Why Minsky Matters (part 5)

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To conclude this summary of L. Randall Wray’s Why Minsky Matters, I turn to Wray’s description of Minsky’s policy proposals. These proposals are grounded in Minsky’s understanding of the capitalist economy as an inherently unstable system. In order to function well, it needs more than the occasional nudge from government to counter departures from equilibrium arising from external shocks. It needs a set of institutionalized constraints to keep business cycles from spinning out of control, especially because they are amplified by financial cycles of speculation and panic.

Minsky’s approach to policy is based on a broad conception of capital development: “Minsky used the term ‘capital development’ in a very broad way to include public and private infrastructure investment, technological advance, and development of human capacities (through education, training, and improvements to health and welfare).”

Minsky saw two main ways that capital development could go wrong. One is that the economy might not be investing enough to utilize its productive capacity and keep workers fully employed. That was the problem that preoccupied most Keynesian economists. The other is that the financial system was financing the wrong investments, especially speculative investments that are doomed to fail. Overinvesting in lavish office buildings and mansions while failing to build affordable housing would be an example. This problem relates more to Minsky’s distinctly financial brand of Keynesian economics.

To address both problems, Minsky envisioned a larger role for government than orthodox economists have traditionally envisioned. This applies not only to neoclassical economists, but also to Keynesians who sacrificed too many of Keynes’s original insights in their effort to accommodate neoclassical thinking.

Limitations of postwar policy

Minsky regarded the economy of the postwar era as more stable than either the economy of the earlier Roaring Twenties or that of the more recent Reagan era. Nevertheless, because he believed that stability could lead to overconfidence and instability, he saw the seeds of future problems in postwar policy, especially the standard form of Keynesian policy at that time.

As an example, I’ll use what has been called “military Keynesianism,” the heavy reliance on defense spending to keep the economy running at high capacity. It did stimulate production, as did the wartime spending often credited with ending the Great Depression. But Minsky had several concerns, which also applied to other ways that government encouraged private investment. First, the economic benefits went especially to corporate shareholders and high-skilled workers. Second, the high incomes of those groups encouraged their high consumption—as well as “emulative consumption by the less affluent, creating the potential for demand-pull inflation.” When inflation did occur, government would tighten fiscal or monetary policy to fight it, slowing the economy and making sustained progress against unemployment impossible. Finally, booms in private investment could produce business overconfidence and debt-financed speculation, according to Minsky’s instability theory.

Minsky was very interested in reducing poverty, but he was a critic of the War on Poverty launched by the Johnson administration in the 1960s. His main concern was that it did not sufficiently address the underlying problem of job creation. Instead, it focused on income assistance through such programs as food stamps and Aid to Families with Dependent Children, and on job training programs. Minsky objected to the assumption that the barrier to employment was the worker’s qualifications instead of industry’s demand for workers and its incentive to train them.

The idea was that the War and Poverty would prepare those who could work, upgrading their skills, and it would provide welfare and food stamps to those who could not, would not, or should not work. Finally, it would rely on the private sector to create jobs for the new workers seeking them.
Still, unemployment rates (and especially jobless rates) have trended upward since the 1960s, long-term joblessness has become increasingly concentrated among the labor force’s disadvantaged, poverty rates have remained rigid, real wages for most workers have declined since the early 1970s, and labor markets and residential neighborhoods have become increasingly segregated as the “haves” construct gated communities and the “have-nots” are left behind in the crumbling urban core. In other words, the War on Poverty not only failed to reduce poverty, but it also failed to provide jobs on a sustained basis to those who wanted them.

Of course, Minsky was even less enthusiastic about the policies of the Reagan-Bush era, which continued to stimulate the economy through defense spending, but prioritized inflation-fighting over full employment and largely abandoned the effort to raise wages or reduce poverty. The results of returning to laissez-faire economics were just what Minsky expected—greater economic inequality and more financial instability.

