled his administration with leaders associated with the moderate Clinton administration—economic thinkers who had trouble thinking beyond the restoration of financial stability. The Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) tightened regulation on the big banks and securities ratings agencies. But unlike Roosevelt, Obama didn’t have the benefit of many years of more sweeping proposals—in FDR’s case from the Populist and Progressive movements—and a public that was willing to try them. Even Obama’s rather moderate proposal for subsidized health insurance stirred up ferocious opposition.

Levy regards the Obama years as another lost opportunity. Because government could borrow money at near-zero interest rates, it was a great time to consider bigger public initiatives:

[M]any productive opportunities for spending cried out: to repair public infrastructure on dilapidated roads and bridges, to lay the foundations of a “green” energy grid, to invest in productivity-enhancing technology, or to support early childhood education to reverse the drastic effects of education gaps in the future labor market, to name some obvious candidates.

After Levy wrote those words, Joe Biden proposed such an ambitious agenda. But what Levy observed in the aftermath of the Great Recession was a “Great Repetition,” another expansion led more by asset speculation than by productive investment. This time it was an expansion of corporate debt that led the way.

Levy observes that each transition from one age of capitalism to another has required some form of state action. The victory of the Republican Party in 1860 and the Civil War ushered in the Age of Capital, as the nation transitioned from an agrarian economy based on land and slaves to a manufacturing economy based on steam-driven machinery. Then in 1932, the New Deal ushered in the Age of Control, as government tried to guide the economy with regulation, income supports, and fiscal or monetary policies to counter extremes of the business cycle. The “Reagan Revolution” of 1980 reacted against the reliance on government in the Age of Control and initiated the Age of Chaos.

A new age of capitalism—which Levy does not name and does not yet exist—would require more than an income politics focusing on the distribution of the benefits from capitalism. It requires a “democratic politics of capital,” giving citizens a voice in directing capitalist investments toward socially useful ends. Traditionally, government has directed investment primarily to wage war and maintain a military-industrial complex. Otherwise it has left major investment decisions to the private sphere and the owners of capital, who waste too much capital on short-term speculation. Now other urgent national needs may call for an expanded conception of public investment. Levy would probably like Biden’s concept of “human infrastructure.”

Readers who are not put off by the length of this book will find it historically informative and intellectually challenging. I highly recommend it.

Ages of American Capitalism (part 4)

July 5, 2021

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Now I turn to the last of Jonathan Levy’s four ages of capitalism, the “Age of Chaos” that began in 1980. Here is his overview:

What most distinguishes the Age of Chaos is a shift in what has always been capitalism’s core dynamic: the logic of investment, as it works through production, exchange, and consumption. Since 1980, a preference for liquidity over long-term commitment has dominated capital investment as never before. Fast-moving money, rapid investment and disinvestment, across various asset classes, as well as in and out of various companies, has not only overturned the old methods of production—its logic has often threatened to overwhelm other economic patterns. In short, the liquidity of capital has made for a chaotic age dominated by the vagaries of appreciating assets.

For Levy’s assumptions about liquidity, I refer the reader to my first post on his book, especially the section “Economic growth and the liquidity problem.” The gist of it is that the capitalist economy needs liquidity in some form, but too much of certain kinds of liquidity are a problem. Transactional liquidity—money to buy things—is essential, but too much speculative liquidity—money held for short-term trading—generates booms and busts in asset prices without increasing long-term investment, improving productivity, or generating sustainable prosperity.

This post discusses the two chapters that concern the 1980s and 1990s respectively, “Magic of the Market” and “The New Economy.”

The 1980s and the Reagan administration

Levy presents a balanced and insightful description of the interplay between Reaganomics and the economic developments of the 1980s. Reaganomics did not live up to either the hopes of its proponents or the fears of its detractors. Conservatives hoped that if the government would just get out of the way, the “magic of the market”—one of Reagan’s favorite phrases—would restore the postwar prosperity interrupted by the economic shocks and stagflation of the 1970s. But Reagan was unable to revive the manufacturing-based economy with its high productivity, broad-based income growth and trade surpluses. On the other hand, liberals feared that Reaganomics would undo New Deal accomplishments in regulation and income security, taking the country back to the bad old days of predatory robber barons and exploited workers. But many key elements of New Deal liberalism were here to stay, such as Social Security, securities regulation and progressive taxation. And Reagan himself wholeheartedly embraced one aspect of Big Government—higher spending on the military-industrial complex.

Arthur Laffer’s controversial “supply-side economics” had proposed that tax cuts, especially for the wealthy, would stimulate so much private investment and economic growth that they would pay for themselves by expanding the tax base. When that turned out not to be true, Reagan was forced to curb his tax cutting in order to deal with growing budget deficits. He did not succeed in ending the deficit spending that had become chronic in the “Age of Control.”

