“Veblen was a forerunner of what I hope will be the development of economic thought; the understanding that principles that underlie biological systems are the same principles that underlie all living systems. The concepts of hierarchies and controlled and uncontrolled predatory conduct are universal. And so when we encounter a doctrine of harmonization, of the smoothly functioning realization of the interests of all, the great and the small, which is textbook market economics, people should recognize that this is sand being thrown in their faces—that this cannot possibly be a realistic representation of the world in which we actually live. Take it as an analytic principle that one has to look at the behavior of the great with a cold eye.”
—James Kenneth Galbraith, interview with The Straddler, March 14, 2010
By way of introduction
In mid March, The Straddler met with James Kenneth Galbraith in midtown Manhattan to seek his perspective on recent events—and the way in which orthodox modes of thought, and ingrained habits of behavior, affected the response to the collapse of 2008.
Galbraith holds the Lloyd M. Bentsen, Jr., Chair in Government/Business Relations at the LBJ School of Public Affairs at the University of Texas, Austin. A Senior Scholar of the Levy Economics Institute, he also directs the University of Texas Inequality Project and is chair of Economists for Peace and Security, a professional association. He previously served on the staff of the U.S. Congress as executive director of the Joint Economic Committee.
In his most recent book, The Predator State (2008), Galbraith mounts a sustained attack on the “legitimating myth” that has delineated the parameters of permissible debate surrounding economic activity in the United States since the ascent of an ideology that saw itself comfortably ensconced in the seats of power with the election to the presidency of Ronald Reagan. At its core, Galbraith argues, this myth presents us with a Manichean narrative in which we are urged to believe, with Panglossian certainty, that “the market,” divinely efficient, delivers the best of all possible outcomes to all, in contradistinction to “the state” or “the government,” which, in the elegant simplicity of Ronald Reagan’s famous formulation, “is the problem.”
But just what, Galbraith asks, does the word “market” mean?
“When you come down to it, the word market is a negation. It is a word to be applied to the context of any transaction so long as that transaction is not directly dictated by the state.”[1]
The principles of conservative economics argue for the unfettered freedom of the market and the ruthless starvation of the state. Rhetorically, conservatives have successfully managed to conflate the concept of freedom with the construct of “economic freedom.” From this view, any challenge to the unregulated operation of the market has behind it a more sinister motive: a challenge to freedom itself.[2]
And yet, Galbraith contends,“the reality is that the disciplined application of conservative principles to economic policy leads to disaster.” The Predator State’s subtitle—How Conservatives Abandoned the Free Market and Why Liberals Should Too—speaks to his claim that nowadays, most conservatives who make or affect policy recognize the bankruptcy of conservative economic creeds, even if they, along with liberals, continue to pay public lip service to them.
The real debate to be had, therefore, is not over whether or not the state should be involved in economic activity—everybody recognizes that it must—but rather: who gets cut in on the action? Towards what end, in other words, should government activity be directly guided: the gain of private interests or the benefit of the public welfare?
Drawing on the thought of Thorstein Veblen, who explores predatory activity within social systems in his seminal The Theory of the Leisure Class (1889), Galbraith maintains that conservative economics has devolved into a disjointed practice with two characteristic features. There is, first of all, the maintenance and perpetuation of the myth, dressed up in elaborate and instantly recognizable rhetorical trappings, which continues to provide the framework in which economic debate takes place. Then there is the reality of practice:
“[W]hat we see is not, in fact, a principled conservative’s drive to minimize the state. It is a predator’s drive to divert public resources to clients and friends.”[3]
Galbraith’s thought makes clear that, as with any other system that operates in history, one of the disadvantages of following principles whose consequences are destructive is that the likelihood of further future destruction comes to take its predictable place somewhere on a narrow continuum between probable and inevitable. In other words, decisions made at a moment in history affect the intellectual and material environment in which future decisions are made—and the marriage between crisis and empowered philosophy can go one of two ways. If the empowered philosophy is reformist in tendency, one would expect some mitigation of the crisis. If, on the other hand, the empowered philosophy is a version—consolidated and more puissant, or even half-hearted—of the same thinking that formed the basis of the crisis in the first place, one would expect less desirable outcomes.