Government spending

While Minsky was no Marxist, he did want a larger role for government in the economy. Given the large fluctuations in private investment as business confidence rises and falls, the government’s budget must be large enough to offset investment declines when they occur. The government’s fiscal deficit must also be at least as large as the country’s current account deficit (which is the surplus of dollars held by the country’s trading partners when the U.S. imports more than it exports). Otherwise, the country’s private sector will be running a deficit and accumulating more financial liabilities than assets. Since private debt is riskier than federal debt, that increases the risk of financial bubbles and busts.

Minsky wanted more from government spending than national defense or “welfare” in the narrow sense of the term. He wanted it to grow the economy more from the bottom up.

[G]overnment spending—especially on wages—should play a major role in generating growth. This is because a sovereign government can increase its spending—even if that results in a budget deficit—without increasing risk of insolvency and default. In contrast, if private spending leads the way, it will tend to outpace income of households and firms, meaning that private indebtedness will grow. That is risky and ultimately unsustainable

Minsky’s preferred method for keeping the economy going without encouraging speculative and unsustainable investments was targeted government spending. He wanted to spend on things that simultaneously boosted incomes and added to the productive capacity of the economy, such as improvements in infrastructure. The model for this was the New Deal programs that put people to work doing socially useful things. As Keynes said, “To set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth.”

At the heart of his program is the idea of government as the Employer of Last Resort (ELR). A government jobs program would automatically stabilize the economy by maintaining full employment in times of low private-sector demand, but provide some job experience for workers who could enter or re-enter the private sector in times of economic expansion. Stephanie Kelton’s Public Service Employment proposal, which I discussed recently, was inspired by Minsky’s work.

Financial reform

The general goal of financial reform is to encourage prudent banking, but not riskier financial speculation. “Banking should not be like gambling because the bank needs to ‘win’ around 98 percent of the time whereas a casino can be profitable if the house wins 52 percent of the bets.” The prudent banker is committed to repaying all depositors and expecting repayment from the vast majority of borrowers. Some segmentation of prudent banking from speculation is desirable, so that people can obtain financial services without taking on more financial risk than they want.

Minsky wanted the government to promote small community banks that knew their customers well enough to perform good underwriting. He was willing to let banks expand their financial services beyond federally insured accounts, as long as they reserved their insured accounts for the safest investments. He wanted the Federal Reserve to supervise the banks more closely. For example, instead of creating additional reserves for any bank willing to borrow them, he wanted the Fed to see evidence that the bank had the cash flow to service the additional lending.

Minsky was not a fan of the huge financial institutions he saw emerging in his time.

Minsky worried that the trend to megabanks “may well allow the weakest part of the system, the giant banks, to expand, not because they are efficient but because they can use the clout of their large asset base and cash flows to make life uncomfortable for local banks: predatory pricing and corners [of the market] cannot be ruled out in the American context.”

Minsky was concerned both that the financial sector was growing so large, and that it was dominated by such big and highly speculative firms. Letting them grow too big and then protecting them from their failures created a “moral hazard,” rewarding socially irresponsible behavior. Financial institutions should not be able to claim deposit insurance or other forms of government protection for high-risk investments. If they did get into financial trouble, their owners and their uninsured creditors should bear the losses. Minsky did not live to see how the government had to protect “too-big-to-fail” financial firms during the global financial crisis, but he would have seen it as a sad result of an era of financial excess.

Closing remarks

I found Wray’s presentation of Minsky’s economics very enlightening, although I thought the book could have been better organized. I found the introductory and concluding chapters too long and detailed, resulting in the same topics being discussed several times in somewhat different ways. When I came to summarize a topic, I found the information I needed scattered around the book. What is more important, however, is that Wray introduces readers to a critic of contemporary capitalism whose views need to be a part of the economic debate going forward, as I am confident they will be. Minsky’s economics seems more realistic than the highly idealized picture of the economy painted by more orthodox theory.

This quote from Minsky himself goes to the heart of his policy position:

When designing and advocating policies economists and practical men alike have to choose between the Smithian theory, that markets always lead to the promotion of the public welfare, and the Keynesian theory, that market processes may lead to the capital development of the economy being ill-done, i.e., to other than the promotion of the public welfare.

Wray concludes that Minsky’s economics is a step in the direction of a more humane “shared-prosperity” capitalism, a path which contemporary democracies have yet to take.

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