There was no going back to an earlier time, because a new kind of economy was emerging. Reaganomics didn’t create it, although it did influence it by favoring capital and weakening labor and government. But something else shaped it more decisively—the spike in interest rates engineered by the Federal Reserve under Jimmy Carter’s appointee, Paul Volcker, in order to tame inflation. It worked, but it also triggered the 1981-1982 recession and altered global investment patterns. As inflation fell and the economy recovered from recession, confidence in the value of the dollar returned. It was no longer based on the dollar’s fixed value in gold, however, but on the high interest lenders could earn on dollar-denominated assets. International capital flowed toward the United States, creating a strange new kind of global dominance—a “far more novel U.S. global hegemony.” Postwar America had been a net exporter of goods and capital, like powerful countries before it. Now capital “ran uphill,” and the world’s richest country became a debtor nation. The strong dollar helped Americans buy foreign goods, while making it harder for foreign consumers to buy our goods. But foreigners were happy to take the dollars they accumulated by selling to Americans and lend them back to us by buying American bonds earning high rates of interest. Foreigners helped finance both the trade deficit and the government deficit. As capital flowed in this direction, the U.S. economy had a surplus of credit, while poorer countries had a shortage of credit, reflected in the Latin American debt crisis of 1982.

Earlier, Levy discussed the highly speculative capitalism of the 1920s, which set the stage for the crash of 1929 and the Great Depression of the 1930s. Underlying causes included the manufacturing boom already in progress, the confidence in the currency after the return to the gold standard after World War I, and the quest for high profit margins to compensate for the high cost of borrowing. Levy sees a similar pattern in the 1980s:

Confidence high, to hurdle over the high interest rate, investors resorted to debt to leverage up short-term speculative profits in stocks, bonds, and commercial real estate especially. Speculative investment was back, as the dynamic factor in economic life, joining hands with an insatiable American consumerism.

In one respect though, the 1980s were very different from the 1920s. While the 1920s expansion was associated with the boom in manufacturing investment, the 1980s expansion occurred despite the disinvestment in manufacturing and the lack of any new surge in fixed investment overall. “As profit making shifted toward short-term finance, tellingly the macroexpansion of the 1980s remains the only one on record in which there was a declining share of fixed investment in GDP.” What did occur was a wave of speculative trading and investment in existing companies. There were takeovers by “corporate raiders” and “leveraged buyouts” financed by high-interest “junk bonds.” There were acquisitions of savings and loans by shady owners who took them into bankruptcy at public expense. And if the Ford Motor Company was the iconic firm of the early twentieth century, Donald Trump’s real estate company was a poster child for 1980s speculation:

Trump, leveraging his real estate assets and no less his celebrity, built his Manhattan real estate and Atlantic City casino empire on debt, funded by a “sprawling network of seventy-two banks”…. Trump was emblematic of a larger trend. He was a business concern with very little underlying income generation, relative to his assets, which he purchased through bank debt. When his assets increased in price, he used them as collateral for more loans, which became his income, given that his actual businesses usually lost money in the end. “Truthful hyperbole” was what Trump branded the business model in his ghostwritten autobiography The Art of the Deal (1987).

Reagan’s “capital-friendly policies,” especially tax cuts for the wealthy, contributed to the expansion, but maybe not as he intended. Much of the newly available capital went into speculation rather than productive investment. Some forms of deregulation, such as more permissive rules governing savings and loans and relaxed enforcement of antitrust laws, gave speculators more freedom to operate.

Sources of income also shifted in the 1980s, as income growth became less dependent on productivity gains and more dependent on asset appreciation. The people who gained the most were those who owned tangible assets like homes or financial assets like stocks and bonds. “The financial appreciation of the asset—through its sale (capital gains) or its capacity to be leveraged in credit markets—generated the pecuniary income.” After-tax income for the wealthy increased even more, because of tax cuts. Meanwhile, average hourly compensation for workers remained flat, but their households could increase their spending by taking on more debt.

The expansion that began after the 1981-1982 recession lasted until 1990. When the Federal Reserve raised interest rates in the late 1980s, fearing inflation, firms and households became more reluctant to borrow. Consumer spending declined, real estate values dropped, and the market for junk bonds collapsed. Donald Trump went bankrupt, although he would not stay down for long.

The 1990s and the Clinton administration

The collapse of the Soviet Union in 1991 was a “remarkably optimistic moment” for capitalism. There was even talk of the “end of history,” since capitalist democracy seemed to have emerged victorious over its greatest economic and political rival. Americans expected the United States to remain the strongest economy in the world, dominating what was becoming an increasingly global economy. Prosperity would depend more than ever on the free movement of capital, people and goods across national boundaries. All three, however, tended to flow toward the U.S., as the country continued becoming more a consumer of manufactured goods than a producer, and more a borrower of capital than a lender. The largest American company, Walmart, was not a producer, but a retailer, mostly selling goods made elsewhere.

The good news about the 1990s was that the total rate of fixed investment increased in spite of the continued disinvestment in old manufacturing industries. This was mainly due to new investments in information technology. Productivity growth accelerated and wages improved a bit, while inflation remained under control. The silicon microprocessor was a general-purpose technology adaptable to a wide variety of uses. Silicon Valley emerged as the leading center of the electronic revolution.

A silicon chip is a physical thing, much smaller but just as tangible as an industrial machine. Recall, however, Levy’s broader definition of capital—the “process through which a legal asset is invested with pecuniary value, in light of its capacity to yield a future pecuniary profit.” In the information age, intangible assets like data, social networks and technical skills meet that definition. Intellectual, social and human capital became more vital wealth-producing assets. Society became fascinated by the Internet as the “information highway,” the infrastructure for the free flow of ideas. In that respect, although the forms of capital were different, the emerging economy had something in common with the early manufacturing economy.