Take, for example, the dismantling of the Bretton Woods system. As Galbraith notes in The Predator State, the system established at Bretton Woods in 1944 was far from perfect—both in philosophical underpinnings and technical configuration—but it had, with its fixed exchange rates and centrality of the U.S. Dollar, provided stability in international finance and trade for the noncommunist world for more than a quarter century. When it came under pressure[4]in the early 1970s, President Richard Nixon abruptly dismantled it,
“partly because keeping it going was incompatible with Richard Nixon’s reelection campaign in 1972. On August 15th, 1971, Nixon closed the gold window, imposed export restrictions, wage and price controls, and set the stage for the fiery economic recovery which carried on for fifteen months and got him reelected. It was a political expedient, not a world-economic necessity, to get rid of it abruptly. But getting rid of it—and in particular, the move to fully floating exchange-rate regimes in 1973—had both the intent and the effect of re-empowering the private banking system in international finance. Up to that point, if you had a balance of payments issue, your primary interlocutor was the IMF. After that point, you went to the banks to lend you funds. And so this was a way of putting the US commercial banks at the center of global finance for the first time since the 1930s, and the result was disastrous.”[5]
The disastrous result was a commodities boom with concomitant inflation, the latter quickly evading all attempts at control. By the time 1979 came around, the need to douse the wildfire levels of inflation was deemed so urgent that then Federal Reserve Chairman Paul Volcker, applying monetarist principles straight out of the playbook of free-market luminary Milton Friedman,
“stepped in with 20% interest rates, and again in 1981 threw the whole system into reverse. It would have crashed at that point, sooner or later anyway, but Volcker precipitated the crash. The world certainly would have been better off had the community of leading nations struggled to patch up Bretton Woods and to maintain the authority of the public, collective institution over the private banks. Things could hardly have gone worse than they did in the 1970s.”[6]
And yet, precisely because Nixon’s precipitant act resulted in such destructive consequences, Volcker’s actions in the late 1970s and early 1980s, while themselves disastrous, must be seen in the appropriate context:
“Whether there was a plausible alternative to what Volcker did at that time is a much tougher question. The dye had been caste. At the time, I certainly argued that there was an alternative. The alternative would have been to continue to deal with inflation by a process of negotiations with labor—essentially gradualism. The reality is, there is no way that that alternative could be implemented under the presidency of a guy like Ronald Reagan. In fact, it had been exhausted in the presidency of Jimmy Carter. There was no political force that could have resurrected that path at that moment. Reagan’s first act was to abolish the Council on Wage and Price Stability. He was basically declaring war on labor from the beginning. So, this was an August 1914 situation. What would you have done differently if you were France when the Germans mobilized?
“The costs of this policy were catastrophic, and the policy was unsustainable. The machinery and construction industries were wiped out, in some cases permanently. The whole upper Midwest had an advanced machinery sector which never regained world position—it was ceded entirely to the Germans and the Japanese. And, of course, in the larger world, it precipitated a calamitous crisis which destroyed development for twenty years and had absolutely horrible human costs. People talk about these costs being low, but in fact they were enormous. And the only reason they look low to American economists is that they’re not calculating what happened in Africa or Latin America. And Volcker himself had no appreciation of the extent to which this would cost lives and governments and countries and the progress of development in the rest of the world. Having said all that, it’s one thing to say you ought to have done it this way, and another to say there was any practical alternative at that moment.”[7]
What follows are Galbraith’s reflections on the present, in conversation with The Straddler.
Galbraith, March 14, 2010
I think the crisis has changed the way people think. I think we are going through a multi-stage transformation. It is quite impossible to defend with a straight face the view that you can drown the government in a bathtub, and the view that the private financial markets are stabilizing and that they can be freed from regulation. Now seen properly, this is comparable to the view that you can run a nuclear reactor without a cooling system. And when you think about it, the metaphor isn’t just to a nuclear reactor, it’s to any mechanical system—it’s like the idea that you could run a car without a radiator. I think that is clearly fixed in most people’s minds. The difficulty that we’re facing now is that the political opportunity to act on that perception has been blocked up. It’s been blocked up because the administration shied from taking the dramatic and decisive political steps that would have been necessary at the start of this administration.
