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'Review Essays'에 해당되는 글 21건

  1. 2007/09/17 Perry Anderson LRB
  2. 2007/09/08 Review of Schmpeter (The Nation)
  3. 2007/07/25 The Growth of Nations
  4. 2007/05/30 NY Times Book Review Vol. 54 - Disposable American etc
  5. 2007/05/30 Kornai's Choice (Econ. Principals)
  6. 2007/05/07 Review of Kicking Away the Ladder
  7. 2007/04/18 Review of Gomory and Baumol's new trade theory
  8. 2005/09/08 The History and the Role of the US Fed 5
  9. 2005/09/08 The History and the Role of the US Fed 4
  10. 2005/09/08 The History and the Role of the US Federal Reserve Board 3

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Perry Anderson LRB

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Depicting Europe by Perry Anderson (London Review of Books).
 
An epiphany is beguiling Europe. Far from dwindling in historical significance, the Old World is about to assume an importance for humanity it has never, in all its days of dubious past glory, before possessed. At the end of Postwar, his 800-page account of the continent since 1945, the historian Tony Judt exclaims at ‘Europe’s emergence in the dawn of the 21st century as a paragon of the international virtues: a community of values . . . held up by Europeans and non-Europeans alike as an exemplar for all to emulate’.1 The reputation, he assures us, is ‘well-earned’. The same vision grips the seers of New Labour. Why Europe Will Run the 21st Century declaims the title of a manifesto by Mark Leonard, the party’s foreign policy wunderkind.2 ‘Imagine a world of peace, prosperity and democracy,’ he enjoins the reader. ‘What I am asking you to imagine is the “New European Century”.’ How will this entrancing prospect come about? ‘Europe represents a synthesis of the energy and freedom that come from liberalism with the stability and welfare that come from social democracy. As the world becomes richer and moves beyond satisfying basic needs such as hunger and health, the European way of life will become irresistible.’ Really? Absolutely. ‘As India, Brazil, South Africa and even China develop economically and express themselves politically, the European model will represent an irresistibly attractive way of enhancing their prosperity whilst protecting their security. They will join with the EU in building “a New European Century”.’
 
Not to be outdone, the futurologist Jeremy Rifkin – American by birth, but by any standards an honorary European: indeed a personal adviser to Romano Prodi when he was president of the European Commission – has offered his guide to The European Dream.3 Seeking ‘harmony, not hegemony’, he tells us, the EU ‘has all the right markings to claim the moral high ground on the journey towards a third stage of human consciousness. Europeans have laid out a visionary road map to a new promised land, one dedicated to reaffirming the life instinct and the Earth’s indivisibility.’ After a lyrical survey of this route – typical staging-posts: ‘Government without a Centre’, ‘Romancing the Civil Society’, ‘A Second Enlightenment’ – Rifkin, warning us against cynicism, concludes: ‘These are tumultuous times. Much of the world is going dark, leaving many human beings without clear direction. The European Dream is a beacon of light in a troubled world. It beckons us to a new age of inclusivity, diversity, quality of life, deep play, sustainability, universal human rights, the rights of nature, and peace on Earth.’
 
These transports may seem peculiarly Anglo-Saxon, but there is no shortage of more prosaic equivalents on the Continent. For Germany’s leading philosopher, Jürgen Habermas, Europe has found ‘exemplary solutions’ for two great issues of the age: ‘governance beyond the nation-state’ and systems of welfare that ‘serve as a model’ to the world. So why not triumph in a third? ‘If Europe has solved two problems of this magnitude, shouldn’t it issue a further challenge: to defend and promote a cosmopolitan order on the basis of international law’ – or, as his compatriot the sociologist Ulrich Beck puts it, ‘Europeanisation means creating a new politics. It means entering as a player into the meta-power game, into the struggle to form the rules of a new global order. The catchphrase for the future might be: Move over America – Europe is back!’ In France, Marcel Gauchet, theorist of democracy and an editor of Le Débat, the country’s central journal of ideas, explains, more demurely, that ‘we may be allowed to think that the formula the Europeans have pioneered is destined eventually to serve as a model for the nations of the world. That lies in its genetic programme.’
 
Self-satisfaction is scarcely unfamiliar in Europe. But the contemporary mood is something different: an apparently illimitable narcissism, in which the reflection in the water transfigures the future of the planet into the image of the beholder. What explains this degree of political vanity? Obviously, the landscape of the continent has altered in recent years, and its role in the world has grown. Real changes can give rise to surreal dreams, but they need to be calibrated properly, to see what the connections or lack of them might be. A decade ago, three great imponderables lay ahead: the advent of monetary union, as designed at Maastricht; the return of Germany to regional preponderance, with reunification; and the expansion of the EU into Eastern Europe. The outcome of each remained ex ante indeterminate. How far have they been clarified since?
 
Of its nature, the introduction of a single currency, adopted simultaneously by 11 out of 15 member states of the EU on the first day of 1999, was the most punctual and systematic transformation of the three. It was always reasonable to suppose its effects would be the soonest visible, and most clear-cut. Yet this has proved so only in the most limited technical sense, that the substitution of a dozen monies by one (Greece joined in 2002) was handled extremely smoothly, without glitch or mishap: an administrative tour de force. Otherwise, contrary to general expectations, the net upshot of the monetary union that came into force in the Eurozone eight years ago remains undecidable. The stated purpose of the single currency was to lower transaction costs and increase predictability of returns for business, so unleashing higher investment and faster growth of productivity and output.
 
But to date the causes have failed to generate the results. The dynamic effects of the Single European Act of 1986, held by most orthodox economists to be an initiative of greater significance than EMU, had already been wildly oversold: the official Cecchini Report estimated it would add between 4.3 and 6.4 per cent to the GDP of the Community where in reality it yielded gains of little over 1 per cent. So far, the pay-off for EMU has been even more disappointing. Far from picking up, growth in the Eurozone initially slowed down, from an average of 2.4 per cent in the five years before monetary union, to 2.1 in the first five years after it. Even with the modest acceleration of the last three years, it remains below the level of the 1980s. In 2000, on the heels of the single currency, the Lisbon summit promised to create within ten years ‘the most competitive and dynamic knowledge-based economy in the world’. In the event, the EU has so far recorded a growth rate well below that of the US, and has lagged far behind China. Caught between the scientific and technological magnetism of America, where two-fifths of all scientists – some 400,000 – are now EU-born, and the cheap labour of the PRC, where average wages are well over twenty times lower, Europe has not had much to show for its bombast.
 
Not only has the performance of the single-currency bloc been well below America’s. More pointedly, the Eurozone has been outstripped by those countries within the EU which declined to scrap their own currencies, Sweden, Britain and Denmark all posting higher rates of growth over the same period. Casting a further shadow over the legacy of Maastricht, the Stability Pact which was supposed to ensure that fiscal indiscipline at national level would not undermine monetary rigour at supranational level has been breached repeatedly and with impunity by both Germany and France, the two leading economies of the Eurozone. Had its deflationary impact been enforced, as it was on Portugal, which was in less of a position to resist, overall growth would have been yet lower.
 
Still, it would be premature to think that any unequivocal verdict on monetary union had been reached. The advocates of EMU point to Ireland and Spain as success stories within the Eurozone, and look to the general economic upturn of the past year, led by Germany, as a sign that monetary union may at last be coming into its own. Above all, they can vaunt the strength of the euro itself. Not only are long-term interest rates in the Eurozone below those in the US. More strikingly, the euro has overtaken the dollar as the world’s premier currency in the international bond market. One result has been to power a wave of cross-border mergers and acquisitions in Euroland itself, evidence of the kind of capital deepening the architects of monetary union envisaged. Given the volatility of relative regional or national standings in the world economy – Japan’s is only the most spectacular reversal of fortune since the 1980s – might not the Eurozone, after somewhat over seven lean years, now be poised for their biblical opposite?
 
Here, clearly, much depends on the degree of European interconnection with, or insulation from, the US economy, which dominates global demand. The mediocrity of Eurozone performance since 1999, attributable in the eyes of economic liberals to statist inertias and labour-market rigidities that it has taken time to overcome, but that are now giving way, has unfolded against the background of a global conjuncture, driven principally by American consumption, which for the last five years has been highly favourable – world economic growth averaging over 4.5 per cent, a rate not seen since the 1960s. A large part of this boom has come from rocketing house prices. That holds above all for the US, but also for much of the OECD: not least such once peripheral economies as Spain and Ireland, where construction has been the linchpin of recent growth. In the major Eurozone economies, on the other hand, where mortgages are not so central to financial markets, such effects have been more subdued. But, as the exposure of European banks to the collapse of sub-prime markets in the US is currently showing, the lines of repackaged credit are now so diffused and entangled across financial markets that the Eurozone is unlikely to be sheltered from a transatlantic recession.
 
The role of Germany in the new Europe remains no less ambiguous. Absorption of the DDR has restored the country to its standing at the beginning of the 20th century as the strategically central land of the continent, the most populous nation and the largest economy. But the longer-term consequences of reunification have still to unfold. Internationally, the Berlin republic has unquestionably become more assertive, shedding a range of postwar inhibitions. In the past decade the Luftwaffe has returned to the Balkans, Einsatztruppen are fighting in West Asia, the Deutsche Marine patrols the Eastern Mediterranean. But these have been subcontracted enterprises, in Nato or UN operations governed by the United States, not independent initiatives. Diplomatic postures have been more significant than military. Under Schröder, close ties were developed with Russia, in an entente that became the most distinctive feature of his foreign policy. But this was not a second Rapallo Pact, at the expense of western neighbours. Under Chirac and Berlusconi, France and Italy courted Putin scarcely less, but with fewer economic trumps in hand. Within Europe itself, the Red-Green government in Berlin, for all its well-advertised generational lack of complexes, never rocked the boat in the way its Christian Democrat predecessor in Bonn had done. Since 1991, in fact, there has been no action to compare with Kohl’s unilateral recognition of Slovenia, precipitating the disintegration of Yugoslavia. Merkel has moved successfully to circumvent the will of French and Dutch voters, but was in no position to accomplish this on her own: for that, governments in Paris and the Hague were necessary. The prospects of any informal German hegemony in Europe, classically considered, seem at present remote.
 
Part of the reason for the relatively subdued profile of the new Germany has been the cost of reunification itself, for which the bill to date has come to more than a trillion dollars, saddling the country for years with stagnation, high unemployment and mounting public debt. France, though no greyhound itself, consistently outpaced Germany, posting faster rates of growth for a full decade from 1994 to 2004, with more than double its increase in GDP in the first five years of the new century. In 2006, substantial German recovery finally arrived, and the tables have been turned. Currently the world’s leading exporter, Germany now looks as if it might be about to exercise once again something like the economic dominance of Europe it enjoyed in the days of Schmidt and the early Kohl. Then it was the tight money policies of the Bundesbank that held its neighbours by the throat. With the euro, that form of pressure has gone. What threatens to replace it is the remarkable wage repression on which German recovery has been based. Between 1998 and 2006, unit labour costs in Germany actually fell – a staggering feat: real wages declined for seven straight years – while they rose some 15 per cent in France and Britain, and between 25 and 35 per cent in Spain, Italy, Portugal and Greece. With devaluation now barred, the Mediterranean countries are suffering a drastic loss of competitiveness that augurs ill for the whole southern tier of the EU. Harsher forms of German power, pulsing through the market rather than issuing from the high command or central bank, may lie in store. It is too soon to write off a regional Grossmacht.
 
Germany has now been reunited for 16 years. A single currency has circulated for eight years. The enlargement of the EU is just over three years old: it would be strange if its outcomes were already clearer. In practice the expansion of the EU to the East was set in motion in 1993, and completed – for the moment – only this year, with the accession of Romania and Bulgaria. At one level it is plain why it should be perhaps the principal source of satisfaction in today’s chorus of European self-congratulation. All nine former ‘captive nations’ of the Soviet bloc have been integrated without a hitch into the Union. Only the lands of a once independent Communism, in the time of Tito and Hoxha, wait to join the fold, and even there a start has been made with Slovenia. Capitalism has been restored smoothly and speedily, without vexing delays or derogations. Indeed, as the director-general of the EU Commission for Enlargement recently observed, ‘Nowadays the level of privatisation and liberalisation of the market is often higher in new member states than old ones.’ In this newly freed zone, rates of growth have also been considerably higher than in the larger economies to the west.
 
No less impressive has been the virtually frictionless implantation of political systems matching liberal norms – representative democracies complete with civil rights, elected parliaments, separation of powers, alternation of governments. Under the benevolent but watchful eye of the Commission, seeing to it that criteria laid down at the Copenhagen Summit of 1993 were properly met, Eastern Europe has been shepherded into the comity of free nations. There was no backsliding. The elites of the region were in most cases only too anxious to oblige. For their populations, constitutional niceties were less important than higher standards of living once the late Communist yoke was thrown off, although few if any citizens were indifferent to the humbler liberties of speech, occupation or travel. When the time for accession came, there was assent, but little enthusiasm. Only in two countries out of ten – Lithuania and Slovenia – did a majority of the electorate turn out to vote for it, in referenda which most of the population elsewhere ignored, no doubt in part because they regarded it as a fait accompli by their leaders.
 
Still, however technocratic or top-down the mechanics of enlargement may have been, the formal unification of the two halves of Europe is a historical achievement of the first order. This is not because it has restored the countries of the East to an age-long common home, from which only a malign fate – the totalitarian grip of Russia – wrested them after the Second World War, as the ideologues of Central Europe, Kundera and others, have argued. The division of the continent has deeper roots, and goes back much further, than the pact at Yalta. In a well-received book, the American historian Larry Wolff charged travellers and thinkers of the Enlightenment with ‘the invention of Eastern Europe’ as a supercilious myth of the 18th century.4 The reality is that from the time of the Roman Empire onwards, the lands now covered by the new member states of the Union were nearly always poorer, less literate and less urbanised than most of their counterparts to the west: prey to nomadic invasions from Asia; subjected to a second serfdom that spared neither the German lands beyond the Elbe nor even relatively advanced Bohemia; annexed by Habsburg, Romanov, Hohenzollern or Ottoman conquerors. Their fate in the Second World War and its aftermath was not an unhappy exception in their history, but – catastrophically speaking – par for the course.
 
It is this millennial record, of repeated humiliation and oppression, that entry into the Union offers a chance, finally, to leave behind. Who, with any sense of the history of the continent, could fail to be moved by the prospect of a cancellation in the inequality of its nations’ destinies? The original design for EU expansion to the East, a joint product of German strategy under Kohl and interested local elites, seconded by assorted Anglo-American publicists, was to fast-track Poland, Hungary and the Czech Republic into the Union, as the most congenial states of the region, with the staunchest records of resistance to Communism and the most Westernised political classes, leaving less favoured societies to kick their heels in the rear. Happily, this invidious redivision of the East was avoided. Credit for preventing it must go in the first instance to France, which from the beginning advocated a ‘regatta’ approach, insisting on the inclusion of Romania, which made it difficult to exclude Bulgaria; to Sweden, which championed Estonia, with the same effect on Latvia and Lithuania; and to the Prodi Commission, which eventually rallied to comprehensive rather than selective enlargement. The result was a far more generous settlement than originally envisaged.
 
What of the economic upshot of expansion for the Union itself? Thanks to the modesty of the regional funds allocated to the East, the financial cost of enlargement has been significantly less than once estimated, and the balance of trade has favoured the more powerful economies of the West. This, however, is small change. The real takings – or bill, depending on who is looking at it – lie elsewhere. Core European capital now has a major pool of cheap labour at its disposal, conveniently located on its doorstep, not only dramatically lowering its production costs in plants to the East, but capable of exercising pressure on wages and conditions in the West. The archetypal case is Slovakia, where wages in the auto industry are one eighth of those in Germany, and more cars per capita are shortly going to be produced – Volkswagen and Peugeot in the lead – than in any other country in the world. It is the fear of such relocation, with the closure of factories at home, that has cowed so many German workers into accepting longer hours and less pay. Race-to-the bottom pressures are not confined to wages. The ex-Communist states have pioneered flat taxes to woo investment, and now compete with each other for the lowest possible rate: Estonia started with 26 per cent, Slovakia offers 19 per cent, Romania advertises 16 per cent, while Poland is now mooting a best-buy of 15 per cent.
 
The role configured by the new East in the EU, in other words, promises to be something like that played by the new South in the American economy since the 1970s: a zone of business-friendly fiscal regimes, weak or non-existent labour movements, low wages and – therefore – high investment, registering faster growth than in the older core regions of continent-wide capital. Like the US South, too, the region seems likely to fall somewhat short of the standards of political respectability expected in the rest of the Union. Already, now that they are safely inside the EU and there is no longer the same need to be on their best behaviour, the elites of the region show signs of kicking over the traces. In Poland, the ruling twins defy every norm of ideological correctness as understood in Strasbourg or Brussels. In Hungary, riot police stand on guard around a ruler unabashed at vaunting his lies to voters. In the Czech Republic, months pass without parliament being able to form a government. In Romania, the president insults the prime minister in a phone-in call to a television talk-show. But, as in Kentucky or Alabama, such provincial quirks add a touch of folkloric colour to the drab metropolitan scene more than they disturb it.
 
All analogies have their limits. The distinctive role of the new South in the political economy of the US has depended in part on immigration attracted by the region’s climate, which has given it rates of demographic growth well above the national average. Eastern Europe is much more likely to suffer out-migration, as the recent tide of Poles arriving in Britain, and similar numbers from the Baltics and elsewhere in Ireland and Sweden, suggest. But labour mobility in any direction is – and, for obvious linguistic and cultural reasons, will remain – far lower in the EU than in the US. Local welfare systems, inherited from the Communist past, and not yet greatly dismantled, are also potential constraints on a Southern path. Nor does the East, with less than a quarter of the population of the Union, have anything like the relative weight of the South in the United States, not to speak of the political leverage of the region at federal level. For the moment, the effect of enlargement has essentially been much what the Foreign Office and the employers’ lobbies in Brussels always hoped it would be: the distension of the EU into a vast free-trade zone, with a newly acquired periphery of cheap labour.
 
The integration of the East into the Union is the major achievement to which admirers of the new Europe can legitimately point. Of course, as with the standard encomia of the record of EU as a whole, there is a gap between ideology and reality in the claims made for it. The Community that became a Union was never responsible for the ‘fifty years of peace’ conventionally ascribed to it, a piety attributing to Brussels what in any strict sense belonged to Washington. When actual wars threatened in Yugoslavia, far from preventing their outbreak, the Union if anything helped to trigger them. In not dissimilar fashion, publicists for the EU often imply that without enlargement Eastern Europe would never have reached the safe harbour of democracy, foundering in new forms of totalitarianism or barbarism. There is somewhat more substance to this argument, since the EU has supervised stabilisation of the political systems of the region. But this claim too exaggerates dangers in the service of vanities. The EU played no role in the overthrow of the regimes installed by Stalin, and there is little sign that any of the countries in which they fell were at risk of lapsing into new dictatorships, were it not for the saving hand of the Commission. Enlargement has been a sufficient historical annealment, and so far economic success, not to require claims that it has also been, counter-factually, a political deliverance. The standard hype demeans rather than elevates what has been achieved.
 
There remains the largest question of all. What has been the impact of expansion to the East on the institutional framework of the EU itself? Here the glass darkens. For if enlargement has been the principal achievement of the recent period, the constitution that was supposed to renovate the Union has been its most signal failure, and the potential interactions between the two remain a matter of obscurity. The Convention on the Future of Europe met in early 2002, and in mid-2003 delivered a draft European Constitution that was agreed by the European Council in the summer of 2004. Delegates from candidate countries were nominally included in the Convention, but since the Convention itself amounted to little more than window-dressing for the labours of its president, Giscard d’Estaing, assisted by a British factotum, John Kerr, the two real authors of the draft, their presence was of no consequence. The future charter of Europe was written for the establishments of the West, the governments of the existing 15 member states who had to approve it, relegating the countries of the East to onlookers. In effect, the logic of a constituent will was inverted: instead of enlargement becoming the common basis of a new framework, the framework was erected before enlargement.
 
The ensuing debacle came as a brief thunderclap to the Western elites. The Constitution – more than 500 pages long, comprising 446 articles and 36 supplementary protocols, a bureaucratic elephantiasis without precedent – increased the power of the four largest states in the Union, Germany, France, Britain and Italy; topped the inter-governmental complex in which they would have greater sway with a five-year presidency, unelected by the European Parliament, let alone the citizens of the Union; and inscribed the imperatives of a ‘highly competitive’ market, ‘free of distortions’, as a foundational principle of political law, beyond the reach of popular choice. The founders of the American Republic would have rubbed their eyes in disbelief at such a ponderous and rickety construction. But so overwhelming was the consensus of the continent’s media and political class behind it, that few doubted it would come into force. To the astonishment of their rulers, however, voters made short work of it. In France, where the government was unwise enough to dispatch copies of the document to every voter (Giscard complained of this folly with his handiwork), little was left of it at the end of a referendum campaign in which a spirited popular opposition – without the support of a single mainstream party, newspaper, magazine, let alone radio or television programme – routed an establishment united in endorsing it. Rarely, even in recent French history, was a pensée quite so unique upended so spectacularly.
 