Back then, at the dawning auto-industrial society, financial activity sponsored new long-term fixed investments, just as the 1990s saw new long-term investments at the dawning of an Internet-based economy. (By contrast, the 1980s had been a moment of speculative disinvestment, with little creation.)

As promising as the “New Economy” was, it was emerging within a society with unresolved social issues, in particular the unfinished movements for racial, gender and economic equality. Some forms of human capital were highly valued, such as technical skills, while others were overlooked or devalued. Places in the vanguard of economic development, like Silicon Valley, had their divisions between hi-tech jobs for white men and lower-wage service jobs for women and minorities. Many other places didn’t have enough jobs of any kind, although they had increasing rates of incarceration.

President Clinton came into office in 1993 with a liberal agenda that included health care reform and pro-worker labor laws. But the following year, Republicans took control of Congress for the first time since 1954 and issued a very conservative manifesto, the “Contract with America.” Clinton couldn’t pass liberal legislation, but what he could do was embrace the wealth-creating potential of the “New Economy”:

During the 1990s, by contrast with the more improvisational Reagan administration, the “New Democrats” of President Bill Clinton articulated a coherent political-economic settlement for the new age. Clinton went all in on a finance- and technology-driven, center-left vision of “globalization.”

Clinton accepted the conservative proposition, “The era of Big Government is over,” and counted on the free flow of capital and trade to create prosperity for all. He approved the North American Free Trade Agreement (NAFTA) in 1994, and deregulation of telecommunications and banking in 1996. (The Glass-Steagall Act of 1933, which kept the same firm from engaging in both banking and investing, was repealed, mainly for the benefit of Citigroup.) Clinton also promoted the welfare reform bill that made public assistance more temporary and attached work requirements to aid for single parents.

President Clinton’s fiscal policy was also conservative, accepting the need for fiscal austerity and balanced budgets. The theory was that reduced government borrowing would “free up capital for long-term fixed investment.” In 1993, before Republicans took control of Congress, Democrats passed a deficit reduction measure that included both spending cuts and tax increases. As a result, by the late 1990s, the federal budget was in surplus for the first time since 1960. (Every Republican opposed Clinton’s deficit reduction plan, claiming that the budget could be balanced with spending cuts alone. But no Republican administration since Eisenhower has ever achieved that.)

Clouds on the horizon

The period from 1992 to 2000 was an unusually long period of sustained economic expansion. It was based on high confidence, often justified by long-term investments in emerging technologies and resulting productivity gains. However, assets like company stocks appreciated even faster than productivity and profits. In 1996, Fed chair Alan Greenspan warned that the stock market was beginning to show signs of “irrational exuberance.” Capital continued to flow into the U.S., and the quest of capital for high returns fed another speculative boom. As the federal government reduced its borrowing, more capital flowed into corporate stocks and bonds and less into Treasury bonds.

Although the Internet had great business potential, how it would actually fulfill that potential was not yet clear. In 1995, Netscape’s initial public offering sold for $3 billion, although it had no operating profits. So began the so-called “dot-com” boom, in which investors rushed to finance enterprises whose future returns were questionable, to say the least. “Capital had never before moved so quickly into a new asset class.” When E*Trade went online In 1996, stock-trading joined pornography and social networking as popular Internet pastimes. The Nasdaq exchange, which listed many of the Internet companies, reached a price-earnings ratio of 175, compared to a typical ratio of 10 to 20. Then it lost half of its value in 2000 when the speculative bubble burst. But that was nothing compared to the boom-and-bust cycle that would appear early in the new millennium.


Ages of American Capitalism (part 3)

July 1, 2021

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Here I discuss two chapters of Jonathan Levy’s book that describe the end of what he calls the “Age of Control” and the transition to the “Age of Chaos” that began with the election of Ronald Reagan in 1980. Chapter 17 is called “Ordeal of a Golden Age, and Chapter 18 is “Crisis of Industrial Capital.”

The culmination of postwar liberalism

Readers who are too young to remember the 1950s may not appreciate just how much more structured life was than it is now: A one-size-fits-all family structure predominated, with clearly defined gender roles linking a male breadwinner to an economically dependent female homemaker. Corporations were run by rigid bureaucracies staffed by conforming “organization men.” Management and labor had an understanding in which workers could bargain for better wages and working conditions, but management made the major business decisions. Strict boundaries separated the for-profit, nonprofit and public sectors of the economy. Racial segregation was deeply entrenched.

Underlying these structures were the fixed-capital investments of the mass-production manufacturing economy, which generated strong profits for capital and decent incomes for mostly white, male breadwinners. The system was also supported by the liberal state that regulated business, took action to counter recessions, and provided some measure of income security. All this structure came as a relief after the upheavals of Depression and war from 1929-1945. In contrast, the period from 1945-1970 was a time of relative peace and prosperity, although it was also a time of Cold-War jitters accentuated by the Cuban missile crisis and the Vietnam War.