The government wasn’t refusing to establish some new dark and difficult, unseemly precedent of intervening in the market economy. It was in fact shying away from its established responsibility—something that as a matter of law and practice it is not only supposed to do, but does every week in the banking sector, with respect to smaller banks. There is something called the Prompt Corrective Action Law, which mandates that when intervention is called for—so as to reduce the ultimate losses to the taxpayer, and the ultimate damage to the economy—banks which are in danger of failing are taken over and managed, resolved, by the Federal Deposit Insurance Corporation (FDIC). The reason you do this is that ever since the 1930s, banks have had their liabilities insured to a very large extent by the federal government. And the bargain that a bank enters into when it takes up membership in the FDIC is that the FDIC is entitled to know what’s going on inside the bank and entitled to take over the bank when there is a danger that the insurance fund will be called upon.
The logic behind it is you don’t want a bank to be redoubling its bets, increasing its risk exposure, in order to try and escape from insolvency. When you do that you create all kinds of perverse incentives and the chances are that the insurance fund will be hit much harder than it would be if you intervened early.
What happened in this particular case, when you’re talking about some of the nation’s largest banks, is that we had, first of all, very powerful institutions with very powerful friends who were intervening to protect them from what would otherwise be the routine or necessary action of an established federal agency. The consequences were that the government did save the banks. It’s created an environment in which bank earnings, at least on the surface—as far as they are reporting—have recovered, but one in which there has been no recovery of new bank lending for the purposes of the larger economy.
Putting a charitable construction on things, and taking people at their word, I would say that Larry Summers, Tim Geithner, and the President took the view that you could not only stabilize but restart the economy through the banking system in a relatively short period of time. And I think judging from recent articles and profiles I have seen of Geithner in the press, that is still his view. The President was saying early on that the need was to get the banks lending again. Well, in 2009 lending went down by an order of 600 billion dollars from the previous year. I thought at the time that was a futile quest, that what the banks would do would be to go into a kind of hibernation where they would be taking all of the funds they could get from the Fed at zero percent—collect the funds for basically nothing—and they would be parking them as investments in government debt at three percent. And the difference would be sufficient to provide earnings for the banks, but it was completely unrealistic to expect that the banking system would be providing commercial and industrial loans to commercial real estate, which is in vast excess supply, residential housing, which is likewise in terrible shape—completely collapsed in values—and business enterprises, which don’t have any interest or ability to collateralize a loan. Those are problems that couldn’t be addressed by making exhortations to the banks.
There are two broad issues affecting banking. One of them is the structure of the banks themselves, of the industry. The other is the rules, if you like, under which the banks operate. There was a big opportunity to change the structure of the industry. The FDIC is actually quite good at taking over banks and resolving them. In the case of small banks, what they usually do is merge them into bigger ones, find partners, so that the insurance fund isn’t touched at all. In the case of larger banks, it’s more complicated. You have to rip it up—sell it, close parts of it; you might have had to touch the insurance fund. But the result would have been a smaller overall banking sector in relation to the economy, achieved very quickly. And some part of the leadership class of bankers would have been gone, on the beach, replaced by middle managers and bankers from elsewhere who were not implicated in the same practices. And the result of that would have been a clean audit of the books of the taken-over bank—a straightening out of all kinds of practices that banks should not be engaged in anyway. Regulatory arbitrage, tax arbitrage, would have been a much smaller piece of the business—the government is not going to run a bank that’s in the process of facilitating tax evasion, just for example (at least one hopes).
It would have been hard to do. There’s no question, it would have been a big challenge for the FDIC. These are entities on a scale that is very different from what they ordinarily have to resolve. But if you go through that process, you have a banking sector much better suited to the larger economy than what we’ve got now. In the course of going through and restructuring some of the largest banks, you would have set new rules much more effectively. Basically, you would have been able to make a much stronger case for decisive change in banking practice.
As things stand, the crucial act of denial in the banking sector, in my view, is that it has not come to grips with the extent of fraud, abuse, and failures of documentation that underlay the crisis in the first place. We know from the evidence that we’ve seen so far that there were massively fraudulent practices in mortgage origination—that these practices were abetted by the underwriters and by the ratings agencies, which declined and even refused to look at the underlying loan documentation. And I think the failure to confront that problem—which was covered over by the “stress tests” and the revision of market-to-market accounting rules—remains an unresolved issue.