In the last days of the campaign, as polls showed increasing rejection of the Constitution among voters, panic gripped the French media. But no local hysterics, though there were many, rivalled those in Germany. ‘Europe Demands Courage,’ admonished Günter Grass, Jürgen Habermas and a cohort of like-minded German intellectuals, in an open letter dispatched to Le Monde. Warning their neighbours that ‘France . . . would isolate itself fatally if it were to vote “No”,’ they went on: ‘The consequences of a rejection would be catastrophic,’ indeed ‘an invitation to suicide’, for ‘without courage there is no survival.’ In member states new and old ‘the Constitution fulfils a dream of centuries,’ and to vote for it was not just a duty to the living, but to the dead: ‘we owe this to the millions upon millions of victims of our lunatic wars and criminal dictatorships.’ This from a country where no risk was taken of any democratic consultation of the elector -ate, and pro forma ratification of the Constitution was stage-managed in the Bundesrat to impress French voters a few days before their referendum, with Giscard as guest of honour at the podium. As for French isolation, three days later the Dutch – told, still more bluntly, that Auschwitz awaited Europe if they failed to vote yes – threw out the Constitution by an even wider margin.
 
Such popular repudiation of the charter for a new Europe, not because it was too federalist, but because it seemed to be little more than an impenetrable scheme for the redistribution of oligarchic power, embodying everything most distrusted in the arrogant, opaque system the EU appeared to have become, was not in reality a bolt from the blue. Virtually every time – there have not been many – that voters have been allowed to express an opinion about the direction the Union was taking, they have rejected it. The Norwegians refused the EC tout court; the Danes declined Maastricht; the Irish, the Treaty of Nice; the Swedes, the euro. Each time, the political class promptly sent them back to the polls to correct their mistake, or waited for the occasion to reverse the verdict. The operative maxim of the EU has become Brecht’s dictum: in case of setback, the government should dissolve the people and elect a new one.
 
Predictably, amid the celebrations of the 50th anniversary of the Treaty of Rome that gave birth to the EEC, European heads of state were soon discussing how to cashier the popular will once again, and reimpose the Constitution with cosmetic alterations but without exposing it this time to the risks of a democratic decision. At the Brussels summit this June, the requisite adjustment – now renamed a simple treaty – was agreed. To let it disavow a referendum, Britain was exempted from the Charter of Fundamental Rights to which all other member states subscribed. To throw a sop to French opinion, references to unfettered competition were tucked away in a protocol, rather than appearing in the main document. To square the conscience of the Dutch, ‘promotion of European values’ was made a test of membership. To save the face of Poland’s rulers, the demotion of their country to second rank in the Council was deferred for a decade, leaving their successors to come to terms with it.
 
The principal novelty at this gathering to resuscitate what French and Dutch voters had buried was the determination of Germany to ensure its primacy in the electoral structure of the Council. Polish objections to a formula doubling Germany’s weight, and drastically reducing Poland’s, had – for reasons that voting theory in international organisations has long made clear, as experts in such matters pointed out – every technical consideration of fairness on their side. But issues of equity were of no more relevance to the outcome than issues of democracy. After blustering that demographic losses in the Second World War entitled Poland to proportionate compensation in the design of the Union, the Kaczynski twins crumpled as quickly as the country’s prewar colonels before the German blitz. Brave talk forgotten, it was all over in a phone call. For the region where Poland accounts for nearly half the population and GDP, the episode is a lesson in the tacit hierarchy of states it has entered. The East is welcome, but should not get above itself.
 
Not that crumbs are unavailable. As the British, Dutch and French rulers, so the Polish too received, with their postponed demotion, the fig-leaf needed to dispense them from submitting the reanimated Constitution to the opinion of their voters. It was left to Ireland’s Premier Ahern – along with Blair, another of the conference’s recent escapees from a cloud of corruption – to exclaim, in a moment of unguarded delight: ‘90 per cent of it is still there!’ Even loyal commentators have found it difficult to suppress all disgust at the cynicism of this latest exercise in the ‘Community method’. The contrast between such realities and the placards of the touts for the new Europe could scarcely be starker. The truth is that the light of the world, role model for humanity at large, cannot even count on the consent of its populations at home.
 
What kind of political order, then, is taking shape in Europe, 15 years after Maastricht? The pioneers of European integration – Monnet and his fellow spirits – envisaged the eventual creation of a federal union that would one day be the supranational equivalent of the nation-states out of which it emerged, anchored in an expanded popular sovereignty, based on universal suffrage, its executive answerable to an elected legislature, and its economy subject to requirements of social responsibility. In short, a democracy magnified to semi-continental scale (they had only Western Europe in mind). But there was always another way of looking at European unification, which saw it more as a limited pooling of powers by member governments for certain – principally economic – ends, that did not imply any fundamental derogation of national sovereignty as traditionally understood, but rather the creation of a novel institutional framework for a specified range of transactions. De Gaulle famously represented one version of this outlook; Thatcher another. Between these federalist and inter-governmentalist visions of Europe, there has been a continual tension down to the present.
 
What has come into being, however, corresponds to neither. Constitutionally, the EU is a caricature of a democratic federation, since its Parliament lacks powers of initiative, contains no parties with any existence at European level, and wants even a modicum of popular credibility. Modest increments in its rights have not only failed to increase public interest in this body, but have been accompanied by a further decline in it. Participation in European elections has sunk steadily, to below 50 per cent, and the newest voters are the most indifferent of all. In the East, the regional figure in 2004 was scarcely more than 30 per cent; in Slovakia less than 17 per cent of voters cast a ballot for their delegates to Strasbourg. Such ennui is not irrational. The European Parliament is a Merovingian legislature. The mayor in the palace is the Council of Ministers, where real law-making decisions are taken, topped by the European Council of the heads of state, meeting every three months. Yet this complex in turn fails the opposite logic of an inter-governmental authority, since it is the Commission – the EU’s unelected executive – alone that can propose the laws on which the Council and (more notionally) the Parliament deliberate. The violation of a constitutional separation of powers in this dual authority – a bureaucracy vested with a monopoly of legislative initiative – is flagrant. Alongside this hybrid executive, moreover, is an independent judiciary, the European Court, capable of rulings discomfiting any national government.
 
At the centre of this maze lies the impenetrable zone in which the rival law-making instances of the Council and the Commission interlock, more obscure than any other feature of the Union: the nexus of ‘Coreper’ committees in Brussels,5 where emissaries of the former confer behind closed doors with functionaries of the latter, to generate the avalanche of legally binding directives that form the main output of the EU – close on 100,000 pages to date. Here is the effective point of concentration of everything summed up in the phrase – smacking, characteristically, of the counting-house rather than the forum – ‘democratic deficit’, one ritually deplored by EU officials themselves. In fact, what the trinity of Council, Coreper and Commission figures is not just an absence of democracy – it is certainly also that – but an attenuation of politics of any kind, as ordinarily understood. The effect of this axis is to short-circuit – above all at the critical Coreper level – national legislatures that are continually confronted with a mass of decisions over which they lack any oversight, without affording any supranational accountability in compensation, given the shadow-play of the Parliament. The farce of popular consultations that are regularly ignored is only the most dramatic expression of this oligarchic structure, which sums up the rest.
 
Alongside their negation of democratic principles, two further and less familiar features of these arrangements stand out. The vast majority of the decisions of the Council, Commission and Coreper concern domestic issues that were traditionally debated in national legislatures. But in the conclaves at Brussels these become the object of diplomatic negotiations: that is, of the kind of treatment classically reserved for foreign or military affairs, where parliamentary controls are usually weak to non-existent, and executive discretion more or less untrammelled. Since the Renaissance, secrecy has always been the other name of diplomacy. What the core structures of the EU effectively do is convert the open agenda of parliaments into the closed world of chancelleries. But even this is not all of it. Traditional diplomacy typically required stealth and surprise for success. But it did not preclude discord or rupture. Classically, it involved a war of manoeuvre between parties capable of breaking as well as making alliances; sudden shifts in the terrain of negotiations; alterations of means and objectives: in short, politics conducted between states, as distinct from within them, but politics nonetheless. In the disinfected universe of the EU, this all but disappears, as unanimity becomes virtually de rigueur on all significant occasions, any public disagreement, let alone refusal to accept a prefabricated consensus, increasingly being treated as if it were an unthinkable breach of etiquette. The deadly conformism of EU summits, smugly celebrated by theorists of ‘consociational democracy’, as if this were anything other than a cartel of self-protective elites, closes the coffin of even real diplomacy, covering it with wreaths of bureaucratic piety. Nothing is left to move the popular will, as democratic participation and political imagination are each snuffed out.
 
These structures have been some time in the making. Unreformed, they could not but be reinforced by enlargement. The distance between rulers and ruled, already wide enough in a Community of nine or 12 countries, can only widen much further in a Union of 27 or more, where economic and social circumstances differ so vastly that the Gini coefficient in the EU is now higher than in the US, the fabled land of inequality itself. It was always the calculation of adversaries of European federalism, successive British governments at their head, that the more extended the Community became, the less chance there was of any deepening of its institutions in a democratic direction, for the more impractical any conception of popular sovereignty in a supranational union would become. Their intentions have come to pass. Stretched to nearly 500 million citizens, the EU of today is in no position to recall the dreams of Monnet.
 
So what? There is no shortage of apologists prepared to explain that it is not just wrong to complain of a lack of democracy in the Union, conventionally understood, but that this is actually its greatest virtue. The standard argument, to be found in journals such as Prospect, goes like this. The EU deals essentially with the technical and administrative issues – market competition, product specification, consumer protection and the like – posed by the aim of the Treaty of Rome to assure the free movement of goods, persons and capital within its borders. These are matters in which voters have little interest, rightly taking the view that they are best handled by appropriate experts, rather than incompetent parliamentarians. Just as the police, fire brigade or officer corps are not elected, but enjoy the widest public trust, so it is – at any rate tacitly – with the functionaries in Brussels. The democratic deficit is a myth, because matters which voters do care strongly about – pre-eminently taxes and social services, the real stuff of politics – continue to be decided, not at Union but at national level, by traditional electoral mechanisms. So long as the separation between the two arenas and their respective types of decision is respected, and we are spared demagogic exercises in populism – putting issues that the masses cannot understand, and that should never be on a ballot in the first place, to referenda – democracy remains intact, indeed enhanced. Considered soberly, all is for the best in the best of all possible Europes.
 
In an unreflective sense, this case might seem to appeal to a common immediate experience of the Union. If asked in what ways they have personally been affected by the EU, most of its citizens – at least those who live in the Eurozone and Schengen belt – would certainly not mention its technical directives; they would probably answer that travel has been simplified by the disappearance of border controls and the need to change currencies. Beyond such conveniences, a narrow stratum of professionals and executives, and a somewhat broader flow of migrant workers and craftsmen, have benefited from occupational mobility across borders, though this is still quite limited: less than 2 per cent of the population of the Union lives outside its country of origin. In some ways more significant may be the programmes that take growing numbers of students to courses in other societies of the EU. Journeys, studies, a scattering of jobs: agreeable changes all, not vital issues. It is this expanse of mild amenities that no doubt explains the passivity of voters towards rulers who ignore their expressions of opinion. For nearly as striking as the repeated popular rejection of official schemes for the Union is the lack of reaction to subsequent flouting of the popular decision. The elites do not persuade the masses; but, to all appearances, they have little to fear from them.
 
Why then is there such persistent distrust of Brussels, if so little of what it does impinges on ordinary life, and that quite pleasantly? Subjectively, the answer is clear. There are few citizens who are not banally alienated from the way they are governed at home – virtually every poll shows how little they believe in what their rulers say, and how powerless they feel to alter what they do. Yet these are still societies in which elections are regularly held, and governments that become too disliked can be evicted. No one doubts that democracy, in this minimal sense, obtains. At European level, however, there is all too obviously not even this vestige of accountability: the grounds for alienation are cubed. If the EU really had zero impact on what voters care about, their distrust could be dismissed as a mere abstract prejudice. But in fact the intuition behind it is accurate. Since the Treaty of Maastricht, the Union has not by any means been confined to regulatory issues of scant interest to the population at large. It now has a Central Bank, without even the commitment of the Federal Reserve to sustain employment, let alone its duties to report to Congress, that sets interest rates for the whole Eurozone, backed by a Stability Pact that requires national governments to meet hard budgetary targets. In other words, determination of macroeconomic policy at the highest level has shifted upwards from national capitals to Frankfurt and Brussels. What this means is that just those issues that voters usually feel most strongly about – jobs, taxes and social services – fall squarely under the guillotines of the Bank and the Commission. The history of the past years has shown that this is not an academic matter. It was pressure from Brussels to cut public spending which led Juppé’s government to introduce the fiscal package that detonated the great French strike-wave of the winter of 1995, and brought him down. It was the corset of the Stability Pact that forced Portugal into slashing social benefits and plunging the country into a steep recession in 2003. The government in Lisbon did not survive either. The notion that today’s EU comprises little more than a set of innocuous technical rules, as value-neutral as traffic lights, is a fatuity.
 
There was from the beginning a third vision of what European integration should mean, distinct from either federalist or inter-governmentalist conceptions of the Community. Its far-sighted theorist was Hayek, who even before the Second World War had envisaged a constitutional structure raised sufficiently high above the nations composing it to exclude the danger of any popular sovereignty below impinging on it. In the nation-state, electorates were perpetually subject to dirigiste and redistributive temptations, encroaching on the rights of property in the name of democracy. But once heterogeneous populations were assembled in an inter-state federation, as he called it, they would not be able to re-create the united will that was prone to such ruinous interventions. Under an impartial authority, beyond the reach of political ignorance or envy, the spontaneous order of a market economy could finally unfold without interference.
 
By 1950, when Monnet was devising the Schuman Plan that yielded the initial European Coal and Steel Community, Hayek himself was in America, and played little part in shaping arguments for integration. Later, rejecting the idea of a single currency as statist (he favoured competing private issues), he would come to the conclusion that the Community itself remained all too dirigiste. But in Germany there was a school of theorists that saw the possibilities of European unity in much the same terms as he had originally envisaged, the Ordo-liberals of Freiburg, whose leading thinkers were Walter Eucken, Wilhelm Röpke and Alfred Müller-Armack. Lacking Hayek’s intransigent radicalism, they were close to Ludwig Erhard, the reputed architect of the postwar German miracle, and thereby had more real influence in the early days of the Common Market. But for thirty years, this was still a recessive strain in the make-up of the Community, latent but never the most salient in its development.
 
With the abrupt deterioration in the global economic climate in the 1970s, and the general neo-liberal turn that followed in the 1980s, Hayekian doctrine was rediscovered throughout the West. The leading edge of the change came in the UK and US, with the arrival of Thatcher and Reagan. Continental Europe never produced comparably radical regimes, but the ideological atmosphere shifted steadily in the same direction. The collapse of the Soviet bloc sealed the transformation of working assumptions. By the 1990s, the Commission was openly committed to privatisation as a principle, pressed without embarrassment on candidate countries along with other democratic niceties. Its most powerful arm had become the Competition Directorate, striking out at public sector monopolies in Western and Eastern Europe alike. In Frankfurt the Central Bank conformed perfectly with Hayek’s prewar prescriptions. What was originally the least prominent strand in the weave of European integration had become the dominant pattern. Federalism stymied, inter-governmentalism corroded, what had emerged was neither the rudiments of a European democracy controlled by its citizens, nor the formation of a European directory guided by its powers, but a vast zone of increasingly unbound market exchange, much closer to a European ‘catallaxy’ as Hayek had conceived it.
 
The mutation is by no means complete. The European Parliament is still there, as a memento of federal hopes foregone. Agricultural and regional subsidies, legacies of a cameralist past, continue to absorb most of the EU budget. Services, over two-thirds of Union GDP, have yet to be fully liberalised. But of a ‘social Europe’, in the sense intended by either Monnet or Delors, there is as little left as a democratic Europe. At national level, welfare regimes that distinguish the Old World from the New persist. With the exception of Ireland, the share of state expenditure in GDP remains higher in Western Europe than in the United States, and the larger part of an academic industry – the ‘varieties of capitalism literature’ – is dedicated to showing how much more caring ours, above all the Scandinavian versions, are than theirs. The claim is valid enough; the self-satisfaction less so. For as the numbers of long-term jobless and pensioners have risen, the drift of the age has been away from earlier norms of provision, not beyond them. The very term ‘reform’ now means, virtually always, the opposite of what it denoted fifty years ago: not the creation but the contraction of welfare arrangements once prized by their recipients. The only two structural advances beyond the postwar gains of social democracy – the Meidner plan for pension funds in Sweden, and the 35-hour week in France – have both been rolled back. The tide is moving in the other direction.
 
Today’s EU, with its pinched spending (just over 1 per cent of Union GDP), minuscule bureaucracy (around 16,000 officials, excluding translators), absence of independent taxation, and lack of any means of administrative enforcement, could in many ways be regarded as a ne plus ultra of the minimal state, beyond the most drastic imaginings of classical liberalism: less even than the dream of a nightwatchman. Its structure not only rules out a transfer, of the sort once envisaged by Delors, of social functions from national to supranational level, to counterbalance the strain these have come under from high rates of unemployment and growing numbers of pensioners. Its effect is to increase, rather than compensate for, pressure on national systems of social provision, as so many impediments to the free movement of factors of production. As a leading authority, Andrew Moravcsik, explains, ‘the neo-liberal bias of the EU, if it exists, is justified by the social welfare bias of current national policies,’ which ‘no responsible analyst believes can be maintained’ – ‘European social policy exists only in the dreams of disgruntled socialists.’ The salutary truth is that ‘the EU is overwhelmingly about the promotion of free markets. Its primary interest group support comes from multinational firms, not least US ones.’ In short: regnant in this Union is not democracy, and not welfare, but capital. ‘The EU is basically about business.’
 
That may be so, enthusiasts might reply, but why should it detract from the larger good that the EU represents in the world, a political community that stands alone in its respect for human rights, international law, aid to the poor of the earth, and protection of the environment? Could the Union not be described as the realisation of the Enlightenment vision of the virtues of le doux commerce, that ‘cure for the most destructive prejudices’, as Montesquieu described it, pacifying relations between states in a spirit of mutual benefit and the rule of law?
 
In the current repertoire of tributes to Europe, it is this claim – the unique role and prestige of the EU on the world’s stage – that now has pride of place. What it rests on, ubiquitously, is a contrast with the United States. America figures as the increasingly ominous, violent, swaggering Other of a humane continent of peace and progress: a society that is a law to itself, where Europe strives for a legal order binding on all. The values of the two, Habermas and many fellow thinkers explain, have diverged: widespread gun culture, extreme economic inequality, fundamentalist religion and capital punishment, not to speak of national bravado, divide the US from the EU and foster a more regressive conception of international relations. Reversing Goethe’s dictum, we have it better here.
 
The crystallisation of these images came with the invasion of Iraq. The mass demonstrations against the war of 15 February 2003, Habermas thought, might go down in history as ‘a signal for the birth of a European public’. Even such an unlikely figure as Dominique Strauss-Kahn, the probable incoming director of the IMF, announced that they marked the birth of a European nation. But if this was a Declaration of Independence, was the term ‘nation’ appropriate for what was being born? While divergence with America over the Middle East could serve as a negative definition of the emergent Europe, there was a positive side that pointed in another conceptual direction. Enlargement was the great new achievement of the Union. How should it be theorised? In late 1991, a few months after the collapse of the Soviet Union and a few days after the summit at Maastricht, J.G.A. Pocock published a prophetic essay in these pages.6 A trenchant critic of the EU, which he has always seen as involving a surrender of sovereignty and identity – and with them the conditions also of democracy – to the market, though a surrender never yet completed, Pocock observed that Europe now faced the problem of determining its frontiers, as ‘once again an empire in the sense of a civilised and stabilised zone which must decide whether to extend or refuse its political power over violent and unstable cultures along its borders’.
 
At the time, this was not a formulation welcome in official discourse on Europe. A decade later, the term it loosed with irony has become a common coin of complacency. As the countdown to Iraq proceeded, the British diplomat Robert Cooper, special adviser on security to Blair, and later to Prodi as head of the Commission, explained the merits of empire to readers of Prospect. ‘A system in which the strong protect the weak, in which the efficient and well-governed export stability and liberty, in which the world is open for investment and growth – all of these seem eminently desirable.’ Of course, ‘in a world of human rights and bourgeois values, a new imperialism will . . . have to be very different from the old.’ It would be a ‘voluntary imperialism’, of the sort admirably displayed by the EU in the Balkans. Enlargement ahead, he concluded, the Union was en route to the ‘noble dream’ of a ‘co-operative empire’. Enlargement in the bag, the Polish theorist Jan Zielonka, now at Oxford, exults in his book Europe as Empire that its ‘design was truly imperialist’: ‘power politics at its best, even though the term “power” was never mentioned in the official enlargement discourse’ – this was a ‘benign empire in action’.7
 
In more tough-minded style, the German strategist Herfried Münkler, holder of the chair of political theory at Humboldt University in Berlin, has expounded the world-historical logic of empires in an ambitious comparative work, Imperien, whose ideas were first presented as an aide-mémoire to a conference of ambassadors called by his country’s Foreign Ministry.8 Its theme is that, from ancient to modern times, imperial power has been required to stabilise adjacent power vacuums or turbulent border zones, holding barbarians or terrorists at bay. While naturally loyal to the West, Münkler disavows normative considerations. Human rights messianism is a moral luxury even the American empire can ill-afford. Europe, for its part, should take the measure of its emergent role as a ‘sub-imperial system’, with its own marches to control, matching its tasks to its capabilities without excessive professions of uplifting intent.
 
The prefix poses the question that is the crux of the new identity Europe has awarded itself. How independent of the United States is it? The answer is cruel, as even a cursory glance at the record shows. Perhaps at no time since 1950 has it been less so. The history of enlargement, the Union’s major achievement – extending the frontiers of freedom, or ascending to the rank of empire, or both at once, as the claim may be – is an index. Expansion to the East was piloted by Washington: in every case, the former Soviet satellites were incorporated into Nato, under US command, before they were admitted to the EU. Poland and the Czech Republic had joined Nato in 1999, five years before entry into the Union; Bulgaria and Romania in 2004, three years before entry; even Slovakia, Slovenia and the Baltics, a gratuitous month – just to rub in the symbolic point? – before entry (planning for the Baltics started in 1998). Croatia, Macedonia and Albania are next in line.
 