However, the system—structured as it was—did not work equally well for everyone. It worked better for male breadwinners than working women, better for suburbanites than inner-city dwellers, better for residents of the industrialized Midwest than for residents of Appalachia. Industrial America played an especially cruel trick on Afro-descendant Americans, drawing them into the industrial inner cities only to become trapped there as capital and good jobs flowed to the segregated postwar suburbs.

Things came to a head in the 1960s, when a sustained economic boom raised expectations and highlighted the dissatisfactions of the relatively disadvantaged. Protest movements by minorities and women challenged the existing social structure. When the liberal Kennedy and Johnson administrations addressed the issues with civil rights legislation and antipoverty programs, they shattered the postwar consensus. Americans had broadly supported efforts to maintain full employment and support income security in the aggregate. Maintaining “aggregate demand” for mass-produced consumer goods was at the heart of Keynesian economics. But actions to assist economically distressed subpopulations were a bridge too far for many Americans. While liberals saw problems of inequality as defects of social structure, conservatives tended to blame them on personal deviations from conventional structure, such as the failure of poor men to marry their sexual partners and assume the breadwinner role. The rising urban crime and social unrest of the 1960s led to calls for “law and order” as well as calls for liberal social programs.

Despite its many economic successes, the postwar social system was now failing politically. And it was starting to falter economically as well.

The crisis of industrial capitalism

Postwar economic growth was built mainly on the strength of the manufacturing sector. By the late 1960s, however, manufacturing profits were falling, at least partly due to greater international competition. For the first time in the twentieth century, the U.S. imported more goods than it exported in 1971. That meant that foreigners were accumulating more dollars than they wanted to spend on American goods. The Federal Reserve’s reduction of interest rates to fight the recession of 1969-1970 also made it less rewarding to hold dollars. That posed a problem for the international monetary system created at Bretton Woods, since the fixed price of the dollar in relation to gold kept its value from fluctuating in response to its reduced demand. Facing a run on gold by foreigners who preferred gold to dollars, the U.S. abandoned the gold standard. A new era of floating exchange rates began.

Another problem for the U.S. economy was the rising cost of raw materials on world markets, especially the higher price of oil. This was exacerbated by the OPEC oil embargo in retaliation for American support for Israel in the 1973 war.

In the early 1970s, the rate of productivity growth slowed, suggesting that technological innovations in production were not occurring as rapidly as before. In addition, the productivity gains that were occurring were no longer translating into wage gains for workers.

The recession of 1973-1975 was, at the time, the worst since the Depression. In 1975, both the unemployment rate and the rate of inflation exceeded 8 percent, an unusual condition that came to be known as “stagflation.” Levy gives a number of reasons for the high inflation. Economists continue to debate their relative importance:

  • the Federal Reserve’s low interest rates, which encouraged borrowing and allowed too much money to chase too few goods
  • expansionary fiscal policy (including government spending on the Vietnam War and social programs), which raised aggregate demand relative to supply.
  • rising commodity prices caused by the pressure of demand on supply
  • the slow rate of productivity growth, especially in the expanding service sector
  • expectations of continued economic instability, which discouraged long-range planning and investment and undermined productivity growth

Stagflation created a difficult choice between measures to fight unemployment and measures to fight inflation. The conventional Keynesian way of fighting unemployment—deficit spending by government—could worsen inflation by overstimulating aggregate demand.

As great cities of the industrial era struggled, a new kind of economy was emerging in the Sunbelt. Levy focuses on Houston, whose economy was based primarily on oil, petrochemicals, and real estate. It was a booming, sprawling, rapidly suburbanizing city with no urban plan and no zoning ordinances. It’s manufacturing labor force was relatively small and nonunionized, but its expanding service economy created many jobs for women. This set up a “postindustrial positive feedback loop”—Employed women needed to buy services they might otherwise have provided themselves, and those services in turn provided employment for women. The 1950s marriage with the economically secure breadwinner and the non-employed homemaker was no longer the norm. Houston was a heavily “privatized” city, with low taxes and limited public services. Levy also calls it a “liquid city”—with the pun definitely intended:

Houston was a liquid city because it sat on wetlands and always flooded, and also because of its great economic premise, oil. But its pattern of development uncannily embodied some of the themes of speculative liquidity preference: an energetic restlessness, the convertibility of once seemingly unlike things, markets for everything, and a busy present with no heed for the long term.

In that sense, Houston was in the vanguard of the “Age of Chaos” to come. The more conservative economic ideas that would come to dominate that era were also born in the 1960s and 70s. The monetary school under the leadership of Milton Friedman rejected Keynesian economics and limited the government’s role in the economy mainly to managing the money supply. The Law and Economics movement questioned whether anything could be accomplished with government regulation that couldn’t be accomplished through market competition. The rational expectations school explained how government policies could be undone by people’s conscious reactions to those policies. For example, interest-rate reductions by the Fed could lead lenders to expect more inflation, which induced them to demand higher interest rates on their loans. The mathematical analysis often got complicated, but the conclusion was simple: “In the abstract, markets were efficient and just—which just happened to agree with what the CEOs of the Business Roundtable already knew in their guts rather than from any mathematical model.” Economists were undermining the intellectual rationale that had justified government influence over markets during the “Age of Control.”

