A Measure of Fairness

February 25, 2015

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Robert Pollin, Mark Brenner, Jeannette Wicks-Lim, and Stephanie Luce. A Measure of Fairness: The Economics of Living Wages and Minimum Wages in the United States. Ithaca: Cornell University Press, 2008.

Having looked at a book about the history of the living wage, I turn now to the modern economic debate over efforts to raise wages. Most of this book reports research on the costs and benefits of state and municipal wage legislation. In general, the authors find these laws effective in modestly raising incomes for the low-wage workers they are intended to benefit. They also impose some costs, but those are generally small and widely diffused among many people, such as consumers who have to pay slightly more in prices.

The most common argument against legislated wage increases is that they may hurt the very workers they are trying to help, since some employers may employ fewer workers, relocate their businesses, or spend less money on other things that benefit workers. I will discuss the authors’ research on such issues in a later post.

First, however, I’d like to address a more philosophical issue on which advocates and opponents of living-wage laws often disagree. The argument over wages is not just an economic argument in the narrow sense; it is also a moral debate. The title of Chapter 2, “The Economic Logic and Moral Imperative of Living Wages,” makes that clear. So does this passage from the UN’s Universal Declaration of Human Rights (expressed in the gendered language of the 1940s): “Everyone who works has the right to a just and favorable remuneration ensuring for himself or his family an existence worthy of human dignity and supplemented, if necessary, by other means of social protection.” In discussing Glickman’s history of the living-wage movement in the previous post, I quoted his statement that “religious reformers were the first group outside of the labor movement to call for a living wage, beginning with Pope Leo XIII’s encyclical of 1891.”

Some of the opposition to living-wage proposals is based on resistance to the idea that moral considerations can be brought to bear on economic behavior. Chapter 3 includes a reprint of Paul Krugman’s critique of an earlier book by Robert Pollin and Stephanie Luce, The Living Wage: Building a Fair Economy. For Krugman, the very fact that Pollin and Luce have a moral preference for higher wages over government handouts makes their entire argument suspect.

The problem for Krugman is that markets are “absolutely and relentlessly amoral. Labor, in a market system, is just another commodity; the wage a man or woman can command has nothing to do with how much he or she needs to make to support a family or to feel part of the broader society.” Krugman sees three possible responses to this amorality of markets: (1) a pro-market conservative response that fails to see any moral problem here, since whatever the market does is just, (2) an anti-market “socialist” response that tries to “do away with the market’s determination of incomes,” in favor of some more just alternative, or (3) “after-market intervention: Let the markets rip, but then use progressive taxes and redistributive transfers to make the end result fairer.”

Krugman supports choice #3 as the “standard economist’s solution, which is also the main way the U.S. welfare state operates.” It accepts the amorality of the market and confines moral responses to the political sphere. The living-wage movement, on the other hand, is a form of choice #2, which can’t work because it tries to bring morality into an inherently amoral sphere of behavior. So he concludes:

In short, what the living wage is really about is not living standards, or even economics, but morality. Its advocates are basically opposed to the idea that wages are a market price–determined by supply and demand–the same as the price of apples or coal. And it is for that reason, rather than the practical details, that the broader political movement of which the demand for a living wage is the leading edge is ultimately doomed to failure: For the amorality of the market economy is part of its essence, and cannot be legislated away.

In his response to Krugman, Pollin is troubled by the implications of such a sweeping argument. If living-wage legislation is “doomed to failure” because it tries to counter market forces, then wouldn’t the same objection apply to any effort to regulate wages and working conditions, even laws against child labor and slave labor? If markets are absolutely amoral, then how can “letting the markets rip” always be good social policy?