The expansion of Nato to former Soviet borders, casting aside undertakings given to Gorbachev at the end of the Cold War, was the work of the Clinton administration. Twelve days after the first levy of Poland, Hungary and the Czech Republic had joined the Alliance, the Balkan War was launched – the first full-scale military offensive in Nato’s history. The successful blitz was an American operation, with token auxiliaries from Europe, and virtually no dissent in public opinion. These were harmonious days in Euro-American relations. There was no race between the EU and Nato in the East. Brussels deferred to the priority of Washington, which encouraged and prompted the advance of Brussels. So natural has this asymmetrical symbiosis now become that the United States can openly specify what further states should join the Union. When Bush told European leaders in Ankara, at a gathering of Nato, that Turkey must be admitted into the EU, Chirac was heard to grumble that the US would not like being instructed by Europeans to welcome Mexico into the federation; but when the European Council met to decide whether to open accession negotiations with Turkey, Rice telephoned the assembled leaders from Washington to ensure the right outcome, without hearing any inappropriate complaints from them about sovereignty. At this level, friction between Europe and America remains minimal.
 
Why then has there been that sense of a general crisis in transatlantic relations, which has given rise to such an extensive literature? In the EU, media and public opinion are at one in holding the conduct of the Republican administration outside Nato to be essentially responsible. Scanting the Kyoto protocols and the International Criminal Court, sidelining the UN, trampling on the Geneva Conventions, and stampeding into the Middle East, the Bush regime has on this view exposed a darker side of the United States, that has understandably been met with near universal abhorrence in Europe, even if etiquette has restrained expressions of it at diplomatic level. Above all, revulsion at the war in Iraq has, more than any other single episode since 1945, led to the rift recorded in the painful title of Habermas’s latest work, The Divided West.9
 
In this vision, there is a sharp contrast between the Clinton and Bush presidencies, and it is the break in the continuity of American foreign policy – the jettisoning of consensual leadership for an arrogant unilateralism – that has alienated Europeans. There is no question of the intensity of this perception. But in the orchestrations of America’s Weltpolitik, style is easily mistaken for substance. The brusque manners of the Bush administration, its impatience with the euphemisms of the ‘international community’ and blunt rejection of Kyoto and the ICC, offended European sensibilities from the start. Clinton’s emollient gestures were more tactful, if in practice their upshot – neither Kyoto nor the ICC ever risked passage into law while he was in office – was often much the same. More fundamentally, as political operations, a straight line led from the war in the Balkans to the war in Mesopotamia. In both, a casus belli – imminent genocide, imminent nuclear weapons – was trumped up; the Security Council ignored; international law set aside; and an assault unleashed.
 
United over Yugoslavia, Europe split over Iraq, where the strategic risks were higher. But the extent of European opposition to the march on Baghdad was always something of an illusion. On the streets, in Italy, Spain, Germany, Britain, huge numbers of people demonstrated against the invasion. Opinion polls showed majorities against it everywhere. But once it had occurred, there was little protest against the occupation, let alone support for the resistance to it. Most European governments – Britain, Spain, Italy, Netherlands, Denmark, Portugal in the West; all in the East – backed the invasion, and sent troops to bulk up the US forces holding the country down. Out of the 12 member states of the EU in 2003, just three – France, Germany and Belgium – came out against the prospect of war before the event. None condemned the attack when it was launched. But the declared opposition of Paris and Berlin to the plans of Washington and London gave popular sentiment across Europe a point of concentration, confirming and amplifying its sense of distance from power and opinion in America. The notion of an incipient Declaration of Independence by the Old World was born here.
 
Realities were rather different. Chirac and Schröder had a domestic interest in countering the invasion. Each judged his electorate well, and gained substantially – Schröder securing re-election – from his stance. On the other hand, American will was not to be trifled with. So each compensated in deeds for what he proclaimed in words, opposing the war in public, while colluding with it sub rosa. Behind closed doors in Washington, France’s ambassador Jean-David Levitte – currently Sarkozy’s diplomatic adviser – gave the White House a green light for the war, provided it was on the basis of the first generic UN Resolution 1441, as Cheney wanted, without returning to the Security Council for the second explicit authorisation to attack that Blair wanted, which would force France to veto it. In ciphers from Baghdad, German intelligence agents provided the Pentagon with targets and co-ordinates for the first US missiles to hit the city, in the downpour of Shock and Awe. Once the ground war began, France provided airspace for USAF missions to Iraq (which Chirac had denied Reagan’s bombing of Libya), and Germany a key transport hub for the campaign. Both countries voted for the UN resolution ratifying the US occupation of Iraq, and lost no time recognising the client regime patched together by Washington.
 
As for the EU, its choice of a new president of the Commission in 2004 could not have been more symbolic: the Portuguese ruler who hosted Bush, Blair and Aznar at the summit in the Azores on 16 March 2003 that issued the ultimatum for the assault on Iraq. Barroso is in good company. France now has a foreign minister, Bernard Kuchner, who had no time for even the modest duplicities of his country about America’s war, welcoming it as another example of the droit d’ingérence he had always championed. Sweden, where once a prime minister could take a sharper distance from the war in Vietnam than De Gaulle himself, has a new minister for foreign affairs to match his colleague in Paris: Carl Bildt, a founder member of the Committee for the Liberation of Iraq, along with Richard Perle, William Kristol, Newt Gingrich and others. In the UK, the local counterpart has proudly restated his support for the war, though here, no doubt, the corpses were stepped over in pursuit of preferment rather than principle. Spaniards and Italians may have withdrawn their troops from Iraq, but no European government has any policy towards a society America has destroyed that is distinct from the outlook in Washington.
 
For the rest, Europe remains engaged to the hilt in the war in Afghanistan, where a contemporary version of the expeditionary force dispatched to crush the Boxer Rebellion has killed more civilians this year than the guerrillas it seeks to root out. The Pentagon did not require the services of Nato for its lightning overthrow of the Taliban, though British and French jets put in a nominal appearance. Occupation of the country, which has a larger population and more forbidding terrain than Iraq, was another matter, and a Nato force of five thousand was assembled to hold the fort around Kabul, while US forces finished off Mullah Omar and Bin Laden. Five years later, Omar and Osama remain at large; the West’s puppet ruler, Karzai, cannot move without a squad of mercenaries from DynCorp International to protect him; production of opium has increased tenfold; the Afghan resistance has become steadily more effective; and Nato-led forces – now comprising contingents from 37 nations, from Britain, Germany, France, Italy, Turkey, Poland down to such minnows as Iceland – have swollen to 35,000, alongside 25,000 US troops. Indiscriminate bombing, random shooting and ‘human rights abuses’, in the polite phrase, have become commonplaces of the counter-insurgency.
 
In the wider Middle East, the scene is the same. Europe is joined at the hip with the US, wherever the legacies of imperial control or settler zeal are at stake. Britain and France, original suppliers of heavy water and uranium for the large Israeli nuclear arsenal, which they pretend does not exist, demand along with America that Iran abandon programmes it is allowed even by the Non-Proliferation Treaty, under menace of sanctions and war. In Lebanon, the EU and the US prop up a cabinet that would not last a day if a census were called, while German, French and Italian troops provide border guards for Israel. As for Palestine, the EU showed no more hesitation than the US in plunging the population into misery, cutting off all aid when voters elected the wrong government, on the pretext that it must first recognise the Israeli state, as if Israel had ever recognised a Palestinian state, and renounce terrorism (read: any armed resistance to a military occupation that has lasted forty years without Europe lifting a finger against it). Funds now flow again, to protect a remnant valet in the West Bank.
 
Lovers of Europe might reply that some of this record may be questionable, but these are external issues that can scarcely be said to affect the example Europe sets the world of respect for human rights and the rule of law within its own borders. The performance of the EU or its member states may not be irreproachable in the Middle East, but isn’t the moral leadership represented by its standards at home what really counts, internationally? So good a conscience comes too easily. The war on terror knows no frontiers and the crimes committed in its name have stalked freely across the continent, in the full cognisance of its rulers. Originally, the subcontracting of torture – ‘rendition’, or the handing over of a victim to the attentions of the secret police in client states – was, like so much else, an invention of the Clinton administration, which introduced the practice in the mid-1990s. Asked about it a decade later, the CIA official in charge of the programme, Michael Scheuer, simply said: ‘I check my moral qualms at the door.’ As one would expect, it was Britain that collaborated with the first renditions, in the company of Croatia and Albania.
 
Under the Bush administration, the programme expanded. Three weeks after 9/11, Nato declared that Article V of its charter, mandating collective defence in the event of an attack on one of its members, was activated. By then American plans for the descent on Afghanistan were well advanced, but they did not include European participation in Operation Enduring Freedom; the US high command had found the need for consultation in a joint campaign cumbersome in the Balkan War, and did not want to repeat the experience. Instead, at a meeting in Brussels on 4 October 2001, the allies were called on for other services. The specification of these remains secret, but as the second report to the Council of Europe – released in June this year – by the courageous Swiss investigator Dick Marty, has shown, a stepped-up programme of renditions must have been high on the list. Once Afghanistan was taken, Baghram airbase outside Kabul became both interrogation centre for the CIA and loading-bay for prisoners to Guantánamo. The traffic was soon two-way, and its pivot was Europe. In one direction, captives were transported from Afghan or Pakistani dungeons to Europe, either to be held there in secret CIA jails, or shipped onwards to Cuba. In the other direction, captives were flown from secret locations in Europe for requisite treatment in Afghanistan.
 
Though Nato initiated this system, the abductions it involved were not confined to members of the North Atlantic Council. Europe was eager to help America, whether or not fine print obliged it to do so. North, south, east and west: no part of the continent failed to join in. New Labour’s contribution occasions no surprise: with up to 650,000 civilians dead from the Anglo-American invasion of Iraq, it would have been unreasonable for the Straws, Becketts, Milibands to lose any sleep over the torture of the living. More striking is the role of the neutrals. Under Ahern, Ireland furnished Shannon to the CIA for so many westbound flights that locals dubbed it Guantánamo Express. Social-democratic Sweden, under its portly boss Göran Persson, now a corporate lobbyist, handed over two Egyptians seeking asylum to the CIA, who took them straight to torturers in Cairo. Under Berlusconi, Italy helped a large CIA team to kidnap another Egyptian in Milan, who was flown from the US airbase in Aviano, via Ramstein in Germany, for the same treatment in Cairo.10 Under Prodi, a government of Catholics and ex-Communists has sought to frustrate the judicial investigation of this kidnapping, while presiding over the expansion of Aviano. Switzerland proffered the overflight that took the victim to Ramstein, and protected the head of the CIA gang that seized him from arrest by the Italian judicial authorities – he now basks in Florida.
 
Further east, Poland did not transmit captives to their fate in the Middle East, but incarcerated them for treatment on the spot, in torture chambers constructed for ‘high-value detainees’ by the CIA at the Stare Kiejkuty intelligence base, Europe’s own Baghram – facilities unknown in the time of Jaruzelski’s martial law. In Romania, a military base north of Constanza performed the same services, under the superintendence of the country’s current president, the staunchly pro-Western Traian Basescu. In Bosnia, six Algerians were illegally seized at American behest, and flown from Tuzla – beatings in the aircraft en route – to the US base at Incirlik in Turkey, and thence to Guantánamo, where they still crouch in their cages. In Macedonia, scene of Blair’s moving encounters with refugees from Kosovo, there was a combination of the two procedures, as a German of Lebanese descent was kidnapped at the border; held, interrogated and beaten by the CIA in Skopje; then drugged and shipped to Kabul for more extended treatment. Eventually, when it became clear, after he went on hunger-strike, that his identity had been mistaken, he was flown blindfold to a Nato-upgraded airbase in Albania, and deposited back in Germany.
 
There the Red-Green government had been well aware of what happened to him, one of its agents interrogating him in his oubliette in Kabul – Otto Schily, the minister of the interior, was in the Afghan capital at the time – and accompanying his flight back to Albania. But it was no more concerned about his fate than about that of another of its residents, a Turk born in Germany, seized by the CIA in Pakistan and dispatched to the gulag in Guantánamo, where he too was interrogated by German agents. Both operations were under the control of today’s Social Democratic foreign minister, Frank-Walter Steinmeier, then in charge of the secret services, who not only covered for the torturing of the victim in Cuba, but even declined an American offer to release him. In a letter to the man’s mother, Joschka Fischer, Green foreign minister at the time, explained that the government could do nothing for him. In ‘such a good land’, as a leading admirer has recently described it, Fischer and Steinmeier remain the most popular of politicians. The new interior minister, Wolfgang Schäuble, is more robust, publicly calling for assassination rather than rendition in dealing with deadly enemies of the state, in the Israeli manner.
 
Such is the record set out in the two detailed reports by Marty to the Council of Europe (nothing to do with the EU), each an exemplary document of meticulous detective work and moral passion. If this Swiss prosecutor from Ticino were representative of the continent, rather than a voice crying in the wilderness, there would be reason to be proud of it. He ends his second report by expressing the hope that his work will bring home ‘the legal and moral quagmire into which we have collectively sunk as a result of the US-led “war on terror”. Almost six years in, we seem no closer to pulling ourselves out of this quagmire.’ Indeed. Not a single European government has conceded any guilt, while all continue imperturbably to hold forth on human rights. We are in the world of Ibsen – Consul Bernick, Judge Brack and their like – updated for postmoderns. Pillars of society, pimping for torture.
 
What has been delivered in these practices are not just the hooded or chained bodies, but the deliverers themselves: Europe surrendered to the United States. This rendition is the most taboo of all to mention. A rough approximation to it can be found in what remains in many ways the best account of the relationship between the two, Robert Kagan’s Paradise and Power, the benevolent contempt of whose imagery of Mars and Venus – the Old World, relieved of military duties by the New, cultivating the arts and pleasures of a borrowed peace – predictably riled Europeans.11 But even Kagan grants them too much, as if they really lived according to the precepts of Kant, while Americans were obliged to act on the truths of Hobbes. If a philosophical reference were wanted, more appropriate would have been La Boétie, whose Discours de la servitude volontaire could furnish a motto for the Union. But these are arcana. The one contemporary text to have captured the full flavour of the transatlantic relationship is, perhaps inevitably, a satire, Régis Debray’s plea for a United States of the West that would absorb Europe completely into the American imperium.12
 
Did it have to come to this? The paradox is that when Europe was less united, it was in many ways more independent. The leaders who ruled in the early stages of integration had all been formed in a world before the global hegemony of the United States, when the major European states were themselves imperial powers, whose foreign policies were self-determined. These were people who had lived through the disasters of the Second World War, but were not crushed by them. This was true not just of a figure like De Gaulle, but of Adenauer and Mollet, of Eden and Heath, all of whom were quite prepared to ignore or defy America if their ambitions demanded it. Monnet, who did not accept their national assumptions, and never clashed with the US, still shared their sense of a future in which Europeans could settle their own affairs, in another fashion. Down into the 1970s, something of this spirit lived on even in Giscard and Schmidt, as Carter discovered. But with the neo-liberal turn of the 1980s, and the arrival in power in the 1990s of a postwar generation, it faded. The new economic doctrines cast doubt on the state as a political agent, and the new leaders had never known anything except the Pax Americana. The traditional springs of autonomy were gone.
 
By this time, on the other hand, the Community had doubled in size, acquired an international currency, and boasted a GDP exceeding that of the United States itself. Statistically, the conditions for an independent Europe existed as never before. But politically, they had been reversed. With the decay of federalism and the deflation of inter-governmentalism, the Union had weakened national, without creating a supranational, sovereignty, leaving rulers adrift in an ill-defined limbo between the two. With the eclipse of significant distinctions between left and right, other motives of an earlier independence have also waned. In the syrup of la pensée unique, little separates the market-friendly wisdom of one side of the Atlantic from the other, though as befits the derivative, the recipe is still blander in Europe than America, where political differences are less extinct. In such conditions, an enthusiast can find no higher praise for the Union than to compare it to ‘one of the most successful companies in global history’. Which firm confers this honour on Brussels? Why, the one in your wallet. The EU ‘is already closer to Visa than it is to a state’, declares New Labour’s Mark Leonard, exalting Europe to the rank of a credit card.
 
Transcendence of the nation-state, Marx believed, would be a task not for capital but for labour. A century later, as the Cold War set in, Kojève held that whichever camp achieved it would emerge the victor from the conflict. The foundation of the European Community settled the issue for him. The West would win, and its triumph would bring history, understood categorically – not chronologically – as the realisation of human freedom, to an end. Kojève’s prediction was accurate. His extrapolation, and its irony, remain in the balance. They have certainly not been disproved: he would have smiled at the image of a chit of plastic. The emergence of the Union may be regarded as the last great world-historical achievement of the bourgeoisie, proof that its creative powers were not exhausted by the fratricide of two world wars, and what has happened to it as a strange declension from what was hoped from it. Yet the long-run outcome of integration remains unforeseeable to all parties. Even without shocks, many a zigzag has marked its path. With them, who knows what further mutations might occur.
 
Notes
 
[1] Neal Ascherson discussed Postwar: A History of Europe since 1945 in the LRB of 17 November 2005.
[2] Fourth Estate, 170 pp., £8.99, February 2005, 978 0 00 719531 2.
[3] The European Dream: How Europe’s Vision of the Future Is Quietly Eclipsing the American Dream (Polity, 400 pp., £50 and £15.99, September 2004, 978 0 7456 3425 8).
[4] Inventing Eastern Europe: The Map of Civilisation on the Mind of the Enlightenment (1996).
[5] Committees of Permanent Representatives.
[6] LRB, 19 December 1991.
[7] Europe as Empire: The Nature of the Enlarged European Union (Oxford, 304 pp., £18.99, September, 978 0 19 923186 7).
[8] Rowohlt, 331 pp., £13.66, August 2005, 978 3 8713 4509 8.
[9] Polity, 200 pp., £15.99, September 2006, 987 0 7456 3519 4.
[10] John Foot wrote about this case in the LRB of 2 August.
[11] Paradise and Power: America and Europe in the New World Order (Atlantic, 112 pp., £7.99, March 2004, 978 1 8435 4178 3).
[12] ‘Letter from America’ by Xavier de C* * * (NLR, January-February 2003).
 
Perry Anderson teaches history at UCLA.
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2007/09/17 04:42 2007/09/17 04:42

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Review of Schmpeter (The Nation)

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Perishable Goods
by ROBIN BLACKBURN
 
[from the September 24, 2007 issue]
 
Books on the lives of the great economists might not, at first blush, set the blood coursing. Yet Robert Skidelsky's masterly three-volume biography of John Maynard Keynes proved how engrossing such a life could be. It is high praise to say that Thomas McCraw's biography of Joseph Schumpeter, Prophet of Innovation, has some of the same quality and appeal. But is Schumpeter really a figure who deserves to be numbered among the great economists?
 
Leading economists are a bit like academic royalty: They are counselors to our rulers, they have Nobel Prizes to themselves and in Britain the most influential sit in the House of Lords. Keynes and Schumpeter died before either could win a Nobel, but they made up for this by having a far larger impact than most who win the prize. While Keynes's approach shaped the global postwar economy, Schumpeter's explained why capitalism could never be tamed by Keynesian regulation. Keynes rarely spoke of capitalism. Schumpeter believed the concept to be essential to true economic understanding. His two most important books were The Theory of Economic Development (1911) and Capitalism, Socialism and Democracy (1942). Schumpeter's claim to greatness is that he had great insight into capitalism. Despite living and working in Depression-era America, he was utterly convinced that the great crisis was simply a ground-clearing interlude that would usher in the most prodigious wave of growth in human history.
 
For much of the twentieth century, mainstream social scientists believed the term "capitalism" was unduly loaded and ideological. They spoke instead of "industrial society" and the "mixed economy"--or they saw no need for any label at all. I can still remember the frisson I felt in the late 1970s when I saw a neon sign turning in the Boston night sky reading Capitalism Works. In Europe at this time only the radical left talked about capitalism. Though far from a leftist, Schumpeter shared with the Marxists and the laissez-faire right an interest in capitalism--and a refreshing candor about naming the system. Indeed, influential exponents of these opposed philosophies learned from Schumpeter, with his focus on the importance of the entrepreneur and on a restless, ruthless accumulation process fostering insatiable appetites and limitless capacities. Like those who erected that sign in Boston, Schumpeter believed that capitalism works, or would work if only politicians gave it a chance.
 
Schumpeter was born in 1883--the same year as Keynes--and lived only four years longer, dying in 1950. He had a Czech mother and German-speaking father but was raised by his mother in Graz and Vienna. Among the latter city's galaxy of intellectual stars, several--Ludwig von Mises, who would become the co-founder of the free-market school, and the "Austro-Marxists," headed by Otto Bauer, leader of the Social Democratic Party--were preoccupied by the workings of the market, seen as either a rival or a complement to state bureaucracy. Fear of German power, and of the growing strength of a Marxist labor movement, prompted this Austrian interest in capitalism. A sequence of photographs reproduced in McCraw's book show the members of the famous Marx seminar at the University of Vienna led by professor Eugen Böhm-Bawerk, a former imperial finance minister and author of Karl Marx and the Close of His System (1899). Schumpeter is flanked by Mises, Bauer and Rudolf Hilferding, the Marxist economist and future German finance minister.
 