The administration of Jimmie Carter was already moving away from liberal economic policies before he lost the 1980 election to Ronald Reagan. Congress had passed major new pieces of regulatory legislation—the Clean Air Act, the Consumer Product Safety Act, and the Occupational Safety and Health Act—as recently as 1970. But by 1978, “the drift now was not to write better market regulations: even among liberals, it was to throw in the towel on market regulation altogether.” Industries that experienced a relaxation of regulation were airlines, trucking, and banking. By the end of his administration, Carter was placing a higher priority on fighting inflation and balancing the budget than on spending to create jobs. “For the first time since the early 1930s, austerity was back in economic policy making.” Perhaps Carter’s most economically consequential act was to appoint Paul Volcker as chair of the Federal Reserve. His tight control over the money supply brought the rate of inflation down dramatically, but allowed interest rates to rise to astronomical levels, crushing borrowing and bringing on the 1981-1982 recession.

In retrospect, the Age of Control had succeeded, for a time, in creating conditions under which capital would remain productively invested in a mass-production economy. Government had taken many measures to inspire confidence—confidence that the currency would retain its value, that stock investors would have accurate information about a company they were buying, that workers could bargain for a share of the value added by their rising productivity, that retired employees could have a decent income, that depositors could put their money safely into a bank, and that government would borrow and spend to combat recessions. When faced with new economic conditions, like increased global competition for manufacturing jobs, rising oil prices, and demands for inclusion by historically disadvantaged groups, liberal government was overwhelmed. The Age of Control ended, and government increasingly left it to the capitalists and their free markets to make a new economy.


Ages of American Capitalism (part 2)

June 29, 2021

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Jonathan Levy divides American economic history into four ages:

  1. The Age of Commerce (1660-1860)
  2. The Age of Capital (1860-1932)
  3. The Age of Control (1932-1980)
  4. The Age of Chaos (1980- )

Here I discuss the Age of Control, which is the era of the New Deal, World War II, and the postwar prosperity.

The Great Depression

“Rarely if ever before had an industrial economy been so poised on the brink of a great leap forward in wealth-generating enterprise. But it had stalled in mid-leap.” The run-up to the economic crash of 1929 is a prime example of one of Levy’s general observations, that major investment booms involve both long-term fixed investment that drives real economic growth and speculative bubbles that end badly. In this case, much of the new investment was in “Fordist” mass production of consumer goods like cars and home appliances. The electric assembly line represented the “largest surge in labor productivity ever recorded.” Unfortunately, high productivity does not translate directly into sustained economic expansion and lasting prosperity. The story of economic history must include the cyclical fluctuations in confidence and credit as well as the linear trend in technological innovation and rising productivity.

At the beginning of the 1920s, investor confidence was high. But one reason for the high confidence also contained the potential for a boom-and-bust cycle. During World War I, European governments had gone off the gold standard and expanded the money supply in order to finance the war effort. Now they returned to the gold standard and restricted the money supply to fight inflation. The U.S. Federal Reserve went along by raising interest rates. These policies contributed to a temporary situation of price stability, confidence in the currency, and a willingness of investors to lend, but at relatively high rates. The high rates set a high bar for business investments, which only made sense as long as the returns exceeded the costs of borrowing.

All was well as long as confidence in future profits remained high but also realistic. But once the boom got going, speculators could easily borrow too much in order to pay too much for assets whose real prospects couldn’t justify their cost. When these unrealistic expectations went unfulfilled and profits didn’t materialize, confidence was shaken, credit dried up, and investment collapsed. In 1931, the Federal Reserve made things worse by further tightening the money supply. By the time Franklin Roosevelt was elected in 1932, the economy had entered a “liquidity trap.” Precautionary liquidity had taken over, and businesses were afraid to invest in production even when they could borrow at lower rates. The Fed brought interest rates down, but it was too late. The economy hit bottom in 1933, with economic output only half of what it had been in 1929 and unemployment over 20%. The most productive factories the world had ever seen couldn’t sustain prosperity if they were idle.

New Deal capitalism

One of the first things the new administration had to do was counter the collapse of confidence that kept the economy in the liquidity trap. Much economic activity had simply come to a halt, as lenders were afraid to lend money they might not get back, businesses were afraid to produce goods that wouldn’t sell, and consumers were afraid to spend what little money they had as incomes fell. Roosevelt’s famous declaration that “we have nothing to fear but fear itself” was more than just rhetoric. The crisis of confidence went beyond the economy to challenge government as well. As some European countries turned to authoritarian leaders to address the crisis, many Americans questioned whether liberal democracy was up to the task.

Roosevelt believed that it was, and he welcomed the characterization of his policies as “liberal”. In its early days around the time of the Civil War, the Republican Party had been the liberal party, but now Democrats earned that label, leaving many Republicans to play the part of conservative doubters of the New Deal.

Democratic efforts to get the economic crisis under control initiated the “Age of Control.” One of the first things Roosevelt did was adopt a policy he called “definitely controlled inflation” by taking the country off the gold standard. Rather than be inhibited by the supply of gold, the money supply could expand along with economic activity. In fact, monetary expansion could encourage economic activity—at least in the short run—by putting more dollars in the hands of spenders, including the government itself.