In essence, Krugman’s position seems to me to come down to three propositions:

  1. Powerful market forces determine wages
  2. Efforts to counteract those forces as they are operating are doomed to failure
  3. Only after-market policy measures can be effective

I wonder if scientists working in any other discipline besides economics would accept this logic. If we were talking about forces of nature, such as the weather or harmful bacteria, would we agree not to counteract such forces as they are operating? Well, we don’t have much control over the weather, so we do often resort to “after-weather” measures to undo whatever damage is done. We “let it snow, let it snow, let it snow” (the meteorological equivalent of letting the market rip), and then clean up the mess afterwards, just as Krugman wants to do with incomes through progressive taxation). But where we have gained a measure of control over natural forces, such as diseases, we do try to counteract harmful forces as they are operating, with timely treatment and even preventive measures like vaccination.

Isn’t this true in the economy as well? Supply and demand considerations may lead a pharmaceutical company to market an unsafe drug, but the FDA tries to intervene before the damage is done. The market may reward a company for dumping toxic waste, but society can act to prevent that damage rather than accepting the cost of “after-market” cleanup. And regarding wages, if widespread prejudice has lowered the price of female and minority labor, civil rights legislation can work against that by mandating equal pay for equal work. Economists can study the effects of legislation, but they should not declare entire categories of law a waste of time just because they promote some moral good like health or justice.

Why treat market forces as uniquely powerful and unstoppable, even more powerful than forces of nature? After all, the capitalist economy from which those forces emanate is a modern human creation. Market forces are really aggregations of human decisions that are subject to moral and legal influences. Society allows economic actors to pursue their self-interest up to a point, but also makes some rules to keep selfish behavior from getting out of hand. As a financial advisor, I was subject to a whole set of legal and ethical rules involving matters like respecting client confidentiality, disclosing conflicts of interest, and recommending only investments in the client’s best interest. Economic behavior is not, by definition, amoral behavior.

Of course, some people in powerful economic positions would like to be free to pursue profit without regard to ethical or legal constraints. That’s not a surprise, but what is more puzzling is why economists would want to encourage such an attitude. One reason may be that exaggerating the power of amoral market forces serves to place the field of economics itself in a uniquely powerful and privileged position in society. Other authorities such as political or religious leaders may try to tell us what we should do, but economists are the only ones who can tell us what we must do. Only they understand the amoral forces that rule our lives, and resistance is futile.

Economists have a lot to tell us about the probable consequences of economic actions and policies. If raising the minimum wage is likely to increase unemployment, as Krugman and many other economists believe, the advocates of higher wages need to address that concern (and this book does). But I think economists go too far when they try to settle policy debates by invoking a doctrine of moral fatalism, encouraging people to feel morally impotent in the face of economic forces.


Macroeconomics and Moral Judgment (part 2)

July 6, 2013

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In my last post I argued that the study of economics should inform but not eliminate our individual moral judgments as citizens in a democracy. Economics shifts our attention from the virtues and vices of individuals to the strengths and weaknesses of fundamental economic policies. But that doesn’t mean we have to attribute economic events like the recent financial crisis just to impersonal economic forces. Policies are made by people, and some people have more influence on them than others.

To illustrate how a macroeconomic perspective can inform our moral stance, consider the distinction between personal saving and national saving.

Saving: the more the better?

Recently, I posted a series of investment guidelines called “Principles of Sound Investing.” The very first principle I discussed was “Live within your means,” dealing essentially with the virtues of saving. A household’s savings rate is a crucial determinant of its ability to sustain its income into the retirement years. This is partly just a matter of mathematics. By making assumptions about rates of return, longevity, and so forth, financial planners can calculate recommended savings rates, which usually come out in the range of 10-15%. But the issue also gets entangled with our ideas about how people should live. We tend to think of people who can save for tomorrow as frugal and responsible, while people who run up debt by spending beyond their means as self-indulgent and irresponsible.

Macroeconomics provides a different perspective on saving, one that focuses on national savings rates, not just household savings rates. From this perspective, saving is also a good thing, but only up to a point. Saving provides capital for investment in economic enterprises, which sustains economic production and supports future consumption. National production and national income depend in part on national saving. However, they also depend on national consumption, since producers can’t sustain or increase production if consumers aren’t buying. Too much consumption and too little saving can be a problem, but so can too much saving and too little consumption. That’s why the messages from advertisers seem at odds with our ethic of frugality: Go ahead, live it up; buy that sports car; you deserve it! Already in the 1950s, William H. Whyte was describing how the mass-consumption economy was undermining our traditional ethic of thrift.