Schumpeter's Theory of Economic Development conveyed his conviction that entrepreneurship and competition were constant sources of growth and disruption in capitalist economies. While other economists saw competition as focusing on price, Schumpeter argued that the process also embraced the development of new products and processes, with often devastating effects on established producers. This was the germ of what he was later to call "creative destruction," the wavelike process in which yesterday's leaders are replaced by those with something radically new to offer, be it the railway, the automobile, the PC or the iPod. Others were so mesmerized by the great trusts, and their apparent power to control the market, that they did not see how vulnerable even the greatest could be if challenged by a new product.
 
McCraw argues that Schumpeter gives us a keen insight into the world of globalized capitalism, a world built on the ruins of Keynesian-style national economic regulation. Schumpeter sought to explain the behavior of real-life corporations like International Harvester, Bell and Ford. Keynes's General Theory does not mention a single firm. While others write patronizingly of "widgets" and the "better mouse trap," Schumpeter sought to chart the dynamics of product innovation.
 
But if Schumpeter's work looked forward to the twenty-first century, his early life has an aura of the nineteenth-century fin de siècle and ancien régime. While still in his 20s he won an appointment to a chair in Czernowitz, an eastern outpost of the Austro-Hungarian Empire, where he found that his students were denied proper access to the library. Challenged to a duel by the school's librarian, he fought to help his students and, not least, to demonstrate his honor--satisfaktionsfähig--as an Austrian gentleman. By virtue of his swordsmanship, Schumpeter drew first blood, and the library's collection was made fully available to his students. When he moved from Czernowitz to a chair in Graz, Francis Joseph, the 81-year-old emperor, presided over the ceremony. As a servant of the crown, Schumpeter, like all university professors, wore a civil service uniform during his lectures.
 
Schumpeter spent time in Britain, Cairo and the United States before the outbreak of war in Europe but returned to Austria in 1914 to pursue his academic career. At the war's close, he was invited by Karl Kautsky to join the "socialisation commission" established by the new Social Democratic German government. Hilferding was also a member and claimed that Schumpeter was far more radical in his proposals than his Marxist colleagues. Later Schumpeter explained that he was curious to see if there really was an alternative to capitalism.
 
Before long Schumpeter moved back to Vienna, where the Social Democrats offered him the post of finance minister. But he did not last more than four months in the job, stepping down in October 1919. As minister he sought to introduce a swingeing "capital levy"--a steeply progressive tax on capital. His aim was to stabilize the economy, not to expropriate the bourgeoisie. But he arrived too late to avert a crash. McCraw paints a vivid account of the ups and downs of Schumpeter's early career, but extra tidbits can be gleaned from Wolfgang Stolper's 1994 biography of Schumpeter. For example, while still finance minister, he offered to raise the funds needed for a "Counter Revolution" in neighboring Hungary, where Béla Kun's Communists had seized power.
 
In the early 1920s Schumpeter led a Gatsbyesque existence as Viennese financier and man about town, but he nearly went bankrupt in the second general collapse of 1924. While he comported himself as an aristocrat at the opera and races (as well as on horseback), he married Annie Reisinger, the daughter of the concierge of his swanky apartment on the Ringstrasse. Skillfully drawing on diaries and letters, McCraw gives a poignant account of Schumpeter's devastation following his wife's death in childbirth and of his subsequent lengthy affair with his beautiful young housekeeper and secretary, Mia Stöckel.
 
Following the ruin of his bank, Schumpeter retreated to academia once again, securing chairs first at Bonn and then at Harvard. After a succession of visiting appointments, he eventually moved to Harvard on a full-time basis in 1932. Schumpeter disliked the Nazis and was soon seeking to arrange appointments in the United States for his Jewish and anti-Nazi German friends. But as he later admitted, he gravely underestimated Hitler. He failed to appreciate both the virulence of the Nazi leader's racial hatreds and the effectiveness of his policies for reviving the German economy by means of rearmament and public works.
 
During the 1930s Schumpeter worked on a massive study of business cycles but altogether failed to match the timeliness of Keynes's great campaigns of advocacy. Schumpeter agreed with Keynes that a great injection of demand was required, but he was intensely irritated by the English economist's apparent belief that capitalism needed some semipermanent "oxygen tent" if it was to flourish. Schumpeter's study of American economic history convinced him that capitalism's success depended on mass demand. Capitalism had already transformed the lives of ordinary people and, given the right conditions, it could lift the whole globe into a new cycle of prosperity. However, he believed FDR's policies did not help. The US obsession with monopoly and animus against "economic royalism" were misplaced, in his view, because the large companies should be encouraged to engage in nonprice competition and devote large R&D budgets to product innovation.
 
Schumpeter's work on business cycles was too compendious and complex to have much impact on his colleagues, let alone the general public. But his lively 1942 polemic Capitalism, Socialism and Democracy became a bestseller and brought him renown and respect far outside the ranks of economics departments. It was in this book that he gave definitive expression to "creative destruction" as the animating principle of capitalist competition. While admitting that such competition brings ruin to whole industries and regions, he stressed that the accompanying rise of innovating industries will bring new goods within the reach of working men and women. In a revealing example, he argued that capitalism meant that "factory girls" could now wear "silk stockings," garments that only queens could afford in previous centuries. (My mother tells me that nylon was replacing silk by this time, a detail that only confirms the argument of the "prophet of innovation.")
 
McCraw shows that Schumpeter was, in many ways, a deeply conservative thinker: probusiness, anti-New Deal and anti-welfare. However, in Capitalism, Socialism and Democracy, he at least half-conceals this by appearing to defer to the radical and socialist ideas then thriving in the English-speaking world. Schumpeter starts by declaring that capitalism cannot possibly survive. He claims to be equally convinced that a socialist economic system--despite what its critics say--might be workable and compatible with democracy, though only if it adopts many market mechanisms. McCraw sees an Olympian irony at work as Schumpeter patiently proves to the reader that capitalist collapse will come not from another terrible downswing but rather from an overflowing prosperity that will sap business motivation and encourage irresponsible attempts to tamper with capitalism. Schumpeter predicted--with a prescience matched by no other thinker--that the period 1940-2000 would see US per capita incomes rise by 2 percent a year, just as they had done in the sixty years before 1928.
 
In Schumpeter's view this surge of capitalist prosperity would allow for the solution of all social problems but would also undermine the conditions that made it possible. The motivation of the great business families would be eroded, capitalist growth taken for granted and the anticapitalist moralizing of intellectuals indulged. A drift toward socialism would ensue as governments intervened ever more intimately in the capitalist mechanism. Like Friedrich August von Hayek and Mises, Schumpeter believed in the power of capitalism, but he rejected what he saw as their absurd prejudice against the state, capitalism's necessary handmaiden.
 
In response to the argument that socialist economies have no reliable mechanism for setting rational prices--the refrain of Hayek and Mises--Schumpeter suggests that the socialists could devise a collectivist economy that makes full use of markets, price signals and even "profit" yet delivers egalitarian and welfare goals. While some of Schumpeter's arguments are mischievous--socialism, he suggests, would be a good way of controlling the unions--there is no denying that he had a lifelong curiosity about different economic arrangements.
 
One sign of Schumpeter's open-mindedness is to be found in the circle of the brilliant young economists he gathered around him. In 1947 the Socialist Club of Boston invited Schumpeter to debate the future of capitalism with one of his former students, Marxist economist Paul Sweezy (later editor of Monthly Review). The chair was taken by Wassily Leontief, and the event was written up by Paul Samuelson (both men later received Nobel Prizes). The Schumpeter circle also included James Tobin, another Nobelist. And notwithstanding his own conservatism, Schumpeter sought to secure appointments for such radical younger economists as Joan Robinson and Nicholas Kaldor. Schumpeter corresponded amiably with Keynes, though each man doubted the achievement of the other.
 
During and after the war Schumpeter's work acquired growing prestige. He had produced a new and much revised edition of The Theory of Economic Development in 1931 and a stream of influential articles. He was an enthralling lecturer and a man of wide culture. In 1948 he was elected president of the American Economic Association. Outwardly jovial and ebullient, he was susceptible to despair and depression, only conquering them by throwing himself into his work. In his American exile he offered up prayers of devotion to his dead wife, Annie, and wrote many letters to Mia Stöckel. Although he knew his letters to Stöckel were opened by the German censors, he did not suppress his criticism of the Nazis. Stöckel pleaded with him to bring her to the States, but according to McCraw, Schumpeter didn't think she would fit in at Harvard. She eventually married a young Serbian political scientist, and in 1942 she and her husband were shot by the Nazis. Schumpeter probably blamed himself for not forestalling this tragic end.
 
In 1937 Schumpeter married an American economic historian, Elizabeth Boody Firuski, who helped him overcome his continuing private terrors and complete his intellectual projects, especially a massive History of Economic Analysis (edited by her and eventually published in 1954). Though highly respectable and admired by colleagues, Elizabeth and Joseph became, following Pearl Harbor, the targets of a lengthy inquisition at the hands of J. Edgar Hoover. They and their friends and associates were repeatedly interviewed by FBI agents, and their activities were watched. Hoover was, of course, prone to suspect European intellectuals, but what fed his paranoia in this case were the couple's Japanese connections.
 
The Schumpeters had made several trips to Japan. Japanese economists greatly esteemed Joseph's work, translating his books and articles and inviting him to lecture. Elizabeth researched the Japanese economy and argued that Japan's economic achievements were being greatly underestimated. None of this meant that the Schumpeters backed Japanese imperialism, but they did downplay the strength and ambitions of the Japanese militarists and failed to denounce the Nanking massacre. Joseph also looked with great foreboding on the implications of the US wartime alliance with the Soviet Union. In his view this would give dire scope to a primitive and backward Russian imperialism.
 
Racial categories appear in Schumpeter's writings, as they do in those of many other thinkers of the time--his argument in Capitalism, Socialism and Democracy that socialist ideas will lead to admirable results in Sweden but to misery in Russia is premised on the "racial" inheritance of the two peoples. Schumpeter, though striving to express a logic of cultural evolution, stumbles into a Borat-like ethnic contempt for crude yokels and semicriminal "sub-normals."
 
The private reflections recorded by the Schumpeters in letters and diaries were very distant from the patriotism and progressivism of the time. McCraw tells us that Joseph's bêtes noires were "Harvard, Roosevelt and the Soviet Union." Hoover's belief that the Schumpeters were agents of Japan or Germany was ludicrous. But as the allies pressed to a triumphant conclusion, Joseph did express sympathy for the German and Japanese peoples and horror at the mass slaughter of civilians in Dresden and Tokyo, Hiroshima and Nagasaki. Joseph still had a house outside Bonn, and his German papers were destroyed in a fire-bomb assault on a residential district in November 1944.
 
Without doubt Schumpeter is a great economic historian and an essential writer for anyone who wishes to understand capitalism. McCraw, who has written the definitive biography of his subject, supplies many testimonials to Schumpeter's genius and influence from both his day and our own. (In my view he could have added the debate on the transition from feudalism to capitalism initiated by Paul Sweezy, which drew memorable contributions from Maurice Dobb, Rodney Hilton and Eric Hobsbawm.)
 
Unlike Keynes, Schumpeter was not good at framing policies to tackle specific situations. His strength lay in working out the implications of a policy over time. He thought that Keynesian-style deficit-spending by itself would eventually lead to inflation and stagnation and that it needed to be accompanied by policies to foster and generalize innovation.
 
Schumpeter's ideas were enthusiastically adopted by Japanese economic planners and informed Japan's extraordinarily successful postwar growth strategy. The capital levy he had vainly sought to apply as finance minister in Austria was successfully used to choke off inflation and cut war profits in occupied Japan. The Japanese strategy of creating markets for new products, with industrial groups investing in R&D and the Ministry of Foreign Trade supplying coordination, echoed and confirmed Schumpeter's thinking.
 
Another country whose development path had a Schumpeterian flavor was Sweden. The so-called Rehn-Meidner model put the accent on industrial innovation and full employment as well as generous social provision. Rudolf Meidner, a Social Democrat refugee from Germany who became chief economist of the LO, the main trade union federation, was certainly familiar with the work of Hilferding and Schumpeter. In Sweden large corporations were allowed to build up tax-free reserves so long as they spent them on R&D. Meidner eventually sought to complete the "Swedish home" with social funds raised by means of a share levy, a gentler version of the capital levy. These "wage-earner" funds were terminated in the early 1990s, thwarting Meidner's aim to promote economic democracy; still, they were used to establish a string of research institutes that have kept Sweden at the forefront of the information economy.
 
Schumpeter never worked out a rigorous model of his own, and several of the ideas he tossed out were no more than brilliant jeux d'esprit. Among twentieth-century economists, Keynes and Hayek made more considerable contributions. But in the twenty-first century, with the disappearance of command economies and of most restraints on capital, the process of creative destruction has taken on planetary dimensions that would surely have shaken Schumpeter, and that now give added interest to his work. Indeed, the very considerable interest of McCraw's book derives not only from the story it tells of a life navigating what Eric Hobsbawm has called the "age of extremes" but from the case it makes for seeing Schumpeter as the most farsighted of twentieth-century economists. His focus on capitalism and creative destruction made him the prophet of globalization.
 
Capitalism, Socialism and Democracy remains well worth reading, although it's best read against the grain of the underlying argument. The book insures Schumpeter a place alongside two other Austrians who understood the market and its limits--Karl Polanyi, author of The Great Transformation (1944), which insisted on the social embedding of market forces; and Otto Neurath, the Viennese philosopher who, as financial commissioner in the short-lived Bavarian workers' republic of 1919, became the first public official to insist on the need for carbon rationing. Capitalism, Socialism and Democracy serves as a useful foil for the sort of global prospectus that has been attempted, with such disappointing results, by the likes of Thomas Friedman and Niall Ferguson. Seventy-five years on, Schumpeter's work is still a better guide to the world we live in than the shallow quips and complacent jingoism they offer.
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2007/09/08 08:14 2007/09/08 08:14

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The Growth of Nations

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The growth of nations

Review by Martin Wolf

Published: July 21 2007 01:24 | Last updated: July 21 2007 01:24

In the summer of 1972, as a “young professional” at the World Bank, I went on a mission to South Korea. It was my first experience of something extraordinary: a country that was developing at a breathtaking rate. The country had already enjoyed a decade of economic growth at close to 10 per cent a year. It continued to grow at close to that rate for another quarter of a century.

What struck me about Korea was the determination of its policy-makers to sustain rapid industrialisation. I saw the construction from scratch of the vast Hyundai shipyard at Ulsan that was soon to join the first rank of ship-builders. That bet itself demonstrated something even more remarkable: Koreans’ belief in their country’s ability to achieve global competitiveness.

For the Koreans, exports were both a tool of development and a test of its success. How different this was from east Africa and India, on which I was to work for the following five years. India was almost as sealed from the world economy as it was possible to be. Its annual growth in income per head had fallen in the 1970s to about 1 per cent a year, while industrial productivity seemed to be declining, despite its desperately low level.

The contrast between South Korea’s success and India’s failure was striking. Both used protection and other tools of industrial policy. Yet the orientation of India’s policies was inward-looking and anti-competitive, while that of South Korea was the opposite. In the literature on development and trade, the Korean strategy came to be called “export promotion”, because its economy did not have an overall bias towards the home market.

The contrast between South Korea and India raised the biggest questions in economics: why have some countries succeeded with development and others failed? Why has Korea jumped from poverty to prosperity in a lifetime? Why did India do badly then, but much better recently?

The broad question is the one Erik Reinert states in his title: How Rich Countries Got Rich... and Why Poor Countries Stay Poor. Reinert is a Norwegian professor who now teaches at Tallinn, Estonia. Ha-Joon Chang, a well-known Korean development economist, teaches at Cambridge. But both give strikingly similar answers to this question.

Both state that the priority in development is rapid and sustained growth. Only industrialisation can deliver such growth, because industry is the only sector in which rapid and sustained rises in productivity are feasible. Furthermore, to industrialise, countries must upgrade their technological and managerial capabilities, which can be achieved only if they are able to nurture infant sectors. That requires protection, they both argue, as has been the case in every successful economy of the past half-millennium.

Tragically, they argue, the “neo-liberal hegemony” - the broad consensus on liberal trade and freer markets of the past quarter century - has deprived countries of these valuable tools. The result has been a development disaster, particularly in Latin America and Africa, where the International Monetary Fund and the World Bank have run amuck. The World Trade Organisation and a host of one-sided so-called free trade agreements further constrain the ability of developing countries to adopt sensible policies. This, they agree, is a huge contrast to the era of the Marshall Plan in postwar Europe and the more permissive attitudes towards development policy taken by the US between the 1950s and early 1980s.

While the two books are rooted in a similar world view, their style and tone are different. Reinert’s book, while no less enraged, is more academic. He is fighting an intellectual war with neo-classical economics, the academic orthodoxy since the 19th century. He considers himself “heterodox” and presents an alternative “other canon”.

In place of a priori reasoning, this emphasises practical experience; instead of the theory of comparative advantage in trade invented by the 19th-century theorist David Ricardo, it points to the success of protection against imports since the Renaissance. Reinert argues that, for poor countries, specialisation in line with comparative advantage means specialising in poverty. As Friedrich List, the 19th-century German economist, argued, what a country makes matters. Protection is the solution; free trade is suitable only for countries at the same level of development.

So, in respect of Africa - surely the most important and urgent case for treatment - Reinert recommends internal free trade and external barriers to trade, in place of what he condemns as the mere “palliative economics” of millennium development goals, bed-nets and ever more aid.

Chang’s book Bad Samaritans is shorter and more punchily written. He considers how people who want to help developing countries but instead are hurting them, constrain policy options for developing countries. Among these constraints are limits on their ability to regulate inward direct investment, an undue obsession with privatisation, restrictions on access to intellectual property, exaggerated attention to financial stability, excessive emphasis on corruption and lack of democracy and, last but not least, undue stress on the importance of culture.

Unlike much of the writing produced by opponents of contemporary globalisation, these are serious books by serious people. They deserve to be read.

Moreover, I agree with both authors that the goal has to be faster economic growth. I sympathise with the view that the assumptions of conventional economics ignore the evolutionary character of a dynamic economy. I agree, too, that industrialisation is the principal route to growth. I agree, finally, that some policies that now affect developing countries are dangerous: restrictions on easy access to intellectual property are perhaps the most important.

Yet I also have some important disagreements. Reinert, for example, argues that contemporary neo-liberals believe in “factor-price equalisation” - the theory that free trade would make wages and returns to capital the same everywhere. In fact, those taught the theory always understood that the implication is the opposite: it shows how many unlikely conditions need to hold before these results hold true.

What neo-liberals - if I may use that ugly term - did believe is that new opportunities were at last opening up for developing countries to export manufactures and a range of relatively sophisticated services competitively. Indeed, about 80 per cent of exports from developing countries are now manufactures.

Admittedly, this success has recently been dominated by China. But China is as populous as sub-Saharan Africa and Latin America combined. The exports of manufactures would, it was hoped, build up the virtuous circle of growth and industrialisation in which Reinert believes, operating on a world scale from the start. That is, of course, what China is now achieving.

This brings me to my most fundamental disagreement: the lessons of history. Reinert argues: “US industrial policy from 1820 to 1900 is probably the best example for Third World countries to follow today until these countries are ready to benefit from international trade.” From the emphasis Chang puts on 19th-century examples, he agrees.

Yet this example makes no sense for most, if not all, contemporary developing countries. The technological gap between the UK and the US in the 19th century was trivial by comparison with that between, say, the US and Ethiopia today. Even so it took more than half a century for the US to close it.

The US was also a vast continental country, capable of attracting a huge immigrant workforce, much of it educated, and so generate a domestic market large enough to exhaust the economies of scale offered by the technology of the time, while still permitting strong domestic competition. That proved not to be the case even for India, a giant among developing countries. This is, to put it mildly, hardly a model for Ethiopia, let alone Chad.

Few (I would argue, no) contemporary developing countries are big or technologically sophisticated enough to make a decent job of the 19th-century protectionist model. The big successes of recent decades - from Hong Kong to China, South Korea to Ireland, Singapore to Taiwan, Japan to Finland - were not all free traders (though some were). Some also relied heavily on foreign direct investment (China, Ireland and Singapore), while others resisted it (Japan and South Korea).

Yet all used the world economy - and therefore trade - as a central part of their development success. These were, then, cases of outward-looking, infant-industry promotion far more than protection. Indeed, this was precisely what most observant economists learnt from the contrast between the performance of South Korea and India. Apparently similar tools can be used in various ways, with very different results. Both the overall aim and the details of policy make a huge difference.

Moreover, both these books lack a serious discussion of what very late catch-up countries ought to do. Reinert recommends free trade inside Africa or Latin America, with high barriers to trade against outsiders. But this sort of preferential trading agreement among developing countries is a way to transfer income from the most backward to the least backward economies in the region.

Worse, the higher the protection the larger (and so more politically objectionable) is the transfer of income. This is why only those preferential agreements with low external barriers tend to survive. But these do not deliver the greater protection Reinert wants. Higher barriers, even if desirable, would be politically possible only if members also moved towards a single labour market, which is impossible.

What then is left is protection by individual countries. But, to use just one example, Ghana’s national income is about the same as that of a London borough. A policy of import substitution there would be as rational as for Southwark.

Across-the-board import substitution in a country such as Ghana is a recipe for creating a host of small-scale, uncompetitive, rent-extracting monopolies. Obviously, an industrial policy with any hope of success must be both selective and build towards world markets, to obtain scale. What, then, are the chances that often malignantly corrupt, incompetent and ill-informed governments will make sensible choices? Little, I would argue.

South Korea and Taiwan were exceptional cases. The argument that success will follow the overthrow of the neo-liberal consensus and the return of protection is nonsense. But the authors are right that those who argued that free trade alone is the answer were wrong. There are no magic potions for development. Developmental states can work. Many fail. But some may succeed.