Levy distinguishes two different kinds of economic liberalism, regulatory and developmental. While the New Deal was strong on economic regulation, it was weaker on directing the nation’s investment, a weakness that Levy sees as a problem to this day.

The two main objects of New Deal regulation were business practices and income security. The Security Exchange Act created the SEC to regulate publicly traded corporations and curb the worst abuses associated with financial speculation. It banned insider trading, required regular financial reports, and contained many provisions to prevent fraud. The Social Security Act created not only social insurance for retirees, but unemployment compensation and aid to poor women and children. The National Labor Relations Act guaranteed the right of workers to organize and collectively bargain. The Fair Labor Standards Act set maximum hours and minimum wages. New agricultural programs supported commodity prices to provide more stable farm incomes. If Americans were more secure in their incomes, they would feel more comfortable buying the goods that the emerging mass-production economy was capable of producing.

Developmental liberalism tried to stimulate investment in two ways. It lent capital to private investors, especially in banking, real estate and agriculture. It also made massive public investments in infrastructure through projects like the Tennessee Valley Authority.

These programs were liberal but not radical. They did not overturn the fundamental assumptions or power structures of capitalism; nor did they bring the Depression to an end, although the economy did improve from 1933 to 1936. Levy’s assessment:

New Deal capitalism was a variety of capitalism because the discretionary power of when and where to invest remained in the hands of the owners of capital. During the 1930s, whether the investment was private (incentivized or not) or public, its combined magnitude was simply insufficient to draw out sufficient economic activity to end the Great Depression. A general lack of initiative and spending remained.

In 1937, the government contributed to a “recession within the Depression” by prematurely trying to balance the budget and tighten monetary policy. Levy also suggests that a new kind of liquidity preference played a role, one that he calls “political liquidity.” Industrial capitalists who opposed the New Deal “threatened not to invest unless their political demands were met, especially for lower taxation on their incomes.”

In 1938, Roosevelt accepted deficit spending as a way to stimulate the economy. John Maynard Keynes had presented the rationale for this in The General Theory of Employment, Interest, and Money (1936). But he also warned, in 1940, “It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiment which would prove my case—except in war conditions.”

World War II

As Keynes expected, the massive government spending required by World War II was what brought the economy back to full production. It also provided a powerful psychological stimulus, generating popular support for an all-out political and economic effort to win the war. Economic preferences shifted dramatically toward fixed investment and away from any kind of liquidity—precautionary, speculative, or political. Why be shy about investing, when the government provided a willing buyer for all the armaments a factory could turn out? By 1942, the U.S. was winning the “war of the factories,” surpassing both Germany and Japan in the production of munitions.

Big Government liberalism thrived in both its regulatory and developmental aspects. On the regulatory side, government raised taxes, rationed consumer goods like gasoline, and implemented wage and price controls to curb inflation. On the development side, military planners told industry what to invest in.

World War II also encouraged a spirit of shared sacrifice and shared rewards. In addition to winning the war itself, Americans could expect a more equal distribution of economic benefits, through measures such as a more progressive income tax, support for organized labor, and the GI Bill of Rights.

The American military-industrial machine not only won the war, but unlike the economies of other combatants, remained undamaged by the war. Now that we had a fully-functional mass-production system up and running, we just had to convert it to peacetime uses.

Postwar prosperity

Levy uses the term “postwar hinge” to refer to the unique connection between domestic politics and international politics at the end of World War II. “At the war’s close, Americans owned three-quarters of all invested capital in the world, and the U.S. economy accounted for nearly 35 percent of world GDP….” Big Government combined with capitalist industry to make the U.S. the most powerful country in the world, the biggest exporter of products, capital, democratic ideas and consumer culture. The U.S. was the newest hegemonic power, although its hegemony was challenged by its next-strongest rival, the Soviet Union.

As a result of the Bretton Woods conference of 1944, the American dollar became the anchor of the global financial system. The dollar was agreed to have a fixed value in relation to gold. Other currencies would have a value in dollars, but could be revalued under certain circumstances. This arrangement institutionalized the dollar as the world’s strongest currency and helped secure the value of investments denominated in dollars.

Although wartime military spending declined, government contributed in a number of ways to the continuation of the private investment boom—not only maintaining the strength of dollar, but continuing support for income security, maintaining a military establishment during the Cold War, and engaging in Keynesian deficit spending to counter recessions.

At the same time, postwar politics placed definite limitations on government’s role in the economy, especially with respect to developmental liberalism. The owners of capital reassumed control over investment decisions, choosing, for example, to direct investments toward single-family homes and shopping malls in all-white suburbs, while inner cities were allowed to decay. Government cooperated by providing highway construction and racially discriminatory housing loans. Once the Cold War began, conservatives could exploit the fear of communism to defeat liberal proposals for greater government influence. Among the casualties were Harry Truman’s call for national health insurance in his “Fair Deal,” the Taft-Ellender-Wagner public housing bill, and a provision within the Full Employment Act of 1946 that called for supplementing private investment with public investment in order to maintain full employment.

The federal government might tax and redistribute incomes, and it might regulate specific industries, but it remained incapable of acting autonomously and creatively in furtherance of a recognized public interest beyond “national security.” Cold War military spending was the most legitimate form of government expenditure to sustain economic growth…. That the government enjoyed an autonomous arena of action only when targeting benefits toward white male breadwinners, or invoking national security, warped state action at home and abroad…. Surely government planning for long-term economic development on behalf of the public interest was off the table.