Economists like Michael Pettis argue that underconsumption can be just as big an economic problem as overconsumption. He warns us against applying our individualistic conceptions of virtue to entire countries, seeing countries with a high ratio of savings-to-consumption like China and Germany as good, and those with a low ratio of savings-to-consumption like the United States and Greece as bad. In the global economy, the two kinds of countries are complementary, and together they have created the global imbalances that resulted in the financial crisis.

One country’s underconsumption enables and even forces another country’s overconsumption, through its export of goods and capital. A country whose citizens spend too little to absorb its productive capacity can rely on exports to keep the economy booming. But for that country to be a net exporter, generating trade surpluses, some other country must be a net importer, running up debt.

Underconsumption as a growth strategy

In addition to seeing underconsumption as a possible problem and exports as a solution, global macroeconomics can see underconsumption and exports as two sides of a conscious strategy for growing an economy. The idea is to hold consumption down, limit the production of consumer goods for the domestic market, and invest heavily in infrastructure and export industries. That’s been a common model for developing countries in Asia recently, as well as in countries like Brazil and the Soviet Union somewhat earlier.

The prime example of an underconsumption growth strategy today is the Chinese economy. Several key policies support that strategy. Employers raise wages at a slower rate than worker productivity. The central bank sets the value of the national currency low in relation to other currencies, reducing the buying power of Chinese consumers while making Chinese goods cheap on world markets. The central bank also sets interest rates very low, hurting ordinary depositors but helping producers borrow to expand production. The low interest rates are more helpful to producers than consumers, since China provides less financing for consumer expenditures.

This is one way to grow an economy, but it is not without costs. It limits the ability of the domestic population to benefit from the results of their own increasing productivity. In addition, it leads some other country to compensate by spending beyond its means, which it can’t do forever.

US debt in global perspective

What do the Chinese (and other net exporters) do with all the dollars they make by selling things to Americans? One thing they don’t do very much is buy our goods. If they did, the trade imbalance wouldn’t be so large. What they do a lot is lend those dollars back to us by purchasing US securities. They are net exporters of capital as well as net exporters of trade goods.

Here I’ll repeat what I said in an earlier post about international capital flows, quoting at some points from Pettis: Under some conditions, a capital or trade imbalance can be useful for the deficit country as well as the surplus country. For much of the nineteenth century, the United States depended on foreign capital–especially British and Dutch–because investment opportunities in its growing economy were actually greater than domestic savings could fund. But that didn’t hurt the country because “the wealth generated by foreign-funded investment was more than enough to repay the foreign debt and equity obligations.” Poor countries can also benefit by relying on foreign capital for a time. “For countries that lack technology, that have weak business and management institutions, or that suffer from low levels of social capital, foreign investment can bring with it the technology and management skills that allow the economy to grow faster than its foreign debt and equity obligations.”

Today, of course, the United States is no longer a poor country, nor a developing economy with more investment opportunities than we can fund ourselves. The large infusion of foreign capital into the US economy before the crash appears to have hurt the economy more in the long run than it helped it. With our manufacturing sector in decline and our net exports falling, there wasn’t much demand for new capital to expand production, at least not enough to absorb what Ben Bernanke has called a “global savings glut.” Instead, the capital went heavily to finance consumer and government spending. Economic activity was sustained, for a time, by running up government and personal debt. Foreigners bought a lot of Treasury bonds and–more relevant to the financial crisis–mortgage backed securities. The glut of capital pushed interest rates down, encouraging investors to “reach for yield” by considering untraditional but potentially high-return investments, such as the complicated pools of mortgages assembled by Wall Street firms.

So the housing bubble was driven by much more than irresponsible buyers borrowing beyond their means. A housing boom was one way to sustain a high level of economic activity in an increasingly uncompetitive US economy. It gave investors one place to invest and households one way to get ahead. We no longer seemed as capable of making products the world wanted to buy or expanding the middle class by raising wages. But we could finance an increase in home ownership anyway by making shakier loans and packaging them so they appealed to investors.