Above all, developing countries should be allowed to try, and so learn from their own mistakes. Countries should be warned of the difficulties of following South Korea’s example, but allowed to do so if they wish.

Big and relatively successful developing countries, such as China and India, must participate in and be bound by global rules. They cannot be free riders. But the bulk of developing countries should be allowed to choose their own policies. Almost all will need to attract inward foreign direct investment. A few might still manage without it.

Chang is right that some of the constraints imposed upon developing countries, notably on intellectual property, are unconscionable. Most should enjoy the benefit of open markets from the rich, but be allowed to pursue their own paths, from laissez-faire to its opposite. They will make many mistakes. So be it. That is what sovereignty means.

Martin Wolf is the FT’s chief economics commentator.

How Rich Countries Got Rich...and Why Poor Countries Stay Poorby Erik S. Reinert
Constable & Robinson £25, 320 pages
FT bookshop price: £20

Bad Samaritans: Rich Nations, Poor Policies and the Threat to the Developing World
by Ha-Joon Chang
Random House £18.99, 288 pages
FT bookshop price: £15.19

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2007/07/25 02:40 2007/07/25 02:40

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NY Times Book Review Vol. 54 - Disposable American etc

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Review

The Specter Haunting Your Office By James Lardner

The Disposable American: Layoffs and Their Consequences by Louis Uchitelle

Vintage, 287 pp., $14.95 (paper)

The Great American Jobs Scam by Greg LeRoy

Berrett-Koehler, 290 pp., $24.95

The Battle for the Soul of Capitalism by John C. Bogle

Yale University Press,260 pp., $16.00 (paper)

1.

Donald Davis was not concerned about imports in the late 1960s, when he started out as CEO of the Stanley Works, the country's leading manufacturer of hand tools. By the early 1980s, the challenge of competing against inexpensive tools made in Taiwan, Korea, and China had swept most of Davis's other concerns aside. His first response was a plan to streamline management, reducing the company's white-collar ranks through attrition. An old-school CEO who had been with Stanley most of his adult life, Davis considered layoffs a last resort. But by the time he stepped down as CEO in 1987, hundreds of factory workers had lost their jobs on his orders.

His successor, Richard Ayers, had the advantage of knowing what he was in for. An industrial engineer by training, Ayers mapped out a long-term strategy that called for layoffs, plant closings, and outsourcing: sledgehammer and crowbar production was moved to Mexico; socket wrench production to Taiwan. But the company also invested in making its domestic operations more efficient, and Ayers took special care to preserve jobs and facilities in New Britain, Connecticut, where Stanley had been a major employer for more than a century. By the mid-1990s, revenues had stabilized, profits were up, and Ayers could reasonably tell himself that his "evolutionary" approach had worked.

Wall Street, however, was not impressed. Securities analysts, comparing the jobs eliminated by Ayers with the layoff numbers at other old-line companies—Scott Paper (11,000), Sears (50,000), General Motors (94,000)— suggested that Stanley's key problem might be leadership rather than imports. At age fifty-five, according to Louis Uchitelle's The Disposable American, Ayers concluded that he did "not have the stomach" for any more job-cutting.


 

When Ayers retired, Stanley's directors turned to an outsider. The new CEO, John Trani, approached the import question with a clear mind. In his seven years as CEO, he shifted virtually all tool production to East Asia and Mexico, closed forty-three of Stanley's remaining eighty-three plants, cut the payroll from 19,000 to 13,500, and reduced its presence in New Britain to, in Uchitelle's words, "a collection of mostly empty factory buildings and reproachful former workers."

Through the story of the three Stanley CEOs, Uchitelle traces a mental journey taken by a great many top managers over the past few decades, and it would be hard to find a better distillation of the new mindset than his brief account of an interview with Trani in November 2004 (just a few days before he, too, retired, with an $8 million bonus and a $1.3 million-a-year pension). "Layoffs and plant closings," Trani says, "are not such a rare event anymore that one generally makes a big deal out of them." Scarcely mentioning the laid-off workers, he acknowledges no hesitation, no regret—in fact, no alternatives. The story, as he tells it, comes down to the difference between successful leaders, who "look at reality as it exists," and unsuccessful ones, who make the mistake of "hoping for it to change."

Trani came to Stanley from General Electric. In his attitude toward layoffs he resembled his former boss, Jack Welch, who had pushed more than a hundred thousand workers off the GE payroll. Welch's combative style has gone out of fashion lately; in fact, Uchitelle had something to do with that. A longtime reporter for The New York Times, he was largely responsible for "The Downsizing of America," an attention-getting series of Times articles on the mass layoffs of the early and mid-1990s. Those articles helped inspire a backlash. Few CEOs, questioned now about layoffs, would permit themselves to boast, as Trani did, of "taking out" workers—as in, "We took out 23 percent of the people" at Best Access, one of the companies Stanley acquired. In his actions if not his affect, however, Trani speaks for a school of management that remains ascendant. He drove Stanley down the path of a great and continuing migration—away from the postwar view of the corporation, whose success rested on a secure workforce and a strong local economy, toward what Greg LeRoy, in The Great American Jobs Scam, calls the "rootless corporation," which defines success by financial measures alone, making it possible to "save" a company by destroying much of what it was.


"The Downsizing of America" came out in March 1996—not the best moment, in hindsight, for a 40,000-word lament on the theme of growing economic insecurity. Inflation and unemployment were falling. The stock market was rising. In Silicon Valley, Washington, D.C., and other centers of optimism, influential commentators were turning out books and articles intended to explain why, unlike previous good times, these could be expected to last virtually forever. Even many of Uchitelle's journalistic peers thought the Times had been too intent on telling an old, downbeat story to notice the new story of America's astonishing resurgence. In The Disposable American, Uchitelle makes it plain that he is writing about a long-term change—one that neither began nor ended in the 1990s, and one that transcends even the wrenching adjustment of an economy moving from manufacturing toward information and service. "The permanent separation of people from their jobs, abruptly and against their wishes," he asserts, has become "standard management practice."

It's a fair statement. Over the past quarter-century, the victims (and potential victims) of layoffs have come to include managers, professionals, and workers in such growth industries as banking and telecommunications. Hardly any company is too successful nowadays to consider a large-scale cutback in jobs. Early last year, Intel was showering cash on its shareholders in the form of dividends and share buybacks after reporting record 2005 profits of $12.1 billion (partly thanks to a custom-made tax break known as the American Jobs Creation Act). None of that kept CEO Paul Otellini from announcing, several months ago, plans to eliminate 10,500 jobs—10 percent of Intel's total—in order to become a "more agile and efficient" company.

The modern layoff is frequently a hidden layoff, entered in the personnel records as a buyout, an early retirement, or the severing of relations with someone deemed a contractor rather than an employee. Procter and Gamble has unloaded some 20,000 employees since 1993, Uchitelle says, while scarcely registering a blip on the Bureau of Labor Statistics' count of involuntarily displaced workers. With all their omissions, however, even the official data suggest a sharp decline in job security. In 1978, a middle-aged American male could expect to remain with the same employer for eleven years, according to BLS figures. Now it's 7.5 years. Over that same period, the average duration of unemployment has lengthened from thirteen to almost twenty weeks. The long-term economic damage that people suffer has grown, too. If you factor in the impact of foregone pay raises in the old job and lower wages in the new one, according to the Princeton University economist Henry S. Farber, the typical laid-off college graduate now suffers a 30 percent loss of income, up from 10 percent in the early 1980s.

Uchitelle sees Jack Welch as a pivotal figure. Before he came along, a CEO was expected to manage the existing enterprise. Welch enlarged the job description: lifting a page from the corporate raider's playbook, he promised to manage the shareholders' capital as well, by maintaining a steady lookout for more profitable places to put it. There is a case to be made for his approach. It may be better for a company—better even for its workers, and for the economy—to have layoffs spread over time rather than deferred until a moment of crisis. What today's managers like to call a "flexible workforce" has arguably helped American corporations seize opportunities they would have missed if the US had the kind of employment protection that exists in, say, France. Uchitelle is not dogmatic on these points. He simply wants it acknowledged that we are going through something more than a few bumps on the road to "a new equilibrium at the high end of innovation and production." Permanent disequilibrium, he argues, would be a more accurate picture of where we're headed.

Uchitelle's harsh view of the new workplace order sets him at odds not only with corporate leaders but with economic advisers to the last four presidents. Layoffs, he reminds us, were a hot issue in the 1992 presidential campaign. Although Ross Perot's "great sucking sound" is better remembered, Bill Clinton also came down hard on companies that closed factories where Americans made "a decent standard of living" while opening "sweatshops to pay starvation wages in another country." Candidate Clinton wanted corporations to spend at least 1.5 percent of their earnings on "continued education and training." (Companies that made such a commitment were less likely to let employees go, research showed.)

But once he became President Clinton—and as the budget deficit moved to the center of his thinking—continued education and training got a new name and spin. Now the Clintonites began to speak of "lifetime learning," which was more exhortation than policy and directed mainly at employees, not employers. Americans who had lost their jobs or who sensed their skills becoming outmoded were told that they could take charge of their careers, go back to school, and emerge retooled and "reempowered."


While the policy experts may have believed some of this, it bore little relation to the experience of laid-off workers around the country, according to Uchitelle. There were many retraining programs, but scarcely any actual retraining, he says, largely because few appropriate jobs were waiting to be filled even in the surging economy of the late 1990s. The first order of business in many retraining programs was to defuse anger and lower expectations—a process known in the trade, he reports, as "housebreaking." In The Disposable American, Uchitelle describes an Indianapolis program created largely for United Airlines mechanics who lost their jobs when the company bailed out of an advanced maintenance shop for narrow-body jets. The mechanics show up looking for tips about companies that might be hiring or new careers beckoning. What they receive, mostly, is airy wisdom about attitude, interpersonal relations, and the inner self; at least one classful gets free copies of the global best seller Who Moved My Cheese?, which warns those in economic distress not to be led into indignation or dismay by the overly complex human brain. Far better, the book suggests, to adopt the existential pragmatism of mice: No cheese in that corner? Check out this corner.

Uchitelle is a fine reporter. In The Disposable American, he follows several of United's mechanics as they head out into the world of the downsized. After twenty-five years in the airline industry, Ben Nunnally, a specialist in delicate wingskin repairs, becomes a window-washer. Erin Breen goes back to college, gets an engineering degree, and winds up as a janitor in the Indianapolis public schools. Tim Dewey, who has been through one layoff already, resolves to go into business for himself rather than run the risk of a third. With his wife and children, he moves to the Florida panhandle to run a water taxi service, impulsively charging the $54,000 purchase price on three credit cards. He spends five months "hawking boat rides to passing tourists," as Uchitelle puts it, before the business goes bust and the family goes bankrupt. A few hard knocks later, he grabs a chance to return to his old line of work for $17 an hour (half his United pay) as an employee of one of the non-union subcontractors he and his former coworkers had scorned.

As well-paid blue-collar workers, union members, and, for the most part, males without college degrees, United's mechanics were out on a limb. But Uchitelle finds much the same pattern of downward mobility among women, white-collar workers, professionals, and executives. The "vast majority of laid-off workers never get back to where they were," he writes. Moreover, he finds, being laid off is a "fundamental in-the-bones blow to ego and self-worth." People are "cut loose from their moorings and rarely achieve in their next jobs a new and satisfactory sense of themselves."

"The Downsizing of America" was criticized for treating the postwar era as the natural order of the US economy. The relatively secure employment of the 1950s, 1960s, and 1970s was historically exceptional, Uchitelle acknowledges, and it was secure mainly for Americans fortunate enough to land full-time jobs with major corporations or professional firms. Nevertheless, he regards the ideal as one to cherish and build on. To Uchitelle, the labor practices that others now celebrate as bold and unprecedented look a lot like those of the nineteenth-century robber barons. We should hold today's corporate leaders to a higher standard, he argues, because they know better —or, at any rate, because more is now known about what stable employment means to mental and physical health.

Resentment and self-castigation are recurring themes in The Disposable American. Persuaded to accept a buyout package after twenty-five years at Procter and Gamble, Elizabeth Nash seems unable to find any source of self-confidence other than the scraps of contract work that her former employer throws her way. "It vindicates that I have value," she says. Some people, of course, have more of what it takes to hop from job to job and stay afloat emotionally as well as financially. Among the United mechanics, Uchitelle cites Craig Imperio, who after moving to Georgia and taking a job with Pratt & Whitney, the engine maker, networks around the clock, plays golf with his superiors, and earns a promotion to quality engineer. (Even then, his $50,000-a-year salary remains about $20,000 short of what he made in Indianapolis as a mechanic.) Imperio's brand of resilience could become more widespread as time passes and freelancing becomes an increasingly common way of life. But in the here and now, Uchitelle reasonably insists, lifetime learning is a delusion—and a cruel one, providing cover for layoff-prone companies and setting unrealistically high expectations for layoff victims, who then blame themselves when their experiences fall short.

Layoffs can be unavoidable, Uchitelle acknowledges. His quarrel is with corporate leaders who do not seek to avoid them—and with those, in the corporate world and elsewhere, who count the cost purely in material terms. In conversations with layoff victims, Uchitelle emphasizes the systemic nature of the problem. People tend to "agree perfunctorily," he writes, before going "right back to describing their own devaluing experiences, and why it was somehow their fault or their particular bad luck." Even when thousands of jobs are eliminated at once, few can depersonalize the experience.

Uchitelle resists the temptation to spell out an anti-layoff program. His caution arises partly out of a temperamental inclination to let his reporting speak for itself, and partly out of a bleak assessment of the political world's readiness to entertain the measures he would be tempted to propose. His policy recommendations really boil down to one: when we think about layoffs, we should consider the full range of consequences, and, above all, the emotional and psychological ones, which are, he says, "deep, consistent, and ignored in the political debate."

Ignored and, as he shows, compounded—and not just by callous rhetoric. United could abandon its Indianapolis center with impunity, turning its back on a spectacularly efficient facility, because it would not have to continue making mortgage and maintenance payments of $37.5 million a year. That responsibility passed to the taxpayers of Indiana and Indianapolis under the terms of a 1991 agreement in which United had received the land and $320 million in cash—more than half the facility's total cost. The city and state had done this in the name of "economic development," a seedy business that is briefly discussed in The Disposable American and thoroughly dissected in Greg LeRoy's The Great American Jobs Scam.

2.

The economic development story goes back to the 1930s when a group of southern governors set out to capture some of the manufacturing business of the North by offering cheap capital on top of the traditional lure of cheap labor. In more recent decades, the practice has gone national, and the private sector has taken firm control. To work their will with job-hungry public officials, corporations now routinely deploy teams of lobbyists, site consultants, and other hirelings. The formula rarely fails: drop word of a planned expansion or relocation; create the illusion of a wide-ranging search; overstate the company's own investment and the number of jobs involved; hire fancy experts to talk about the economic ripple effects; walk off with huge subsidies and tax concessions.

Among the southeastern states, North Carolina once had a reputation for refusing to play the economic development game; its relatively prosperous economy was founded on infrastructure, education, and public investment. Nevertheless, the state was easy prey for Dell Computer when, in 1994, the company dangled the prospect of a factory in the Piedmont Triad area. So anxious was the administration of Governor Mike Easley to land the prize that state officials became stooges in Dell's efforts to pit one North Carolina community against another. The company eventually wangled $37 million in tax incentives out of Winston-Salem and Forsythe County, on top of a $267 million subsidy from the state; the total far exceeded the cost of the plant property, and construction combined. After the deal was made, leaked documents revealed a negotiating process that resembled an organized-crime shakedown. "[I'm] not wowed here," Dell's chief emissary complained at one point, adding that a twenty-year income-tax exemption was "my line in the sand." A few weeks later, he was threatening to pull out "unless I can get that income tax resolved."

Was Dell really prepared to go elsewhere? Most companies, LeRoy shows, enter the process with their minds made up. Site selection experts, when they are not off helping companies stage their elaborate "searches," acknowledge that business fundamentals, such as access to key customers and suppliers, generally carry more weight than subsidies do. But while the game may have little to do with where companies decide to locate, it has everything to do with the taxes they pay. LeRoy puts the national cost of these deals at $50 billion a year; they go a long way, he says, toward explaining a sharp decline in corporate taxes as a share of state revenues— from 9.7 percent in 1980 to about 5 percent today. The falloff in some states has been even more precipitous. Corporations paid a third of all taxes in Arkansas as recently as the 1970s; by 2002, the figure was 2 percent.

Beyond the injury to city, county, and state treasuries—and the services they fund—the economic development process "demeans" and "degrades" public officials, LeRoy writes. He means not only the officials who participate, but also those who are cut out of the process—such as the school board members who get "no say in property tax abatements that will corrode their budget" or the revenue director whose "sober advice is upstaged by the frothy projections of an economist rented by the Chamber of Commerce." The rules are designed to bestow the biggest rewards on the companies least likely to show any true attachment to workers or communities. New businesses are subsidized at the expense of existing ones. Big-box retailers gain while independent merchants lose. Commercial and social life is pulled away from Main Streets and downtowns toward malls and strips. Local and state leaders have been known to grovel before telemarketing firms, gambling casinos, and the operators of private prisons.


LeRoy is an activist. His organization, Good Jobs First, has worked with unions, environmentalists, and citizen watchdog groups to resist the giveaways. But realism often compels them to aim for modest goals, such as job-quality guarantees with "clawback" provisions calling for the recovery of taxpayer funds if a company fails to deliver. LeRoy foresees a long campaign of organizing and consciousness-raising before it is even worth talking about more sweeping reforms.

That is about how Uchitelle sizes things up, too, and it is a conclusion shared by John C. Bogle, author of The Battle for the Soul of Capitalism. Bogle has been an investor and innovator in financial management for close to fifty years. He was railing against the chicanery and high fees of the mutual fund industry before Eliot Spitzer had been to law school. Vanguard Management, which Bogle founded in 1972, became the biggest company in the field by keeping commissions low and transactions infrequent—and advertising it. Bogle went on to invent the index fund; while innumerable others claimed the ability to beat the market, he merely offered to approximate the market year after year. That proved to be a better deal for most clients, as he had theorized.

After a heart transplant ten years ago, Bogle retired to a life of full-time hell-raising. The Battle for the Soul of Capitalism is his response to the recent corporate scandals—Enron, MCI WorldCom, and Tyco among them. Not being a prosecutor, though, Bogle fails to see much difference between the acts that sent Jeffrey Skilling, Bernard Ebbers, and Dennis Kozlowski to prison and a host of more common and accepted forms of executive self-enrichment—for example by playing around with employee pension funds in order to inflate company profits and bonuses. At Verizon, Bogle notes, bonuses for the year 2001 were based on profits of $389 million, which rested, in turn, on a supposed $1.8 billion in pension-fund gains.

By the time the company reported those numbers, however, the stock market bubble had burst, making it clear that Verizon's pension funds had actually lost money that year; as it turned out, they had lost a staggering $3.1 billion, obliterating all the claimed profit and then some. Verizon, moreover, was only one of 1,570 companies—"an enormous part of the giant barrel of corporate capitalism"—required to restate corporate earnings for one or more of the years 2000–2004; and "I have not heard of a single instance," Bogle adds, "in which...bonuses have been recalculated and the overpayments returned to the stockholders."

Since the publication of Bogle's book, executives and directors of more than 250 companies have come under suspicion of profiting from fraudulently timed stock option grants. The whistle was blown by Erik Lie, a professor of finance at the University of Iowa. Through statistical analysis, he established a pattern that could not be explained by chance, thus giving new meaning to the term "probable cause." His 2005 paper "On the Timing of CEO Stock Option Awards," prompted investigations by The Wall Street Journal and eventually the Justice Department and the Securities and Exchange Commission; their objective, however, was to prove what Bogle might consider a minor point, for, in his mind, stock options were a scam to begin with. In the overheated market of the late 1990s, he shows, options—backdated or not—brought windfall gains to virtually all executives, including some who were leading their companies to ruin while concealing the evidence from (among others) the eventual purchasers of their stock.

Viewing these evils through a shareholder-rights lens, Bogle attributes them to a triumph of "managers' capitalism" over "owners' capitalism." But while he offers plenty of evidence to justify his low opinion of "our imperial chief executives" with "their jet planes...their pension plans, their club dues, their Park Avenue apartments," his argument ranges well beyond the territory suggested by the manager/ owner framework. In almost all their recent misdeeds, he demonstrates, self-serving executives have been abetted by self-serving directors, securities analysts, auditors, lenders, investment bankers, and others. And while shareholders have suffered in case after case, many could be said to have brought their losses on themselves by being just as fixated on market trends—and just as oblivious to business realities—as anyone else in the equation. To Bogle's dismay, few of today's shareholders have much appetite for the rights he asserts on their behalf (over the election and removal of corporate directors, for example); most seem content with the only right that today's executives would willingly grant them —the so-called "right of exit," which gets exercised nowadays with promiscuous frequency, in Bogle's judgment. Twenty years ago, the annual rate of share turnover was about 25 percent; by 2004, he says, it was 150 percent. That kind of manic buying and selling, Bogle convincingly argues, generates wildly irrational levels of market volatility and endless opportunities for insiders to play the market for short-term gain.

Institutional investors now control approximately two thirds of all publicly traded stock in the US. Bogle has for years been trying to mobilize these giants into a new community of owners, capable of restraining corporate avarice and opportunism. Except for a few unions and public pension funds, he has found few takers. Not a single "mutual fund firm, pension manager, bank, or insurance company," he writes, "has ever sponsored a proxy resolution that was opposed by the board of directors."