I think it’s fair to say that so far, what we’re looking at here is a failure of the rule of law. We have lots of reasons to believe that a serious investigation, criminal and civil, would lead to a very large-scale prosecutorial response. That’d be the case in the largely now-defunct industry of mortgage originators; it would be the case with respect to some of the ratings activity; it would be the case with respect to the accounting behavior of some of the largest investment banks. Fraud begets fraud. In the case of Lehman Brothers, there was a systematic evasion of recognition of the extent of the losses that were occurring and already known to Lehman’s top management, who manipulated their accounts in order to avoid reporting how deficient that capital impact already was. The last time I looked, accounting fraud was considered a criminal activity. If it turns out that the regulators knew that this practice was going on and looked the other way, then the regulators also would become, it seems to me, the targets of an investigation. The regulating authority at the time was the New York Federal Reserve Bank. If you want to restore confidence in the system—confidence in a system—this is an exercise through which you must pass. You cannot have a situation in which the broader public, which is not stupid, is getting new information every month—sometimes more frequently than that—which indicates to it that massive wrongdoing was protected and covered up, and continues to be.
In March of 1933, Roosevelt closed the banks. They were closed for, I think, ten days. And they were audited, and only those that were deemed solvent were allowed to reopen, and when they did, people lined up to put their money back in the banks. It was a clear assertion of the public responsibility, and stability in the banking system. And my view is that comparable action in January or February of last year would have created a much stronger climate for major changes.
First of all, it would have given you an opportunity to, as I said earlier, shrink the banking system, to replace its management. That would have changed the political climate, because the remaining banks would have been less inclined to use their existing lobbies to block banking reform, and the whole terrain of public/private interaction in this area would have been substantially different. Something similar can be said on the fiscal side—though that is a much more complicated judgment because they had to get a bill through Congress. And I can understand why respecting the political limits of what the Congress was prepared to do got you something which was better than nothing, whereas getting you what you needed to do might have gotten you nothing rather than something. Nevertheless, the package was not large enough to make a decisive difference—it was large enough to hire back a lot of teachers that were being fired, but not large enough to prevent crises in the fiscal affairs of New York and California and Florida and other places; large enough to stabilize the job situation, but not large enough to put it on the path of improvement by now, with the result that most people looking for jobs are not seeing the prospect that they will be created.
Now, maybe if things get underway, six months from now jobs are being created, the mood will shift in a favorable direction. But what I fear is that it won’t, and I think that the opportunity to have done it already by now—well, of course, was missed. And the consequence of that is a second wave of political upheaval in which—this was predictable a year ago, and I wrote something to this effect—every snake-oil salesman in the country would start having a field day. That’s an understandable reaction. The first thing that you try, which was based upon sensible principles, but not applied with sufficient force, doesn’t do the full job, then people start cropping up from every corner saying you should have done it my way. “You should have eliminated the government, you should have cut spending, you should have cut taxes.” And, of course, you’re going to find an audience for any well-organized and well-funded and media-boosted cacophony of that kind. And that’s what you’re getting, that’s what the Tea Party movement is, for example.
The Tea Party is a tool. It is a stirring up of the grass roots. Of the “rabble” by people who make a professional practice of stirring up people who they have no intention of ever ceding actual power to. I think the Tea Partiers are largely sincere, naïve people who are maybe under the impression that they are being empowered, but the people behind them have no more intention of actually implementing their ideas, of giving them a leadership role, than Ronald Reagan had of overturning Roe v. Wade, for example. The purpose of the Tea Party is to create a blocking force, particularly aimed at healthcare reform, and to fuel this sort of Scott Brown phenomenon, wherein more people, like the current Republican Congressional leadership, will get themselves elected. Then we will see that, fundamentally, they’re the same lobby-driven, obstructionist forces—the same predatory forces that they were all along.
The larger society cannot function in an environment of unrestricted predation. That’s certainly not a system which can operate on a democratic principle. The entire structure and function of government is to ensure that predators are subject to restraints, and we actually have a fairly high standard in that respect. We say no man is above the law. We write laws which ostensibly apply to everybody in matters of clarity and honesty of economic accounts, the reporting thereof, and the transparency of the process of protecting investors. And it’s the application of that system of management and controls which gives the would-be predator a sphere of activity. We say, okay, let’s be realistic: eliminate all of the predator wannabes of the high predator classes, well, you have a system which is called socialism, and the difficulty with socialism is the lack of economic dynamism; that’s a straightforward and historically demonstrated fact.