Economic imbalances

The financial crisis resulted from unsustainable imbalances in the global economy, especially the imbalance between net importers and net exporters, debtors and creditors, high-consuming and low-consuming nations. The economies involved had their own internal imbalances. China grew its export industries at the expense of domestic consumption. In the United States, the financial services industry boomed while manufacturing languished. We financed consumption more creatively than we developed the products and workforce required for success in the twenty-first century.

Economic imbalances also developed in Europe. Germany became a net exporter and creditor, while poorer countries like Greece became net importers and debtors. The use of a strong common currency, the euro, enabled the debtor countries to buy more than they should have, just as the strong dollar enabled Americans to import so much. One difference is that in Europe, the poorer countries are usually the debtors, while in the US-China relationship, it’s the richer country that is the debtor.

One lesson to learn from all this is that it takes both creditors and debtors to create a debt crisis. Those who heap moral blame on the debtors alone are not seeing the larger picture. Furthermore, the solution cannot just be that the debtors change their behavior to emulate that of the creditors. Since the roles are complementary, changes on one side require changes on the other side. The polices and practices of creditor economies depend on those of debtor economies. If Greeks and Americans suddenly adopted the frugality of Germans and Chinese, without complementary changes on the other side, the decline of consumption would produce global economic contraction and higher unemployment.

As the United States tries to solve its problems as a debtor nation, we don’t want to undermine the high output of our own economy either. Four things drive economic activity: household consumption, government spending, investment and net exports. (Since the US is a net importer, the last part of the equation drives foreign economies instead of our own.) Living beyond our means has been a way of sustaining aggregate demand for economic goods and services, both domestically and globally. Telling households and government to spend less may sound wise and responsible, but it fails to address the larger question of how to rebuild our economy on a stronger foundation. How can we grow the economy in a more sustainable way, without relying on consumers and government to spend beyond their means and run up debt? That is the subject of my next post.


Macroeconomics and Moral Judgment

July 6, 2013

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Many of my posts over the past year have aimed at making sense out of the Great Recession that began in 2008. Several of the books I’ve discussed here have dealt with it specifically: Alan Blinder’s After the Music Stopped, Michael Grunwald’s The New New Deal, Michael Pettis’s The Great Rebalancing, and Peter Temin & David Vines’s The Leaderless Economy. I have found the latter two works especially helpful in seeing the recession from a global macroeconomic perspective. For one thing, international capital flows helped produce the housing bubbles in the United States and other countries.

In this post I want to raise the question of how an understanding of large-scale economic relationships might affect one’s moral judgment about economic behavior. Once that we have a better idea how the recession happened, are we–or should we be–more critical of the policies and practices that led up to it? Do we see moral failures where we didn’t see them before? Do we appreciate how wide and deep the responsibility lies? Or are we so overwhelmed by the economic complexity of the whole thing that we give up trying to assign any moral responsibility at all?

Finding villains

When things go wrong in society, a natural response is to find someone to blame. During the Great Depression of the 1930s, many Americans blamed Wall Street speculators for pushing up stock prices to unsustainable levels. They also vilified Herbert Hoover for policies that made the Depression worse, and they called the shantytowns that housed the homeless and unemployed “Hoovervilles”. They celebrated Franklin Roosevelt as the hero who rescued them, making his Democratic Party the dominant political party for decades afterwards.

Our Great Recession struck a much more polarized society, making it much harder to agree on villains and heroes. A popular conservative response has been to blame homeowners who borrowed more than they could repay, along with those in government who wanted to help them. When the Obama administration proposed assistance for people who were in danger of losing their homes, CNBC reporter Rick Santelli delivered an angry rant from the floor of the Chicago Mercantile Exchange, saying that the proposal would “subsidize losers’ mortgages.” This was a variation on an old theme in American conservatism: the economically successful are the virtuous ones, and it’s the losers whose irresponsible behavior is the problem. (To be fair, many conservatives also opposed helping the big banks, but in the end, the “too big to fail” argument carried the day there.)