The political economy of the postwar era was strong enough to produce a postwar economic boom and raise incomes for millions of white working families. The era became known as a “golden age” of capitalism. Yet it was not sustainable enough to last more than a few decades before things started to go seriously wrong again.


Ages of American Capitalism

June 24, 2021

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Jonathan Levy. Ages of American Capitalism: A History of the United States. New York: Random House, 2021.

I found this book to be a remarkable work of economics and American history. A lot of economics consists of ahistorical models intended to describe economies in general but no one time and place in particular. Such abstract models are useful tools, but need historical context to bring them to life. On the other hand, many historical accounts do not demonstrate a very good grasp of economic principles. Jonathan Levy is one of those rare scholars with both a fine command of historical facts and great insights into the workings of capitalism. The fact that he has accomplished this at an early stage of his career is all the more impressive.

I cannot do justice to the entire book (over 900 pages long with notes and index), but I will discuss selected chapters. Here I start with the Introduction, which sets forth Levy’s assumptions about the nature of capital and the capitalist economy.

Capital and capitalism

Levy presents three main theses, the first of which is:

Rather than a physical factor of production, a thing, capital is a process. Specifically, capital is the process through which a legal asset is invested with pecuniary value, in light of its capacity to yield a future pecuniary profit.

The first things that come to mind when one hears the word “capital” may be capital goods like the steam engine, which Levy describes as the most important capital good of the Industrial Revolution. But capital is anything that can generate a return greater than its cost. That includes financial capital like stocks and bonds, intellectual capital like software and data, or human capital like educational credentials. In the antebellum South, slaves were the most valuable capital, more costly in total than southern land or northern factories. Many forms of capital produce marketable goods, but capital assets can also appreciate in value while not producing anything at all. What capital assets always have is some “scarcity value” because some people own more of them than others. Those owners are, of course, the people we call capitalists.

Levy defines a capitalist economy as “one in which economic life is broadly geared around the habitual future expectation that capital assets will earn for their owners a pecuniary reward above their cost.” The term expectation is key. A future reward is always uncertain, since it depends on the “flow of historical events.” What drives capitalism is investment, and what drives investment is confidence in some future. Andrew Carnegie could only sink massive quantities of financial capital into steel mills if he believed in the future demand for steel. In the twentieth century, when the economy produced far more consumer goods, business confidence became more dependent on consumer confidence, which depended in turn on consumer income and its security. People can buy more if they have a reliable income and are confident they can make next month’s rent.

Another important form of confidence is faith in the value of the nation’s currency, especially on the part of financial investors. Lenders would like to know that the dollars they lend will come back to them—with interest or dividends, of course—in dollars that have retained their value. They want the government to maintain the scarcity value of money through relatively tight control of the money supply. A challenge for monetary policy is to maintain the confidence of lenders while allowing the money supply to grow along with the expansion of domestic product and commerce. “Because a capitalist financial system is a perpetual leap of faith, over and over again, confidence becomes the emotional and psychological mainstream of economic activity.” The corollary to that proposition is that every financial crisis is a crisis of confidence. That’s why financial crises have often been called “panics”.

I would add that capitalism may require a modern culture that encourages faith in a worldly future, one imagined as better than the present. That view is in contrast to a static conception of life or a preoccupation with an otherworldly afterlife. (Although that is a secular vision, the historical religions of Judaism and Christianity may have prepared the way with their belief in a future “promised land.”) Interest in a worldly future was a feature of the Enlightenment, and one of its proponents was Adam Smith, a major figure in the Scottish Enlightenment and the father of classical economics.

Profit motives in political and social context

The second of Levy’s three theses is:

Capital is defined by the quest for a future pecuniary profit. Without capital’s habitual quest for pecuniary gain, there is no capitalism. But the profit motive of capitalists has never been enough to drive economic history, not even the history of capitalism.

The pursuit of profit, while central to capitalism, is normally part of some larger project. Henry Ford had a vision not only of selling automobiles, but of helping create a society of mass production, consumption and leisure, a vision he got partly by reading Emerson. He also rather heavy-handedly imposed a vision of the ideal worker, characterized by self-discipline, sobriety and frugality and enforced by visits of company representatives to workers’ homes. In an earlier time, southern plantation owners were motivated by white supremacy as well as economic profit. Among the many ill-gotten gains were sexual privileges for white males.

Major developments in capitalist history have been political as well as economic projects. When the Republican Party came to power in 1860, its political agenda included stopping the spread of slavery into the West, thus both striking a blow for free labor and undermining the value of slave capital. Republicans also supported the Homestead Act of 1862, which made 160-acre plots of federal land available for western settlers. Since farmland was also a form of capital, this was a contribution to a democratic “politics of capital.” But that was before the huge concentrations of capital in the latter part of the century. As the nation industrialized and urbanized, and mechanization reduced the need for farm labor, the portion of the population that could own land or businesses declined. Political debate eventually came to focus more on a “politics of income.” The New Deal was a political project with large economic implications, as the Roosevelt administration tried to boost incomes by supporting job creation, labor unions and the ideal of the male breadwinner. The “Reagan Revolution” of 1980 was a very different political and economic project, turning away from the democratic politics of income to provide more support for capitalists in the form of reduced taxes and regulation. These interconnections allow Levy to assert, “The history of capitalism must be economic history but also something more.”