"Managers' capitalism," then, is Bogle's shorthand for a system of rules, practices, and standards of behavior designed to bring quick and sure rewards to a few at long-term cost to many. Executives are not the only suspects here, and shareholders are not the only victims.[*] Often, Bogle observes, workers and shareholders get defrauded together. That is obviously true when managers cook the books; it can also be true when they cook up dramatic "restructuring" plans entailing mass layoffs. As Uchitelle points out, these plans often generate smaller-than-anticipated savings and bigger-than-anticipated costs—in morale and trust, especially. The point of many recent layoffs has been to free up capital for the repayment of debt incurred in mergers and acquisitions; those deals have a notably bad track record of their own. To understand why so many mergers continue to occur—$3.79 trillion worth in 2006—Bogle suggests that we consider the consequences for the executives who arrange them: not just the bonuses and the increased pay and power, but the ability to "take huge writeoffs—largely ignored by market participants —and create 'cookie jar' reserves"—paper assets created through mergers —"available at the beck and call of management to inflate future earnings on demand."

From their different vantage points, Uchitelle, LeRoy, and Bogle are writing about the breakdown of what some have called the postwar social contract, and about the rise of a new "money power" more daunting, in some ways, than that of the late 1800s and early 1900s. To gain their political ends, the robber barons and monopolists of the Gilded Age were content with corrupting officials and buying elections. Their modern counterparts have taken things a big step further, erecting a loose network of think tanks, corporate spokespeople, and friendly press commentators to shape the way Americans think about the economy. Much as corporate marketing directs our aspirations disproportionately toward commercial goods and services, the new communications apparatus wants us to believe that our economic wellbeing depends almost entirely on the so-called free market—a euphemism for letting the private sector set its own rules. The success of this great effort can be measured in the remarkable fact that, despite the corporate scandals and the social damage that these authors explore; despite three decades of deregulation and privatization and tax-and-benefit-slashing with, as the clearest single result, the relentless rise of economic inequality to levels so extreme that since 2001 "the economy" has racked up five straight years of impressive growth without producing any measurable income gains for most Americans—even now, discussions of solutions or alternatives can be stopped almost dead in their tracks by mention of the word government.


The rules, procedures, and understandings of the postwar social contract were designed for a world in which practical forces kept businesses anchored in geographical place, reinforcing the sense of obligation that many corporate leaders felt toward workers and communities. That being said, those arrangements were spectacularly successful in creating a broad, accessible, and secure middle class, and in bringing unprecedented transparency and fairness to the hazardous relations between individuals (whether customers, workers, neighbors, or shareholders) and corporations.

In addition to being good for the society at large, the postwar social contract turned out to be very good for American business. (No matter what they may say about the role of government, today's corporate chieftains and financiers—the scalawags and the rest—owe their fortunes in no small part to the legacy of trust in the financial markets created by the securities regulations of the New Deal era and onward.) Economically and in other ways, then, the future will depend on our ability to find more durable means toward the same ends; and while none of these books lays out a blueprint, taken together, they suggest a few operating principles.

The economic policy of the United States has in recent memory been directed almost entirely toward the goal of growth, and treated, accordingly, as the preserve of experts and corporate and financial insiders. Policy initiated outside this preserve has been limited, for the most part, to a set of narrowly defined issues (such as health care, retirement security, pollution, etc.) considered fit for democratic deliberation. This compartmentalized approach, we now know, is guaranteed to be an exercise in damage control, requiring obsessive vigilance and leaving a trail of frustration. Instead of trying to prod or seduce companies into doing what they cannot justify from a profit standpoint, we should be trying to bring everyday corporate thinking into rough alignment with the goals of society as a whole.

That will mean, as Bogle says, finding efficient ways to check the speculative excesses of today's financial markets and cut down on the tremendous amount of energy and human as well as economic resources that go into the pursuit of what he calls "aggressive financial targets" at the expense of "character, integrity, enthusiasm, conviction, and passion." It will also mean (in exchange for the privileges and rewards of incorporation and access to regulated financial markets) coming up with mechanisms to recognize the stakeholder status of longtime employees and local communities, and— as we are just beginning to do on environmental issues—bringing some of the intangible concerns of work life and community and social wealth onto the corporate balance sheet.

Devising workable policies in service of these aims; forging new approaches into a coherent and convincing program; looking for strategic ways to loosen the hold that the free-market mythology still has on us—that is the great challenge of this fluid moment in our national story. It is a project filled with difficulties, and, as yet, not so obvious potential. The injuries examined by these books are felt, to one degree or another, by most Americans. A countermovement might eventually be as broad as the harm, reaching across some of the lines that have defined American politics, unconstructively, since the 1970s; such a movement could, in time, draw support from inside as well as outside the business world, since, as Bogle so plainly shows, many corporate decisions reflexively attributed by supporters and critics alike to a "bottom-line mentality" in fact serve what he calls "the wrong bottom line"—one that not only shortchanges investors but tramples on many of the impulses that people naturally bring to the work of creating and building businesses.

Most Americans are troubled by the culture of dealmaking and financial engineering and insider self-enrichment that Bogle deplores; by the callous treatment of workers and work life that Uchitelle describes; by the erosion of communities and community institutions that LeRoy examines. Not very far below the political surface, most of us feel some version of the same vexed ambivalence toward corporate America—dazzled by the conveniences and comforts it delivers, yet resentful of the tradeoffs that it continually demands; few Americans would be anything but grateful if our corporations and financial institutions could develop some respect for our non-material and non-individualistic selves. It is hard to imagine such a fundamental transformation of these giant institutions. It is even harder to imagine a better world in which they remain essentially what they are.

Notes

[*] In fairness to managers—the honest and dutiful ones, that is—long-term thinking becomes a tricky business when you're operating in a stock market so focused on the short term that a penny-a-share shortfall in earnings can whack a few hundred million dollars off your company's market value between one day and the next.

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2007/05/30 10:41 2007/05/30 10:41

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Kornai's Choice (Econ. Principals)

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Kornai's Choice

 

http://www.economicprincipals.com/issues/07.05.20.html

One of the most striking features of the years after the collapse of communism has been the general lack of interest on the part of Americans, at least, in what the former communists have to say about their lives, their experiences, their societies. We make exceptions, of course, for defectors, those who wholeheartedly adopted our point of view:  most conspicuously, Alexander Solzhenitsyn (at least for a time). Otherwise, without the full confession of error, it is assumed that the experience they accumulated in all those years of living under central planning is of very little value. No matter who they are, we figure, they only need to take lessons from us.

There is an obvious exception to this rule at the moment, of course.  It is "The Lives of Others," a German drama about the corruption of everyday life by the Stasi secret police in the DDR, the old East Germany. The film won an Academy Award earlier this year (although even here a Hollywood remake is being discussed.) Another, considerably more illuminating testimony is to be found in Janos Kornai's newly-published memoirs, By Force of Thought: Irregular Memoirs of an Intellectual Journey.

Kornai is a famous Hungarian dissenter who, having been hit by the Marxist meatball as a youth (the phrase is that of R. Crumb, coined to describe the many similar conversion experiences among the young in the West of the 1960s), who then broke with the Communist party, who stayed home after the 1956 Hungarian revolt was crushed by the Russians, taught himself economics, and managed to build a formidable reputation among economists in the West as an expert on the mechanics of socialist systems.

Kornai embraced communism after the Russian Army chased the Nazis out of his country in 1945.  The Germans had murdered his lawyer father and older brother the year before. Thus cruelly tumbled from a comfortable haute bourgeois childhood, the 17-year-old changed his name from Kornhauser (which sounded German and Jewish); and traded what had been an "open and flexible" view of the world for a mechanical Spenglerian mindset, in which "the fresh energy and raw barbaric force of the communist movement heralded the coming of a new age."

He joined the Communist Party, read Das Kapital with a friend, annotating every page, and, in due course, got a job on what, under the communists, rapidly became the country's main newspaper. Of Marx, he writes, "The young man who at 14 to 16 had feverishly sought enlightenment in a hundred types of reading now found it radiating like sunshine from those thousand pages." 

The newspaper education was a good one. Kornai rose swiftly, vaulting ahead of more experienced men (two main criteria governed advancement, he says, Party loyalty and ability).  He worked hard, wrote fluently, convinced that he had the inside track on history. The death of Stalin was the crucial watershed; almost immediately, Russia's new rulers recognized the chaos that Stalinist directives had produced, called their Hungarian franchisees to Moscow, and loosened up a bit.  "I was not among those who had suffered in the period before June, and I did not feel the time had come to breathe a sigh of relief," Kornai writes of the "New Course" that Hungarian communism sought to adopt after Stalin's death. But many others did, and in the course of the next two years, Kornai paid attention to them. 

He met an old editor of his paper who had been imprisoned during a purge in 1951 and beaten at the direction of a friend with whom Kornai had joined the Party; after that,  he started paying attention to the number of political prisoners in his little country (40,000 in a nation of ten million in 1953).He read the British journalist Isaac Deutscher's biography of Stalin, and various Yugoslav writers on economic topics.(Tito, having been thrown out of the international Communist party by Stalin, had already begun to decentralize.)  He defied the party boss who told him to attribute electricity shortages and service cuts to "objective circumstances" rather than poor state planning. 

And then, in October 1954, he joined a memorable two-day meeting of Party members at his newspaper at which a couple of dozen staffers endorsed the "New Course" and openly criticized the regime. Inevitably, word of the newspaper rebellion leaked out. Other organizations followed suit. Self-determination was in the air.

Alas, it's hard to loosen by degrees. The Communist Hungarian government reacted. The first three rebellious newsmen were fired in December; Kornai and several others (including his wife) were let go a few months later, after a humiliating "self-criticism."

"My mental state in those months was one of disillusionment, bitterness and horror," he writes in By Force of Thought. "My earlier blind faith was dispelled once and for all.  My eyes had been opened wide to what was happening. Stomach-turning lies, infamous slanders, hypocritical arguments, sly use of real and false reports compiled by informers, threats and blackmail, and mental torture and humiliation of opponents were among the 'normal' weapons used in Communist factional fighting. .... I wanted to get as far as I could from this pollution." 

Already his first newspaper editor, his old friend Miklós Gimes, had told him, "Politics is not for you. You would do better if you became a researcher; it would suit you better." Kornai earlier had wangled admission to Budapest's Institute of Economics as a result.  Now he took advantage of it, becoming a full-time student. From the start, his work as a scholar displayed a strong empirical bent: countless interviews with managers in light industry. What were the problems with which they dealt?  In little more than a year, he had written a dissertation:  Overcentralization in Economic Administration.  It contained none of the usual Marxist jargon, just a steady parade of facts about bottlenecks, plan bargaining, mismatched incentives of all sorts. Within the Institute, it was well received -- enough to win Kornai an appointment as a research fellow, with a salary and a bonus to boot.

But first there would be a public defense. It was held September 24, 1956 -- barely a month before the outbreak of the Hungarian revolt against Russian rule. Word of the event had got around town, naturally; some two hundred persons showed up for what the cognoscenti described as "a choice political morsel."  Newspapers carried news of the highly favorable debate. No wonder, then, that Kornai was enlisted a month later to write the economic section of the speech Imre Nagy would give as new prime minister. That night Hungarian security police shot unarmed demonstrators at the state radio station.  The next morning he started to work on a draft.

It was the last time Kornai would dabble in politics. Ten days later, Soviet tanks rolled into Budapest. His friend and former editor Gimes, having started an illicit newspaper (Kornai declined to participate) was hunted down by police (after hiding for a few days in Kornai's mother's apartment) and later hanged. So was prime minister Nagy.  Kornai was interrogated repeatedly, though never tortured.  He did not turn on his friend, though he buckled in small degrees in other situations. (The passages in which he reconstructs his calculus in these matters are among the most moving in the book.)

Nor did he take the opportunity to leave Hungary for the West, as did some 200,000 to 250,000 others, including his closest friend. Instead, between times, he studied his German edition of Paul Samuelson's Foundation of Economic Analysis. As Soviet tanks shut down the city, he had decided both to remain in Hungary, and to become part of the economics profession of the West, even while declining to emigrate.

A year later, towards the end of 1957, blackballed at Budapest's Karl Marx University of Economics, he was quietly dismissed from his job at the Institute.

That was the nadir. Starting in 1958, Kornai found jobs that permitted him to carry on his work, first with the Light Industry Planning Board, then with the Textile Industry Research Institute. He remarried, the economist Zsuzsa Dániel, whom he met while he worked on mathematical models at the National Planning Office. On Oxford economist John Hicks' recommendation, Overcentralization was translated into English.  It appeared in 1959, to glowing reviews. Who had the nerve to write so candidly about the Communist world from the inside?

As early as 1958, London School of Economics professor Ely Devons had invited him to teach there. Only in 1962 was he permitted to lecture in East Germany, Poland and Czechoslovakia. Edmund Malinvaud succeeded in winning him permission to travel to the West -- to England -- in 1963, where he met Tjalling Koopmans, who would become his long-time friend. Kenneth Arrow invited him to Stanford in 1968, and thereafter he was relatively free to work abroad, in Cambridge, at Yale, Princeton, Stockholm University, the Institute for Advanced Study in Princeton.  But it was not until 1986, when he accepted an offer from Harvard University that permitted him to split his time between Cambridge and Budapest, that he finally became a full professor at a university.

Until then, Kornai had had relatively few doctoral students of his own, the mathematical frontier having steadily moved on since he learned linear programming from Samuelson, Robert Solow and Robert Dorfman's text. But at last there was time to excavate an idea that had been implicit in his work for years -- the "soft budget constraint," meaning the socialist practice of routinely plowing resources into failing enterprises even when they routinely exceeded their budgets, year after year (as opposed to the "hard" constraint of bankruptcy.) Kornai first employed the phrase in 1979, but not until he acquired a Swedish co-author (and not long thereafter, a son-in-law), Jörgen Weibull, did the pair undertake mathematical modeling of what by then they were calling "paternalism." With Ágnes Matits, a young Hungarian collaborator, Kornai then sought to empirically document the phenomenon in socialist economies.

Meanwhile, Richard Quandt at Princeton had begun formal modeling of the propensity to bail out failing enterprises -- what he called "the Kornai effect." Soon Eric Maskin and Mathais Dewatripont at Harvard had cast the familiar phenomenon of "too big to fail" in game-theoretic terms. Yet when Kornai sent a literary summary to the American Economic Review in 1984, it was rejected.

Kyklos, an international journal noted for publishing original approaches, immediately accepted it without revision, and at last Kornai had a famous paper, perhaps the most frequently cited of all his papers.

It is sometimes said that Kornai's reputation rests on four books. Overcentralization (1959), Anti-Equilibrium (1971), The Economics of Shortage (1980), and The Socialist System (1992). It is held against him that he failed to foresee the collapse. "Kornai's tragedy is that by the time he finished explaining why the socialist system did not work, it had disappeared," wrote Robert Skidelsky in the current New York Review of Books. In fact, The Road to a Free Economy (1990) is in some ways Kornai's best and most important book, and the real tragedy is that the gradualist approach to privatization that he advocated in it was almost universally ignored in Eastern Europe and Russia.

The patching and darning of socialism had to end, wrote Kornai.  There could be no more wistful longing for "a third way."  Socialist economies would have to change completely.  But the accelerated privatization schemes of Western reformers were misguided, he argued. Vouchers, mutual fund distributions and other "big-bang" schemes conveyed the impression "that Daddy state has unexpectedly passed away and left us, his orphaned children, to distribute the patrimony equitably.... The point is not to hand out the property, but rather to place it into the hands of a really better owner."

In the end, Hungary preferred the slow sequence of events recommended by the book, while Russia tried to convert to democracy and capitalism overnight. The rest is history.

Kornai was in Cambridge, Mass., last week in connection with the publication of his book. At one point, he gave a seminar to a circle of old friends.  Here is how his old friend (and fellow Hungarian), Harvard economist Francis Bator concluded his introductory remarks:

"Some might think a blemish Kornai's choice, as he puts it in the book, 'not [to] indulge in heroic, illegal forms of struggle against the communist system...[instead] to contribute to renewal through...scholarly activity.'  Not so. If you want your bold ideas to affect the real world, you have sometimes to restrain your impulse to be bold. It is the courageous tradeoff of a quintessentially autonomous man." 

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2007/05/30 10:36 2007/05/30 10:36

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Review of Kicking Away the Ladder

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http://www.paecon.net/PAEReview/development/Chang15.htm

post-autistic economics review
Issue no. 15,  1 September 2002
article 3

Kicking Away the Ladder:
How the Economic and Intellectual Histories of Capitalism Have Been
Re-Written to
Justify Neo-Liberal Capitalism

Ha-Joon Chang   (Cambridge University, UK)

© Copyright 2002 Ha-Joon Chang

There is currently great pressure on developing countries to adopt a set of “good policies” and “good institutions” – such as liberalisation of trade and investment and strong patent law – to foster their economic development.


When some developing countries show reluctance in adopting them, the proponents of this recipe often find it difficult to understand these countries’ stupidity in not accepting such a tried and tested recipe for development. After all, they argue, these are the policies and the institutions that the developed countries had used in the past in order to become rich. Their belief in their own recommendation is so absolute that in
their view it has to be imposed on the developing countries through strong bilateral and multilateral external pressures, even when these countries don’t want them.

Naturally, there have been heated debates on whether these recommended policies and institutions are appropriate for developing countries. However, curiously, even many of those who are sceptical of the applicability of these policies and institutions to the developing countries take it for granted that these were the policies and the institutions that were used by the developed countries when they themselves were developing countries.

Contrary to the conventional wisdom, the historical fact is that the rich countries did not develop on the basis of the policies and the institutions that they now recommend to, and often force upon, the developing countries. Unfortunately, this fact is little known these days because the “official historians” of capitalism have been very successful in re-writing its history.

Almost all of today’s rich countries used tariff protection and subsidies to develop their industries. Interestingly, Britain and the USA, the two countries that are supposed to have reached the summit of the world economy through their free-market, free-trade policy, are actually the ones that had most aggressively used protection and subsidies.

Contrary to the popular myth, Britain had been an aggressive user, and in certain areas a pioneer, of activist policies intended to promote its industries. Such policies, although limited in scope, date back from the
14th century (Edward III) and the 15th century (Henry VII) in relation to woollen manufacturing, the leading industry of the time.  England then was an exporter of raw wool to the Low Countries, and Henry VII for example tried to change this by taxing raw wool exports and poaching skilled workers from the Low Countries.

Particularly between the trade policy reform of its first Prime Minister Robert Walpole in 1721 and its adoption of free trade around 1860, Britain used very dirigiste trade and industrial policies, involving measures very
similar to what countries like Japan and Korea later used in order to develop their industries. During this period, it protected its industries a lot more heavily than did France, the supposed dirigiste counterpoint to its
free-trade, free-market system. Given this history, argued Friedrich List, the leading German economist of the mid-19th century, Britain preaching free trade to less advanced countries like Germany and the USA was like someone trying to “kick away the ladder” with which he had climbed to the top.

List was not alone in seeing the matter in this light. Many American thinkers shared this view. Indeed, it was American thinkers like Alexander Hamilton, the first Treasury Secretary of the USA, and the (now-forgotten)
economist Daniel Raymond, who first systematically developed the infant industry argument. Indeed, List, who is commonly known as the father of the infant industry argument, in fact started out as a free-trader (he was an ardent supporter of German customs union – Zollverein) and learnt about this argument during his exile in the USA during the 1820s

Little known today, the intellectual interaction between the USA and Germany during the 19th century did not end there. The German Historical School – represented by people like Wilhelm Roscher, Bruno Hildebrand, Karl Knies, Gustav Schmoller, and Werner Sombart – attracted a lot of American economists in the late 19th century. The patron saint of American Neoclassical economics, John Bates Clark, in whose name the most prestigious award for young (under 40) American economists is given today, went to Germany in 1873 and studied the German Historical School under Roscher and Knies, although he gradually drifted away from it. Richard Ely, one of the leading American economists of the time, also studied under Knies and
influenced the American Institutionalist School through his disciple, John Commons. Ely was one of the founding fathers of the American Economic Association; to this day, the biggest public lecture at the Association’s annual meeting is given in Ely’s name, although few of the present AEA members would know who he was.

Between the Civil War and the Second World War, the USA was literally the most heavily protected economy in the world. In this context, it is important to note that the American Civil War was fought on the issue of
tariff as much as, if not more, on the issue of slavery. Of the two major issues that divided the North and the South, the South had actually more to fear on the tariff front than on the slavery front. Abraham Lincoln was a
well-known protectionist who cut his political teeth under the charismatic politician Henry Clay in the Whig Party, which advocated the “American System” based on infrastructural development and protectionism (thus named on recognition that free trade is for the British interest). One of Lincoln’s top economic advisors was the famous protectionist economist, Henry Carey, who once was described as “the only American economist of importance” by Marx and Engels in the early 1850s but has now been almost completely air-brushed out of the history of American economic thought. On the other hand, Lincoln thought that African Americans were racially inferior and that slave emancipation was an idealistic proposal with no prospect of immediate implementation  – he is said to have emancipated the slaves in 1862 as a strategic move to win the War rather than out of some moral conviction.

In protecting their industries, the Americans were going against the advice of such prominent economists as Adam Smith and Jean Baptiste Say, who saw the country’s future in agriculture. However, the Americans knew exactly what the game was. They knew that Britain reached the top through protection
and subsidies and therefore that they needed to do the same if they were going to get anywhere. Criticising the British preaching of free trade to his country, Ulysses Grant, the Civil War hero and the US President between 1868-1876, retorted that “within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade”. When his country later reached the top after the Second World War, it too started “kicking away the ladder” by preaching and forcing free trade to the less developed countries.