Progressives tend to find their villains near the top of the economic pyramid. Teddy Roosevelt attacked the “malefactors of great wealth,” describing a battle “to determine who shall rule this free country—the people through their governmental agents, or a few ruthless and domineering men whose wealth makes them peculiarly formidable because they hide behind the breastworks of corporate organization.” The Occupy Wall Street movement has focused its attack on the richest 1% of the population, and especially Wall Street bankers. More specifically, many observers blame the Great Recession on:

  • Subprime lenders: In order to make more loans, lenders lowered their lending standards and made more subprime loans–loans with less favorable terms for people with shakier credit. They moved away from the traditional 30-year fixed-rate mortgage and heavily promoted more confusing arrangements like adjustable-rate mortgages with temporarily low “teaser rates.” They became less concerned about defaults because they increasingly sold off their mortgages to financial firms that packaged them for sale to other investors.
  • Investment bankers: Wall Street firms bought mortgages and repackaged them as complicated Collateralized Debt Obligations (CDOs). These pools of mortgages were divided into slices called “tranches,” with varying degrees of risk. In theory, at least some of the tranches were supposed to be extremely safe; in practice, even the safest ones were riskier than they were cracked up to be.
  • Rating agencies: Since the securities rating agencies were paid by the banks whose securities they rated, they had little incentive to be critical. Previously exclusive AAA ratings went to too many risky securities that ultimately collapsed.
  • Regulators: Both Congress and regulatory agencies such as the SEC and Federal Reserve acquiesced to financial lobbyists and resisted calls for regulatory reform to deal with the increasingly risky financial practices. In particular, they exempted derivative securities (those like CDOs that derive their value from other securities) from regulation.

Economics and moral engagement

An economic understanding of how the housing bubble grew and then burst can help focus our moral outrage on the most responsible players. On the other hand, it could also muddy the ethical waters. After all, economics in general–and macroeconomics in particular–isn’t about personal moral decisions. It’s about impersonal economic forces like supply and demand and interest rates and global capital flows. Maybe subprime lenders and investment bankers were just responding rationally to market conditions, doing what they needed to do to make a profit. One could argue that individuals are just cogs in some gigantic economic machine, and bad things like severe recessions just happen from time to time. Maybe we should react to them the same as we react to hurricanes–we don’t like them but we can’t blame anyone for them. In other words, maybe the effect of economics is to substitute analytic detachment for moral engagement.

And yet, complete moral disengagement certainly doesn’t work, even for climate events. They are coming to be seen as partly a result of human activity, for which we need to take some responsibility. And that should be even more true for the economy, which is, after all, a human creation.

A less extreme argument for moral disengagement is that someone must take responsibility for good economic policy, but ordinary citizens lack the expertise to do so. They should leave it to the experts. The job of keeping the economic machine humming along is a job for economists and others with technical skills. This is an appealing argument. Many people seem willing to put a relatively small number of people in charge of social institutions, as long as they are selected on the basis of merit. However, Chris Hayes’s book Twilight of the Elites tries to show that even a hierarchy originally based on merit has a tendency to become self-serving and detrimental to democracy. In the aftermath of the financial crisis, economists themselves got some criticism for being too cozy with powerful financial firms, having too rosy a view of the economy, and completely missing the impending disaster.

Call me a liberal, but I think that an informed and morally engaged citizenry is essential to a democratic society. The average citizen cannot be an expert on the details of every policy issue. But each citizen can try to tell the difference between policies that serve the broad public good and those that serve some narrower interest.

Macroeconomics does not have to make ordinary people disengaged, resigned or fatalistic about economic events. What it can do is inform and shape their moral judgments, so they have a clearer and more realistic idea about what is right or wrong about economic policies and practices. It can shift the focus from a few obvious players in an economic drama to the more fundamental economic choices that societies make. That’s what I’ll be trying to illustrate as I discuss the global macroeconomics of the Great Recession in the following two posts.