Economic growth and the liquidity problem

Levy describes capitalism as having two different dynamics related to time. The first is a long-term, linear pattern of economic growth, driven by technological improvements and increases in productivity. The second is a cyclical pattern of boom and bust, driven by fluctuations in confidence that affect lending and investment. That brings us to Levy’s third thesis:

The history of capitalism is a never-ending conflict between the short-term propensity to hoard and the long-term ability and inducement to invest. This conflict holds the key to explaining many of the dynamics of capitalism over time, including its periods of long-term economic development and growth, and its repeating booms and busts.

The key concept for understanding these dynamics is liquidity. The capitalist economy needs liquid assets, which are assets that hold value but can also be readily exchanged for other assets. Cash is the best example, but financial assets that are easily traded, like Treasury bills, also qualify. But here’s the other side of the coin, no pun intended. For capitalism to work, someone must invest in “relatively illiquid factors of production,” like factories! Up to a point, liquid and illiquid assets work together in capitalism. One kind of liquidity is transactional liquidity, which means that buyers have the cash to buy the products that a capitalist enterprise produces when it invests in the (illiquid) factory or other capital goods.

In other ways, liquidity can be the enemy of long-term investment. In the case of precautionary liquidity, people hoard capital because of a lack of confidence in the future. They are reluctant to invest because of a fear of losing their money. In the case of speculative liquidity, capitalists maintain a large cash position so they can jump in and out of short-term investments, seeking the quickest return. The day trader buys stocks in the morning and sells them in the afternoon, ready with the cash to repeat the process tomorrow. (That works best when prices are generally rising, but as they say, you should never confuse genius with a bull market.)

Historically, investment booms have usually involved both long-term fixed investment and shorter-term speculative trading. When speculation bids assets up to unrealistic levels, the cycle ends in an economic bust, at which point the loss of confidence discourages investment and encourages precautionary liquidity. At the beginning of a boom, confidence is high, based initially on some realistic expectation of production for profit. But the accumulation of profits finances a speculative frenzy, ending ultimately in a crisis of confidence—a panic—and an economic contraction.

In Chapter 7, for example, Levy describes the railroad boom of the 1860s, which ended in the Panic of 1873. Building railroads for steam-powered trains was a pretty good idea, especially to move agricultural produce from midwestern farms to eastern cities and ports. It was a political as well as economic project, with the federal government chartering railroad corporations and granting them millions of acres of land. Soon, however, railroad entrepreneurs—most notably Jay Gould and Cornelius Vanderbilt—were speculating in railroads as well as building them.

Why go through the time, hassle, and uncertainty of actually building a railroad and running it on a profitable basis when credit was readily available (for these men at least)? If the right rumor gripped the trading floor, they could turn a fast buck through leveraged speculation on a financial asset, without ever having to part with liquidity, and put capital on the ground where it became a fixed, running cost.

Notice that this was “leveraged speculation.” The most lucrative way to speculate is to make money with borrowed money (just as a home buyer can do by making only a downpayment, but immediately getting the right to any appreciation). But when doubts appear that a boom is sustainable, credit dries up, debts are called in, and panic-selling devastates asset values. In the Panic of 1873, which began with a credit crunch and higher interest rates in Britain, railroad stocks lost 60% of their value, and half of American railroad corporations went bankrupt. That same year, by the way, Mark Twain and Charles Dudley Warner gave the era its name when they published The Gilded Age.

Similarly, the “greatest leap forward in productive capacity in world history” occurred when Henry Ford introduced his moving assembly line in 1913—another useful idea, although not much loved by those who had to work on it. But this was quickly followed by the frenzied stock market speculation of the 1920s, the crash, and the Great Depression of the 1930s. Most recently, the housing boom of 2003-2006 turned into the Great Recession of 2007-2009.

The “key economic problem,” according to Levy, is the perennial weakness of investment resulting from the hoarding of capital for purposes of precautionary or speculative liquidity. He sees this as an especially acute problem in our economy today. The assumptions he lays out in this Introduction—a broad definition of capital, a conception of motivation that includes but goes beyond financial profit, a conviction that economics and politics are always intertwined, an appreciation of the importance of expectations and confidence, and the tension between some forms of liquidity and long-term productive investment—enable Levy to tell the story of American capitalism in an exciting and insightful way.

Levy’s main message is that a capitalist economy is not a standalone machine that automatically produces general prosperity if it is left alone, as some economists in the neoclassical tradition still teach. Rather he says:

History does not confirm the belief in the existence of some economic mechanism through which the pattern of capital investment will simply lead to the best possible outcome so long as it is not interfered with. One likely outcome, among others, is that the propensity to hoard will win out, exacerbating inequality and crippling economic possibilities. As the profit motive is not enough, a high inducement to investment must come from somewhere outside the economic system, narrowly conceived. History shows that politics and collective action are usually where it comes from.

In other words, getting the economy to work for all of us is a continuing challenge for society in general, and democratic politics in particular.