The UK and the USA may be the more dramatic examples, but almost all the rest of the developed world today used tariffs, subsidies and other means to promote their industries in the earlier stages of their development. Cases like Germany, Japan, and Korea are well known in this respect. But even
Sweden, which later came to represent the “small open economy” to many economists had also strategically used tariffs, subsidies, cartels, and state support for R&D to develop key industries, especially textile, steel,
and engineering.

There were some exceptions like the Netherlands and Switzerland that have maintained free trade since the late 18th century. However, these were countries that were already on the frontier of technological development by the 18th centuries and therefore did not need much protection. Also, it should be noted that the Netherlands deployed an impressive range of interventionist measures up till the 17th century in order to build up its maritime and commercial supremacy. Moreover, Switzerland did not have a patent law until 1907, flying directly against the emphasis that today’s orthodoxy puts on the protection of intellectual property rights (see below). More interestingly, the Netherlands abolished its 1817 patent law in 1869 on the ground that patents are politically-created monopolies inconsistent with its free-market principles – a position that seems to elude most of today’s free-market economists – and did not introduce another patent law until 1912.

The story is similar in relation to institutional development. In the earlier stages of their development, today’s developed countries did not even have such “basic” institutions as professional civil service, central
bank, and patent law. It was only after the Pendleton Act in 1883 that the US federal government started recruiting its employees through a competitive process. The central bank, an institution dear to the heart of today’s free-market economists, did not exist in most of today’s rich countries until the early 20th century – not least because the free-market economists of the day condemned it as a mechanism for unjustly bailing out imprudent borrowers. The US central bank (the Federal Reserve Board) was set up only
in 1913 and the Italian central bank did not even have a note issue monopoly until 1926. Many countries allowed patenting of foreign invention until the late 19th century. As I mentioned above, Switzerland and the Netherlands refused to introduce a patent law despite international pressure until 1907
and 1912 respectively, thus freely “stole” technologies from abroad. The examples can go on.

One important conclusion that emerges from the history of institutional development is that it took the developed countries a long time to develop institutions in their earlier days of development. Institutions typically took decades, and sometimes generations, to develop. Just to give one example, the need for central banking was perceived at least in some circles from at least the 17th century, but the first “real” central bank, the Bank of England, was instituted only in 1844, some two centuries later.

Another important point emerges is that the levels of institutional development in today’s developed countries in the earlier period were much lower than those in today’s developing countries. For example, measured by
the (admittedly highly imperfect) income level, in 1820, the UK was at a somewhat higher level of development than that of India today, but it did not even have many of the most “basic” institutions that India has today. It did not have universal suffrage (it did not even have universal male suffrage), a central bank, income tax, generalised limited liability, a generalised bankruptcy law, a professional bureaucracy, meaningful securities regulations, and even minimal labour regulations (except for a couple of minimal and hardly-enforced regulations on child labour).

If the policies and institutions that the rich countries are recommending to the poor countries are not the ones that they themselves used when they were developing, what is going on? We can only conclude that the rich countries are trying to kick away the ladder that allowed them to climb where they are. It is no coincidence that economic development has become more difficult during the last two decades when the developed countries started turning on the pressure on the developing countries to adopt the so-called “global standard” policies and institutions.

During this period, the average annual per capita income growth rate for the developing countries has been halved from 3% in the previous two decades (1960-80) to 1.5%. In particular, Latin America virtually stopped growing, while Sub-Saharan Africa and most ex-Communist countries have experienced a
fall in absolute income. Economic instability has increased markedly, as manifested in the dozens of financial crises we have witnessed over the last decade alone. Income inequality has been growing in many developing countries and poverty has increased, rather than decreased, in a significant number of them.

What can be done to change this?

First, the historical facts about the historical experiences of the developed countries should be more widely publicised. This is not just a matter of “getting history right”, but also of allowing the developing countries to make more informed choices.

Second, the conditions attached to bilateral and multilateral financial assistance to developing countries should be radically changed. It should be accepted that the orthodox recipe is not working, and also that there can be no “best practice” policies that everyone should use.

Third, the WTO rules should be re-written so that the developing countries can more actively use tariffs and subsidies for industrial development. They should also be allowed to have less stringent patent laws and other intellectual property rights laws.

Fourth, improvements in institutions should be encouraged, but this should not be equated with imposing a fixed set of (in practice, today’s – not even yesterday’s – Anglo-American) institutions on all countries. Special care has to be taken in order not to demand excessively rapid upgrading of institutions by the developing countries, especially given that they already have quite developed institutions when compared to today’s developed countries at comparable stages of development, and given that establishing and running new institutions is costly.

By being allowed to adopt policies and institutions that are more suitable to their conditions, the developing countries will be able to develop faster. This will also benefit the developed countries in the long run, as
it will increase their trade and investment opportunities. That the developed countries cannot see this is the tragedy of our time.

Ha-Joon Chang (hjc1001@econ.cam.ac.uk) teaches in the Faculty of Economics, University of Cambridge. This article is based on his new book, Kicking Away the Ladder – Development Strategy in Historical Perspective, which was published by Anthem Press, London, on 10 June 2002.
___________________________

SUGGESTED CITATION:

Ha-Joon Chang, “Kicking Away the Ladder”, post-autistic economics review,
issue no. 15, September 4, 2002, article 3.
http://www.paecon.net/PAEReview/issue15/Chang15.htm

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2007/05/07 11:49 2007/05/07 11:49

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Review of Gomory and Baumol's new trade theory

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This article can be found on the web at
http://www.thenation.com/doc/20070430/greider


The Establishment Rethinks Globalization

by WILLIAM GREIDER

[from the April 30, 2007 issue]

 

The church of global free trade, which rules American politics with infallible pretensions, may have finally met its Martin Luther. An unlikely dissenter has come forward with a revised understanding of globalization that argues for thorough reformation. This man knows the global trading system from the inside because he is a respected veteran of multinational business. His ideas contain an explosive message: that what established authorities teach Americans about global trade is simply wrong--disastrously wrong for the United States.

Martin Luther was a rebellious priest challenging the dictates of a corrupt church hierarchy. Ralph Gomory, on the other hand, is a gentle-spoken technologist, trained as a mathematician and largely apolitical. He does not set out to overthrow the establishment but to correct its deeper fallacies. For many years Gomory was a senior vice president at IBM. He helped manage IBM's expanding global presence as jobs and high-tech production were being dispersed around the world.

 

The experience still haunts him. He decided, in retirement, that he would dig deeper into the contradictions. Now president of the Alfred P. Sloan Foundation, he knew something was missing in the "pure trade theory" taught by economists. If free trade is a win-win proposition, Gomory asked himself, then why did America keep losing?

 

The explanations he has developed sound like pure heresy to devout free traders. But oddly enough, Gomory's analysis is a good fit with what many ordinary workers and uncredentialed critics (myself included) have been arguing for some years. An important difference is that Gomory's critique is thoroughly grounded in the orthodox terms and logic of conventional economics. That makes it much harder to dismiss. Given his career at IBM, nobody is going to call Ralph Gomory a "protectionist."

 

He did not nail his "theses" to the door of the Harvard economics department. Instead, he wrote a slender book--Global Trade and Conflicting National Interests--in collaboration with respected economist William Baumol, former president of the American Economic Association. Published seven years ago, the book languished in academic obscurity and until recently was ignored by Washington policy circles.

I asked Gomory if his former colleagues from the corporate world quarrel with his provocative message. "Most of them have never heard it," he said. "It's a pretty new message." He has discussed his reform ideas with some CEOs, "who said, Well, maybe we could do that. Others couldn't have disagreed more strongly."

Now Gomory is attempting to re-educate the politicians in Congress. He has gained greater visibility lately because he has been joined by a group of similarly concerned corporate executives called the Horizon Project. Its leader, Leo Hindery, former CEO of the largest US cable company and a player in Democratic politics, shares Gomory's foreboding about the destructive impact of globalization on American prosperity. Huge losses are ahead--10 million jobs or more--and Hindery fears time is running out on reform.

"We want to be a counter to the Hamilton Project," Hindery explains. "They have a sense of stasis that is more benign than I have. I don't think this is all going to work out." The Hamilton policy group was launched last year by former Treasury Secretary Robert Rubin to make sure the laissez-faire trade doctrine known as Rubinomics continues to dominate the Democratic Party. "We're never going to have the status of Bob Rubin," Hindery concedes. "But we're not chopped liver either. We have respectable business careers. You can't tell Ralph Gomory that he is 'smoke and mirrors,' because he wrote the book."

 

Gomory's critique has great political potential because it provides what the opponents of corporate-led globalization have generally lacked: a comprehensive intellectual platform for arguing that the US approach to globalization must be transformed to defend the national interest. Still, it will take politicians of courage to embrace his ideas and act on them. Gomory's political solutions are as heretical as his economic analysis.

At IBM back in the 1980s, Gomory watched in awe as Japan and other Asian nations captured high-tech industrial sectors in which US companies held commanding advantage. IBM invented the disk drive, then dropped out of the disk-drive business, unable to compete profitably. Gomory marveled at Singapore, a tiny city-state, as it lured American manufacturers with low-wage labor, capital subsidies and tax breaks. The US companies turned Singapore into a global center for semiconductor production.

 

"It was an unforgettable transformation," Gomory remembers. "And it was pretty frightening.

"The offer that many Asian countries will give to American companies is essentially this: 'Come over here and enhance our GDP. If you are here our people will be building disk drives, for example, instead of something less productive. In return, we'll help you with the investment, with taxes, maybe even with wages. We'll make sure you make a profit.' This works for both sides: the American company gets profits, the host country gets GDP. However, there is another effect beyond the benefits for those two parties--high-value-added jobs leave the U.S."

 

China and India, he observes, are now doing this on a large scale. Microsoft and Google opened rival research centers in Beijing. Intel announced a new, $2.5 billion semiconductor plant that will make it one of China's largest foreign investors. China's industrial transformation is no longer about making shirts and shoes, as some free-trade cheerleaders still seem to believe. It is about capturing the most advanced processes and products.

 

The multinationals' overseas deployment of capital and technology, Gomory explains, is the core of how some very poor developing nations are able to ratchet up their technological prowess, take over advanced industrial sectors and rapidly expand their share in global trade--all with the help of US companies and finance, as they roam the world in search of better returns.

 

The Gomory-Baumol book describes this as "a divergence of interests" between multinational firms and their home country. "This overseas investment decision may then prove to be very good for that multinational firm," they write. "But there remains the question: Is the decision good for its own country?" In many cases, yes. If the firm is locating low-skilled industrial production in a very poor country, Americans get cheaper goods, trade expands for both sides and the result is "mutual gain." But the trading partners enter a "zone of conflict" if the poor nation develops greater capabilities and assumes the production of more advanced goods. Then, the authors explain, "the newly developing partner becomes harmful to the more industrialized country." The firm's self-interested success "can constitute an actual loss of national income for the company's home country."

 

American multinationals, as principal actors in this transfer of wealth-generating productive capacity, are distinctively free to make the decisions for themselves without interference from government. They want profit and future consumer markets. Their home country wants to maintain a highly productive high-wage economy. Without recognizing it, the two are pulling in opposite directions--the "divergence of interests" most US politicians ignore, evidently believing church doctrine over visible reality.

 

The Gomory-Baumol book explains the dynamics with charts and equations for economists to study. For the rest of us, it is easier to follow Gomory's personal explanation of changing fortunes among trading nations. "What made America much wealthier than the Asian nations in the first place?" Gomory asks. "We invested alongside our workers. Our workers dug ditches with backhoes. The workers in underdeveloped countries dug ditches with shovels. We had great big plants with a few people in them, which is the same thing. We knew how, through technology and investment, to make our workers highly productive. It wasn't that they went to better schools, then or now, and I don't know how much schooling it takes to run a backhoe.

 

"The situation today is that the companies have discovered that using modern technology they can do all that overseas and pay less for labor and then import product and services back into the United States. So what we're doing now is competing shovel to shovel. The people in many countries are being equipped with as good a shovel or backhoe as our people have. Very often we are helping them make the transition. We're making it person-to-person competition, which it never was before and which we cannot win. Because their people will be paid a third, a quarter of what our people are paid. And it's unreasonable to think you can educate our people so well that they can produce four times as much in the United States."

 

As this shift of productive assets progresses, the downward pressure on US wages will thus continue and intensify. Free-trade believers insist US workers can defend themselves by getting better educated, but Gomory suggests these believers simply don't understand the economics. "Better education can only help," he explains. "The question is where do you put your technology and knowledge and investment? These other countries understand that. They have understood the following divergence: What countries want and what companies want are different."

 

The implication is this: If nothing changes in how globalization currently works, Americans will be increasingly exposed to downward pressure on incomes and living standards. "Yes," says Gomory. "There are many ways to look at it, all of which reach the same conclusion."

 

I ask Gomory what he would say to those who believe this is a just outcome: Americans become less rich, others in the world become less poor. That might be "a reasonable personal choice," he agrees. "But that isn't what the people in this country are being told. No one has said to us: 'You're probably a little too rich and these other folks are a little too poor. Why don't we even it out?' Instead, what we usually hear is: 'It's going to be good for everyone. In the long run we're going to get richer with globalization.'"

 

Gomory and Baumol are elaborating a fundamental point sure to make many economists (and political leaders) sputter and choke. Contrary to dogma, the losses from trade are not confined to the "localized pain" felt by displaced workers who lose jobs and wages. In time, the accumulating loss of a country's productive base can injure the broader national interest--that is, everyone's economic well-being.

 

"Our objective," Baumol told a policy conference last summer, "is to show how outsourcing can indeed reduce the share of benefits of trade, not only for those who lose their jobs and suffer a direct reduction in wages but can wind up making the average American worse off than he or she would have been."

 

The conventional win-win assurances, they explain, are facile generalizations that ignore the complexity of the trading system--the myriad differences in country-to-country relationships and the vast realm of government actions and policy interventions designed to shape the outcomes. "Many of our 'dismal science' colleagues speak unguardedly as though they believe free trade cannot fail, no matter what," Baumol said.

 

Some nations, in other words, do indeed become "losers." Gomory fears the United States is now one of them--starting to go downhill. When he and Baumol wrote their book, they figured US trade relations with China and India produced "mutual gain" for both ends. The United States got cheaper goods, China and India got jobs and a start at industrialization. But the rapid improvements in those two nations during the past decade, Gomory thinks, are putting the United States in the bind where their gain becomes our loss.

 

Essentially, the terms of trade have changed as more and more value-added production has shifted from the United States to its poorer trading partners. America, he explains, becomes increasingly dependent, buying from abroad more and more of what its citizens consume and producing relatively less at home. US incomes stagnate as the high-wage jobs disappear and US exports become a smaller share of the world total.

 

The persistent offshoring of domestic production is leading to a perverse consequence: The United States finds itself paying more for imports. The production that originally moved offshore to get low-wage labor and cheaper goods is now claiming a larger and larger share of national income, as the growing trade deficits literally subtract from US domestic growth. "All the stuff you were already importing from them becomes more expensive," Gomory explains. "That's why you can start going downhill--because you pay more for what you were previously getting." Put another way, one hour of US work no longer buys as many hours of Chinese work as it once did. China can suppress its domestic wages to keep selling more of its stuff, but that does not alter the fundamental imbalance in productive strength.

 

The US predicament is vividly reflected in the nation's swollen trade deficits, now running at nearly 7 percent of GDP every year. The country consumes more than it produces. It borrows heavily from trading partners, led by China, to pay for its "excess" consumption. This allows America to dodge--temporarily--a reckoning with its weakened condition, that is, falling living standards. But that will eventually occur, when Americans are compelled to reduce their consumption and pay off the overdue bills. Postponement will deepen the ultimate injury because, meanwhile, the trading partners will gain greater industrial capabilities, while US productive strength weakens further.

 

Americans can choose to blame China or disloyal multinationals, but the problem is grounded in US politics. The solution can be found only in Washington. China and other developing nations are pursuing national self-interest and doing what the system allows. In a way, so are the US multinationals. "I want to stress it's a system problem," Gomory says. "The directors are doing the job they're sworn to do. It's a system that says the companies have to have a sole focus on maximizing profit."

 

Gomory's proposed solution would change two big things (and many lesser ones). First, the US government must intervene unilaterally to cap the nation's swollen trade deficit and force it to shrink until balanced trade is achieved with our trading partners. The mechanics for doing this are allowed under WTO rules, though the emergency action has never been invoked by a wealthy nation, much less the global system's putative leader. Capping US trade deficits would have wrenching consequences at home and abroad but could force other nations to consider reforms in how the trading system now functions. That could include international rights for workers, which Gomory favors.

 

Second, government must impose national policy direction on the behavior of US multinationals, directly influencing their investment decisions. Gomory thinks this can be done most effectively through the tax code. A reformed corporate income tax would penalize those firms that keep moving high-wage jobs and value-added production offshore while rewarding those that are investing in redeveloping the home country's economy.

 

US companies are not only free of national supervision but actively encouraged to offshore production by government policy and tax breaks. Other advanced economies have sophisticated national industrial policies, plus political and cultural pressures, that guide and discipline their multinationals, forcing them to adhere more closely to the national interest.

 

Neither of Gomory's fundamental policy reforms--balancing trade or imposing discipline on US multinationals--can work without the other. Both have to be done more or less at once. If the government taxed US multinational behavior without also capping imports, the firms would just head out the door. "That won't work," Gomory explains, "because you will say to the companies, 'This is how we're going to measure you.' And the corporations will say, 'Oh, no, you're not. I'm going overseas. I'm going to make my product over there and I'll send it back into the United States.' But if you insist on balanced trade, then the amount that's shipped in has to equal the amount that's shipped out by companies. If no companies do that, then nothing can be shipped in either. If you balance trade, you are going to develop internal companies that work the way you want." Public investment in new technologies and industries, I would add, may not achieve much either, if there is no guarantee that the companies will locate their new production in the United States.

 

Essentially, Gomory proposes to alter the profit incentives of US multinationals. If the government adds rules of behavior and enforces them through the tax code, companies will be compelled to seek profit in a different way--by adhering to the national interest and terms set by the US government. Other nations do this in various ways. Only the United States imagines the national interest doesn't require it.

 

In recent months Gomory and Leo Hindery of the Horizon Project have been calling on Congress with these big ideas and getting respectful audiences. The two met with some thirty Democratic senators and Congressional staffers from both parties. Senator Byron Dorgan, with co-sponsors like Sherrod Brown, Russell Feingold and even Hillary Clinton, has introduced several bills to confront the trade deficits.

 

Gomory's concept for multinational taxation is a tougher sell amid Washington lobbyists because it goes right to the bottom line of major US corporations. On the other hand, this proposal has stronger intuitive appeal for citizens, who reasonably ask why multinationals are allowed to undercut the national interest when they enjoy all the benefits of being "American" companies.

 

Hindery's group is advocating Congressional action to arrange a "national summit" on trade, where all these questions can be thrashed out. The political system has never really had an honest, open debate on globalization in the past thirty years. The dogmatic church of free trade--"free trade good, no trade bad"--wouldn't allow it. As more politicians grasp the meaning of Gomory's analysis, they should start demanding equal time for the heretics.

 

Gomory's vision of reformation actually goes beyond the trading system and America's economic deterioration. He wants to re-create an understanding of the corporation's obligations to society, the social perspective that flourished for a time in the last century but is now nearly extinct. The old idea was that the corporation is a trust, not only for shareholders but for the benefit of the country, the employees and the people who use the product. "That attitude was the attitude I grew up on in IBM," Gomory explains. "That's the way we thought--good for the country, good for the people, good for the shareholders--and I hope we will get back to it.... We should measure corporations by their impact on all their constituencies.

 

"So in my utopian dream, we decide what we want from the corporations and that's how they make a profit--by doing those things. Failing that, I would settle for the general realization of this divergence and let people argue it out."

 

Some older CEOs and board members at least listen to him sympathetically. "They have grandchildren," he says. "They wonder too what's going to happen to our grandchildren. You can't get a vote around the corporate board table about, Is this good for the grandchildren? But you can talk to them and they'll worry about it and say, Well, maybe we need to do something."

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2007/04/18 05:46 2007/04/18 05:46

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The History and the Role of the US Fed 5

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Political aspects of the Reaganomics

Given all of these economic consequences of the 1st Reagan administration, it would be interesting to ask why so many ordinary Americans voted again for the 2nd Reagan administration in 1984’s presidential election. Why did so many owners of farms and middle scale manufacturing industries vote for Reagan? Why did ordinary young Americans vote for the Reaganomics?

With respect to these questions, there might be following two answers: the first is related with Republican Party’s clever political strategy during the election period. From a political perspective, Reagan’s political strategies were more brilliant than those of Jimmy Carter and later Democratic Party’s presidential candidate, Walter Mondale.

Reagan promised relief from the anxieties of inflation without mentioning the costs of recession and unemployment. “Republican Party asked Americans to enlist in a great struggle to restore the nation’s economic health. But instead of demanding sacrifices and self-denial as Jimmy Carter had, Reagan demanded only that citizens accept a reduction in their taxes.”(369)

“Republicans held the symbolic high ground that the Democratic Party had once own in national politics – the party of growth and prosperity. On the contrary, Democratic presidential candidate proposed painful remedies – a major tax increase and substantial budget reductions to restore fiscal order.” (610)

From historical perspective, the historic positions of the two dominant political parties were reversed for the first time in political history during the 1984 election. “The Democratic Party felt trapped by its past government deficit policy, still tarnished by the inflationary anxieties experienced under Jimmy Carter.” Democratic leaders decided that they must convince the public of their newly developed sense of responsibility and so they campaigned for fiscal discipline.