So, in designing a system, you want to have a degree of culling of the uncompetitive, you want a bankruptcy process, you want to have competition, especially through technical change—and regulation can help set the direction in which that competition occurs—and you want to have the spur of economic incentive and profit. All of that is highly desirable. The problem is that if you take the view that the spur should be unlimited, that the culling should be unrestrained, then you turn the economy into a battlefield. And the thing about a war is that the cost and the destruction, characteristically, very soon, greatly exceed what you would have agreed to if you had full sense in advance. Every war is like that. And every situation of unrestrained predatory activity is also going to cause much more destruction than you’re willing to tolerate, which is exactly the financial crisis in a nutshell.
Let’s talk a little bit about the problem of regulation, the problem of standards in that context. How does this play out within any particular sector—group of enterprises. I’ve always felt that it’s very important to understand that an enterprise develops over time, habits are formed, and some enterprises, with habits formed in an earlier period—older capital equipment, less efficient operations, generally employing more labor, and with more intense management-labor conflicts—tend to be more reactionary in any political context. A newer enterprise engaged in the same activity has got a margin of profitability that the older one may not have, and it’s taking advantage of the latest techniques. Let’s say some environmental standard is designed to those techniques that are not costly for the newer enterprise to implement, whereas for the older one, retrofitting—putting a stack-gas scrubber on your smokestack—is a cost. So it’s the older guys, it’s the more reactionary guys who are always in the forefront of opposing regulation. Whereas a sensibly designed regulation is one which is within the range of what is technically feasible for the more progressive branches of the activity. You may want to have a regulation that is being phased in in five or ten years that sets a technical standard that people are asked to try to achieve—a fuel-efficiency standard, emissions standard, for example. But the regulations in force at any given moment need to be regulations that are within the range of what is technically possible, otherwise they’re not going to be met, right? I mean, it’s as simple as that. And so, the point that I make in The Predator State about regulation is that it is a kind of forcing mechanism which splits one type of business from another. It splits the more progressive from the more regressive. And the purpose of the exercise is to put pressure on the regressive guys and eventually to make them change or drive them out.
All of the politics of regulation is about this. In a reactionary, badly run state like Texas, regulatory politics is about “grandfathering.” In practical terms, it’s about saying to an existing enterprise, “no, we’re not going to apply that standard to you.” So then you adapt the regulation to everybody’s level of pollution, and you never get anywhere. In a progressive moment in regulatory history—and the Carter administration had such moments—the Labor Department was cooperating with the more advanced and progressive textile companies to get the cotton dust out of the air, and that meant that the company for whom getting that new machinery in was least problematic was going to come to dominate the market, and did. That’s fine. So, my view is that understanding the interaction between regulation and technical progress is absolutely crucial to understanding what the policies are all about in this area.
What the Reagan period did was to obscure this question, by casting regulation as a burden on business, by speaking of business as a monolithic entity—which I think was a chosen political strategy on their part, and something in which the economic profession colluded, obscuring the kind of argument that I’m making—and then empowering the representatives of the business lobbies. And the business lobbies are almost always dominated by the reactionary elements, because they’re the ones who have the most to lose. They’re the ones who want to fight the government. That’s the problem when you’ve got an administration like the George W. Bush administration, which turns over the regulation to the lobbyists, who fundamentally undermined not only the regulations themselves, but also the forces for technical change and technical progress that are embedded in good regulatory practice. And then, of course, in the case of finance, you’ve created conditions for collapse, which is, of course, exactly what happened.
[2] There is perhaps no more perfect rhetorical crystallization of such thought than the peroration of Ronald Reagan’s 1965 speech against “socialized medicine.” Exhorting his listeners to oppose the enactment of Medicare, Reagan closes with a grim vision of what a socialist future will look like if the forces of freedom do not prevail:
One of these days, you and I are going to spend our sunset years telling our children, and our children’s children, what it once was like in America when men were free.
[4] Why did it come under pressure?
“The Bretton Woods rules provided that if the United States ran a trade deficit other central banks could demand gold in payment, drawing on the formidable gold hoard that the United States had accumulated mainly during the two world wars. This proved to be the Achilles’ heel of the arrangement. Through the 1960s, as the United States reached full employment and the war in Vietnam grew more costly, increasing U.S. trade deficits generated increasing gold outflows. Eventually it became clear that the system, which had been designed for a world in which the United States was running trade surpluses, could not be sustained.” The Predator State.