In the meantime, the president’s party had effectively abandoned the old Republican orthodoxy that the Democrats started to attempt to mimic. From 1984 election, Republicans started to appeal their rhetorical loyalty to the idea of a balanced budget and fiscal order.

Of course, however, the conservative party had adopted the opposite in actual policy – an economy driven by increased federal spending (mainly for military subsidies) and increased debt (mainly from tax cuts), the most serious fiscal deficit policy ever attempted in peacetime. The old Republican complaint that deficit spending ultimately led to ruinous inflation was conveniently discarded in the presence of Republican federal deficits.

Secondly, Reagan fused nationalism into his presidential campaign. “It’s morning again in America,” “America is back,” “You ain’t seen nothing yet” are common slogans he used during the election campaign. “The spirit of nationalism, the warming glow of patriotic ferver swept the country.” And the news media amplified the illusions.

But from the benefits of hindsight, the Reagan administration’s economic policies were anything but nationalistic. Domestic industries – manufacturing, agriculture, oil and other minerals – were being decimated by the combined effects of Washington’s fiscal and monetary policy. “Ronald Reagan’s symbol of American revival, the strong dollar, was in reality assisting America’s foreign competitors, ceding a larger and larger share of world trade to other nations.”(643)

Nonetheless, what most ordinary citizens knew from their own lives appeared to match what the President told them. “The anxiety of price inflation was gone. Most important of all real disposable income per capita was rising throughout the campaign year at an extraordinary pace. In 1980, when Jimmy Carter was up for re-election, price inflation was above 13 percent and real disposable income was shrinking slightly due to brief recession.” Thus, when the President Reagan asked, ‘Are you better off than you were four years ago?,’ “the answer seemed self-evident for the majority of Americans.”(643)

 

Theoretical implication of the 1980s

From theoretical perspectives, economic policies adopted under the Reagan administration in 1980s can be characterized by free market fundamentalism along with monetarist anti-inflation policy. As we already mentioned, these economic strategies was based on the negation of the previously dominant liberal Keynesian economics.

However, unlike the forward-looking expectations of “supply side economics,” it was “demand side” which pulled and induced the investment. Even under the dire circumstances, it was not capitalist or entrepreneurs but ordinary households and consumers who spent their money leading entrepreneurs to expand their production facilities. In this sense, Keynesian notion of “effective demand” has remained effective even under the dominance of “supply side economics” in economic policy area.

Furthermore, Milton Friedman’s concept of inflation turned out to be wrong during the Reagan administration’s policy experiments. Friedman ascribed the cause of inflation to the excessive quantity of money supplied by the central bank. In other words, if the government pumped out too much money relative to the quantity of money necessary for the overall operation of economic activities in a given condition, he argued, this monetary policy would lead to inflationary pressures in the near future. According to him, inflation has been and will always be a “monetary phenomenon.”

However, apart from the question related with adequate quantity of money (how can we know and to what extent is the overall quantity of money necessary in a given condition?), his explanation missed the significant role of the velocity of money. If the velocity of money changes due to various reasons, his argument that the Fed should focus on the overall quantity of money, instead of trying to regulate real interest rates, would lead us in the wrong direction.

In sum, Reagan’s 1981 tax bill failed not only to increase the average saving rates in the United States, but also to induce the investment on productive capital. The Fed’s tight monetarist money policy not only depressed manufacturing sectors but also decimated future growth potentials of the US economy.

 

Concluding remarks

It seems necessary for me to conclude this review essay by introducing the merits of this book. The first virtue that I would like to mention is its style and structure. It is written and organized in plain English. Even those readers with basic level of English proficiency would not find any serious difficulties in understanding the main contents of the author’s arguments. Even though it seemed to be somewhat thick compared to ordinary paperbacks at first glance (717 pages for main contents and total 798 pages including reference, appendix and index), the way of writing was easy to follow and even exciting. It took a week for me to finish reading the book.

Second, the book is well organized. The book consists of four major parts, each of which mainly deals with the Fed’s institutional characteristics (“Part one: secrets of the temple”), its history and traditional roles (“Part two: the money question”), the Fed’s monetary policies in 1980s and their repercussions (“Part three: the liquidation”) and finally evaluations of the Fed’s economic policies in socio-political perspectives (“Part four: the restoration of capital”). Every chapter is closely connected with each other.

Third, this book is based on wide range of references, data analysis and intensive interviews. As you can see, the author spent for about 5 years to gather basic data and references. He also conducted in-dept interviews with former Fed chairman and many government officials in order to represent policy debates and economic climates around the Fed and the White House at the time. The author’s honest and meticulous descriptions of the affairs offer enough information about the Fed and US contemporary economic history.

Fourth, this book contains wide range of knowledge about the US history, philosophy and sociology not to mention economics. It deals with not only domestic consequences of the Fed’s policy in the 1980s but also shows how those policies have affected on world economy. In this sense, I was tempted to conclude that the subtitle of the book should be changed into “How the Federal Reserve Runs the World Economy.”

In sum, this book will be a very helpful guide for those who want to understand the history of US economic affairs – how does it develop and where will it go. Instead of doing laborious work for myself, I would like to finish this essay by citing the following precise praises for the potential readers: “startling and revelatory as well as probing and incisive. It is not only a major journalistic achievement but a major public service, for it is an immensely valuable addition to our understanding of the hidden forces that shape our lives.” – Robert A. Caro; “I expect this book to shake up Washington and probably Wall Street too. Bill Greider’s reporting goes right to the bone and marrow of American politics – how the government really decides the largest economic questions and whose influence really counts. This book may also be the public’s best chance to understand an enormously complex subject – money – because Greider’s narrative makes it lucid and even exciting.” – David A. Stockman; “a fascinating account of Paul Volcker’s extraordinary management of the Federal Reserve Board, and through the Fed, the American economy. I don’t know of any book that has made so ambitious and effort and succeeded so brilliantly.” – Robert L. Heilbroner; “a masterly look at the Federal Reserve System, William Greider drops the other shoes and argues that much of what passes for economic policy is really about politics. This is a book that should be read and talked about from one end of the country to the other.” – Senator Edward M. Kennedy.

 

* Reference for this review

Friedman, M. 1963. A Monetary History of the United States, 1860-1960, Chicago: University of Chicago

Krugman, P. 1990. The Age of Diminished Expectations – U.S Economic Policy in the 1990s, Cambridge: The MIT Press

------------. 1994. Peddling Prosperity – Economic Sense and Nonsense in the Age of Diminished Expectations, New York: Norton & Company

 

* Further reading list about the history and roles of the Fed and the US economy

Greider, W. 1992. Who Will Tell the People – The Betrayal of American Democracy, New York: Simon & Schuster (focuses on the implications of the Fed for the American democracy)

Woodward, B. 2001. Maestro – Greenspan’s Fed and the American Boom, New York: Simon & Schuster (deals with the roles of the Fed in the 1990s focusing on Alan Greenspan’s leadership and personality)

Rothbard, M. 2002. A History of Money and Banking in the United States – The Colonial Era to World War , Alabama: Ludwig von Mises Institutes (deals with the history of the US central bank system from the perspective of Austrian school of economics)

Stiglitz, J. 2003. The Roaring Nineties – A New History of the World’s Most Prosperous Decade, New York: WW. Norton & Company (deals with the US economic affairs in 1990s under the Clinton administration based on his personal experiences as an economic advisor for the President)

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2005/09/08 01:46 2005/09/08 01:46

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The History and the Role of the US Fed 4

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Global consequences – in the name of ‘glory’ of the strong dollar

Until now, we focused on Reagan and Volcker’s policies and their domestic impacts. However, it would be much more interesting to see that the Fed had played a significant role in international financial market even before the term “globalization” became one of the most buzz words in our ordinary lives.

First of all, it would not be so difficult to understand that the world economy has started to enter into the same economic recession due to the Fed’s contractionary money policy. The underlying logic was simple: once the richest market in the world declined, exporters around the world started to lose their customers. When the ordinary wage earners in the North America started to suffer from their losses of jobs and reduced incomes due to higher interest rates, it was natural for export-driven “developmental economies” in the Third World to suffer from losses of their consumers. The global economy was sinking into recession too, large nations and small ones alike, due to the same economic reason.

Even in these circumstances, however, central banks of other industrial nations had no other options but to raise their interest rates too allowing the depression of their own domestic markets. If they resisted raising interest rates in their own countries whatever the reasons, huge amount of money invested on their domestic capital account would flight into the U.S financial market for the short term arbitrage causing abrupt withdrawal and financial disorder in the domestic financial market.

It is not purely theoretical; newly elected socialist president of France, Francois Mitterrand, for instance, tried for a time to boost its economy through expansionary monetary policy in early 1980s. However, as soon as the French central bank lowered the interest rates, capital fled from French enterprises in search for higher returns available overseas. Instead of investing their assets, French capitalist sought for short term interest premium. Instead of lending their financial assets to domestic entrepreneurs, French financial asset holders withdrew their money from domestic capital account and invested on the US market. Due to this capital flight, France was depreciated rapidly. Instead of faster growth and full employment, the Mitterrand government had to face stagnation.

Secondly, there was another aspect the Fed’s monetary policy had. It was more indirect process but surely exacerbated by the Fed’s high interest rate policy. The higher interest rates available in the US attracted more and more foreign wealth to dollar-denominated financial assets. The worldwide demand for dollars was increasing, but the supply of dollars was still held tight by the Fed, so naturally the international price for dollars – the foreign exchange rate at which other currencies were converted into US dollars – started to go up.

From then on, an international bank or a corporations or private investor who wished to buy dollar assets would have to pay with more francs or pounds or yen. “From July 1980 to September 1981, the dollar appreciated by 36 percent in its international exchange value with the German mark. In 1979, the yen had traded at less than 200 yen to the dollar. By 1983 the ratio was 235 yen to the dollar.”(414)

This rapid appreciation of the dollars in turn “drove away foreign buyers of American products, just as high interest rates drove away the domestic customers from goods and services. It made US exports more expensive for overseas customers proportionately, and at the same time made foreign imports cheaper in American marketplace.”

In extreme case, for example, American farmers who have previously produced their grains and corn much more cheaply in Iowa and Kansas and have sold them on overseas markets would lose their price competitiveness in foreign markets accordingly. “The machine tools produced in Germany and Japan would drive away American competitors from Cincinnati and take away customers in their own domestic market.” “American grain farmers lost more than a third of their share of the global market from 1981 to 1983 as the export price of their wheat and corn practically doubled.”(415)

In the meantime, “foreign producers of auto, steel, machine tools, computer chips and a long list of other manufactured products grabbed a larger and larger share of the American domestic market. US import of manufactured goods rose by 66 percent over four years’ time and US exports declined by 16 percent.” (593)

In a sense, this process can be described as an exploitation of producers for the interest of consumers, which every mainstream economic textbook cites as an example of the benefits of free trade. However, since American consumers are consisted of owners of farms and agricultural workers, owners of small scale of factories and industrial workers, the process of cost and benefit analysis will be highly complicated; Those who were engaged in farming and middle scale manufacture industries would lose their lands, factories and jobs due to expensive money borrowing. Those who barely succeeded in maintaining their factories and farm would now finally lose their lands and factories due to the rapid appreciation of their national currency.

During these periods, “hundreds of thousands, perhaps millions of US jobs were extinguished by the strong dollar. The Reagan administration celebrated the stronger dollar as a sign of America’s restored vigor, but in international trade, the advantage flowed to the weakening currencies of Europe and Asia. By 1983, the estimated losses exceed 1.5 million American jobs, most of them high-wage, unionized jobs in manufacturing.”(593)

But what damaged American production was rewarding for American finance, especially for the major banks active in international markets. The rising dollars meant that the value of their overseas dollars was rising too. It also meant that market demand was growing for the commodity that American financial institutions traded – US financial assets. “As long as the Fed held interest rates high – higher than competing returns in foreign countries – capital naturally flowed across boundaries, seeking the higher returns available in American financial institutions. And as the demand for dollars increased, the dollar would naturally get harder and harder in foreign exchange. In other words, the stronger dollar was good for business – if your business was finance.”(416)

Admittedly, the Reagan administration had the power to intervene with the Fed’s policy through Treasury ministry. “The dollar’s international value was one of the few areas of monetary policy where both law and tradition gave higher authority than the Fed to the executive branch. The Treasury Secretary was responsible for US dollar policy, and if it wished he could advise the Fed to adjust its domestic interest rates accordingly. Or Treasury could coordinate interventions in foreign exchange markets – buying or selling dollars by both Treasury and the Fed to push the price of the dollar up or bring it down. But it did not use this power.” (416-417)

Given this unique balance of power controlling the international value of the dollar, it is still mysterious why the then US Treasury did not intervene with international exchange market, allowing the rapid appreciation of the dollars. The author of the book, William Greider estimated that it might be because the Reagan administration truly believed that laissez-faire policy would bring about economic recovery. But it also might be because the officials at the administration were so ignorant that they could not know their legal executive power of balancing the terms of international currency.

 

Global consequences - the Third World debt crisis

However, the most serious impacts of the Fed’s economic policy on global economy were on the less developed countries (LDCs) in the Third World, whose economies largely depended on the US market.

First of all, their economic output and real incomes fell disastrously as much as 10 percent in some instances, as their export markets dried up and the price of raw material commodity such as copper and rubber price began to fall sharply. “What was to become a severe recession for Americans was catastrophe for the citizens of these poorer countries in Africa and Latin America and Asia.”(415)

At the same time, the debt burdens of the LDCs expanded dangerously. The worldwide spike in interest rates had raised the cost of the debt, the hundreds of billions in outstanding loans previously borrowed from the banks of Europe and America. As interest rates rose, the LDCs found themselves surrounded by rising cost of interest payment. They could not even have short time to think of the payment of original loan. “Both government and businesses in the struggling nations were compelled to borrow more and more, simply to keep up the payment of interest on their old loans.” (415)

In a sense, the debt crisis had its origins in the Fed’s policy failure itself. In the late 70s and early 80s, the Fed and other US governmental regulators had failed to impose prudent limits on the money center banks and their competitive lending to the Third World. They had issued mild warnings occasionally, but they had not tried to prevent the risky lending. Then starting in 1979, Volcker launched his aggressive campaign to break inflation, rationing money tightly and imposing a stern discipline on the world currency market.

The Fed’s failures of regulation are now turning its direction to the US domestic financial market like returning boomerang. If some Latin American countries declare the default, this would result in huge amount of losses in commercial banks in the US. If this detrimental effect were not prevented from happening in advance, the whole US banking system and economic order would be collapsed.

The first challenge originated from Mexico. “The United States and Mexico were economically intertwined by trade, labor supply and finance. If Mexico declared default, it would influence most of American banks. At the early 1980s, Mexico owed $80 billion to the major American banks such as Citibank and Continental Illinois.”(485)

Paul Volcker and the Mexican finance minister agreed that Mexico should borrow money from the International Monetary Fund in the near future. However, the Fed’s chairman decided to lend huge short-term loans from the Fed reserves in order to prevent Mexico’s abrupt default declaration before the Mexican government went to the IMF. “The Fed, in addition to its other roles, was authorized to play lender of last resort to other nations. On April 30, it lent Mexico the $600 million, the first in a series of short term multimillion dollar loans called ‘currency swap.’”(485)

In theory at least, the debt crisis might have been avoided if the Fed had not chosen such an abrupt approach to decelerating price inflation. The LDCs were heavily dependent on credit. But the Fed had drastically raised the cost of their borrowing while simultaneously depressed their sales and incomes. “If the world economy had not been pushed down so far, if interest rates had not been forced so high, these debtor nations might have survived the contraction. As it was, they had no time to adjust and really no alternative but to keep borrowing more, just as weakened American corporations had to increase their borrowing to survive the recession.”(521)

In this respect, whether there were no alternative to the Fed’s aggressive anti-inflation policy seemed to be relevant. The Fed tightened money to curb the inflation. “The general public agreed that double-digit inflation must be curbed somehow, but if the question was examined carefully, it was not at all clear that a deep recession induced by the Fed’s monetary policy was the best way. The 1981 inflation, for instance, was driven by escalating prices in oil and agriculture. In this case, the price inflation might have been contained by temporal price controls and other aggressive government policies.”(394)

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2005/09/08 01:45 2005/09/08 01:45

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The History and the Role of the US Federal Reserve Board 3

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The cost and benefit analysis

The Fed imposed the most severe discipline on the US economy ever attempted in the history of the American central bank for thirty-three months. The Fed’s monetary policy had forced interest rates up to the highest levels over 20 percent. In effect, credit was rationed for two and a half years, and the scarce supply of credit was allocated by price. The high price of money effectively eliminated borrowers who were too small or underfinanced to afford the loans.

Despite various problems, however, this policy worked. “The GNP contracted in real terms by more than $82 billion from its peak, and since 1979 the country had accumulated as much as $600 billion in lost economic output. The excess supply of goods, the declining incomes, and the surplus labor had worked to force down their wages and commodity prices. Overall price inflation fell dramatically from above 13 percent to less than 4 percent by 1983.”(507)

Even though the Fed succeeded in its anti-inflation campaign, the cost was tremendously high. We can analyze this cost in its effects on the transformation of the US economy, the changes of consumption patterns, the regressive changes of income distribution.

First, the Fed’s tight money policy affect unevenly on various industrial sectors. As we already mentioned, those who borrowed huge amount of money to expand their lands and production facilities had to face dire circumstances in which their debt burdens increased substantially in a short notice. Those who borrowed money to buy house and car had to suffer from both their reduced incomes and increased interest payment at the same time. Some of farmers and small scale manufacturers went bankrupt losing everything. Some households had to lose their real estates, and suffer from credit (mortgage and loans interest) payment for a long time.

However, there was another manufacturing industry which gained the monopolist profit. Apart from financial investors, the military industry was a major winner under the Reagan-Volcker’s strategy. The production of armaments was an important special case among manufacturing sectors. “The defense companies and their allied support industries enjoyed two special advantages under Reagan administration. Firstly, the massive budget increases for defense sector expanded their market enormously. Secondly, arms manufacturers benefited from cheaper labor, as wages for skilled industrial workers were depressed generally by the slack employment.” (600-601)

Second, the Fed’s stabilization of money was also an underlying cause driving the frenzy of corporate take-over battles in the 1980s. “The Fed deplored the practice and even introduced regulations to curb the use of the junk bond used to finance many of the corporate buy outs. Nonetheless so long as monetary policy maintained such high real returns for financial investments and simultaneously depressed the return from real assets, smart investors would naturally seek ways to get their capital out of one and into the other.” (661)

Third, there is another issue related with household’s consumption patterns. In the age of inflation, it was wise decision for ordinary consumers to buy houses and cars with mortgage or credit whatever the interest rate might be. If the inflation continues, buying something today is a good deal because the credit interest rate will be undermined by high inflationary pressures. From this era on, the ordinary Americans’ consumption pattern would be a good source for boastful strong consumer power.

However, this pattern did not change even after their real incomes were reduced substantially because even under these circumstances people had to buy something to live. But the behind logic became different. While American consumers tried to buy today during the inflationary era because it was a good deal, this time they do the same thing because they could not accept the new reality of their reduced status. “By going deeper into debt, they kept spending and hoped that their prospects improved. Millions of families borrowed money to spend during and since Reagan administration. Personal debt accumulated rapidly.”(656)

From now on, previously praised strong American consumer powers now started to turn out to be a castle in the air. The US’s total outstanding debt – government and private – was $7.1 trillion at the end of 1984, nearly doubled since 1977. The alarming point was that domestic debt had increased by more than 25 percent in 1983 and 1984 alone. The outstanding debt had become more than 60 percent larger than GNP.

The Reagan and Volcker’s economic policies also revealed the changing pattern of the US consumer market structure and aggravating standards of living. First of all, since 1980s “the mass market became shrank and split apart. The auto industry, including the rising sales volume captured by foreign imports, never recovered the same market that it had enjoyed in the 1970s.”

Secondly, the retreat from home buying was more fundamental to the American standard of living. During the 1980s, a lot of young couples were priced out of the housing market by high mortgage interest rates or by reduced personal incomes that were too depressed to support a mortgage. For the first time in forty years, the percentage of American families that owned their own house actually decreased during the Reagan Presidency. “The rate of homeownership among Americans had increased steadily from 44 percent in 1940 to 66 percent by 1980. Starting in 1981, homeownership began to decline for the first time since World War II. By 1984, it was down to 64.5 percent. By 1986, it fell to 63.9 percent.” (654)

Finally, the Reaganomics had detrimental effects on income distributions. The 1981 tax legislation proved to be regressive in a more fundamental way. It became the pretext for a vast redistribution of incomes, flowing upward on the income ladder, through another powerful channel – interest rates. The largest benefits in reduced tax burden went to the wealthiest taxpayers, and the tax relief became proportionately smaller and smaller for families that were less well off.

According to the US Census, “only families on the top 20 percent of the economic ladder enjoyed real increases in their after-tax household incomes from 1980 to 1983. The others, the bottom 80 percent actually lost. The highest fifth, families earning $38,000 or more, gained an average of $1,480 per household in real income, and the top 5 percent, earning more than $60,000, gained an average of $3,320. Families in the middle lost about $560 and the working poor lost about $250.”(401)

Apart from these analyses, the author argues that the Fed strategy may have left larger consequences for the US economy as a whole. Once the boom was broken, “the economy never regained a normal vigor. After the second quarter of 1984, the path of expansion remained below the historic trend line for economic growth, even below the growth rate during the decade of the 1970s, which was universally considered disappointing. The economy did not go into recession. But it sputtered and started and disappointed normal expectation.” (647) From then on, the US economy has showed staggering economic growth patterns and has entered the new era which Paul Krugman once called “the age of diminished expectation.”

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