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Unformatted text preview: Social Policy and Politics: Lessons from Europe Fall 2017 LECTURE 13 Austerity or Stimulus? Global Financial Crisis Worldwide Began in 2007-2008 Considered by most experts to be the worst financial crisis since the Great Depression Failures of businesses and banks, bailouts by governments, stock market downturns, huge job loss Active phase began in August 2007 The US is out of recession now, but the economy is still recovering slowly and income growth is anemic. Global Financial Crisis Many causes suggested and given different credence by experts: High risk investments, especially the US housing market Failure of regulation By government, by the market, etc. Wall Street excesses Interest rate spreads The difference between what a financial institution charges for a loan and what they receive for it What is a sub-prime mortgage? Credit scores are used to predict how likely a particular individual is to repay a loan. Prime scores: 650 or so to 850. Best risks for banks. Sub-prime is HIGH RISK Why sub-prime mortgages? intense competition between mortgage lenders Numbers of good candidates for mortgages were limited, so they relaxed standards to make more money —gave out riskier mortgages Major US investment banks, as well as government entities like Fannie Mae and Freddie Mac, led the way In 2004 subprime mortgages peaked at 20% of market 2004-2007 were worst years for subprime mortgages Pressure to make it easier to buy a home began during Clinton administration Background to the crisis Housing crisis spread to other parts of the economy Government policy emphasized deregulation from 1970s on, resulting in less oversight Policymakers didn’t immediately see problem because there was less regulation, particularly of entities like hedge funds and investment banks Housing bubble: Between 1997 and 2006 price of homes increased 124% Resulted in many refinancing or taking out second mortgages By September 2008 housing prices had dropped over 20% Prices declined, so interest rates went up and homeowners had higher payments, which led to default Background to the crisis Deregulation: Shadow banking system (hedge funds and investment banks) became more important; financial regulation didn’t keep pace with this 1982 law signed by Reagan began deregulation process, contributing to savings-and-loan crises of mid- to late-80s, and created adjustable-rate mortgages 1999: Clinton signed law reducing separation between commercial and investment banks 2004: SEC relaxed net capital rule—investment banks could increase debt they were taking on; led to selfregulation by investment banks All of this contributed to less oversight by government agencies over investments being taken by private entities Background to the crisis US Financial Crisis Inquiry Commission reported findings in January 2011: "the crisis was avoidable and was caused by: widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; an explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels" The Crisis August 2007: BNP Paribas (French bank) blocked withdrawals from 3 hedge funds because they had no more liquidity This soon led to a panic as investors and savers tried to liquidate assets even in highly regarded financial institutions What does this mean? It’s a Wonderful Life https:// www.youtube.com/watch?v=iPkJH6BT7dM The Crisis 2008-09 IMF estimates large US and European banks lost more than $1 trillion in toxic assets/bad loans from Jan 2007-Sept 2009 US Banks that failed/were acquired/were taken over by the government: Bear Stearns – allowed to fail in March 2008. Lehman Brothers -- allowed to fail in September 2008. Merrill Lynch Fannie Mae/Freddie Mac Washington Mutual Citigroup Wachovia AIG The Crisis – financial impact TARP: signed into law 10/3/2008 Bailout of US financial system Authorized US Secretary of the Treasury to purchase up to $700 billion in distressed assets and supply cash to banks both foreign and domestic Mostly mortgages but also other types Provided judicial and legislative oversight $426 billion actually spent $441 billion recovered by sale of assets The Crisis in the “real” economy Nearly 1/3 of the US lending mechanism was frozen into June 2009—so fewer people could put money into the economy even if they could afford it Decline in wealth, decline in consumption, decline in business investment Between June 2007-November 2008, Americans lost a average of 25% of their collective net worth Housing prices dropped Consumer confidence fell The Crisis in the “real” economy Huge job loss=huge unemployment rate increase Hours worked per week declined to 33 (lowest since 1964) Decline in wealth for most Americans The Crisis Labor Force Participation rate http://www.financialsense.com/contributors/doug-short/july-new-jobs-beat-expectations The Crisis The Crisis What were the global effects? Euro crisis in EU Decline in economic growth across the world: Germany, Japan, Iceland, Mexico Developing countries seeing growth saw slowdowns Government Responses American Recovery and Reinvestment Act of 2009 Cost: approximately $831 billion through 2019 Keynesian rationale Tax incentives for individuals and businesses Healthcare: Medicaid, military hospitals, VHA, research Education: prevent layoffs/cutbacks, increase Pell Grants, Head Start, childcare services Aid to low income workers/unemployed: extended unemployment benefits, more food stamps, job training, WIC, free lunch, etc. Infrastructure investment Transportation: highway construction, bridges, high-speed rail, public transit, Amtrak, FAA upgrades Water, sewage, environment, public lands Energy infrastructure, renewable energy investment/research Housing, scientific research, many other items Government Responses Auto industry particularly helped Tax credits for new car purchases Semi-nationalization of Chrysler, GM GM = Government Motors Chrysler sold to Fiat Government Responses Reaction to the stimulus bill in America? Many economists said it did not go far enough to cover the spending gap Some wanted act to address consumer spending and unemployment more directly Some economists felt it was too much government intervention and plan should focus on reducing impediments to work, saving, investment, production, lower tax rates Many more approved entirely Impact? CBO estimated in 2014 that ARRA saved or created 1.6 million jobs/year 2009-12. Other estimates differ Crisis in Europe European financial crisis caused by several factors: Same high-risk lending and borrowing practices as US Massive home building sprees in Spain and Ireland Investments in the US market Financial crisis of 2007-2008 that spread globally This led to the so-called Great Recession Greek debt crisis Who remembers what caused this? Crisis in Europe Timeline of eurozone crisis: Early 2010: Greek underreporting is exposed Greek government introduces austerity April 2010: EMU leaders agree on bailout for Greece, Greek bonds downgraded to junk bond status September 2010: EU and IMF approve second bailout November 2010: Ireland bailout April 2011: Portugal bailout 2011: problems appear in Italy, Spain; global fears grow Dec 2011: ECB infuses credit into European banking system May 2013: interest rate cuts in ECB January 2015 ECB announces QE program of $60 billion/month Crisis in Europe What is the current state of the European economy? Technically eurozone is out of recession (economy is growing) as of early 2013 However, struggling to gain momentum due to weak domestic demand, more challenging environment for exporters Euro continues to appreciate (at a 2-year high against the dollar in early November) Economists call for ECB to continue cutting interest rates Emerging from crisis but not over yet—there is less talk of nations like Greece leaving the euro EU and euro area unemployment US dollars/ 1 euro 1.5:1 2017: 1:1 Responses to the Crisis How did different European governments respond to the crisis? Germany Today, Germany has completely bounced back Revitalized export industries Record-low unemployment (3.9% March 2017) Some say it’s because of fiscal responsibility and past austerity Others say it’s due to adjustments in business and labor relations which encouraged employment, plus Germany’s place in the monetary union that allowed it to boost exports Others say it’s their hefty stimulus package Germany Germany’s bailout 50 billion euros, approved Jan 2009—1.6% of GDP Wage subsidy to keep certain workers employed Infrastructure investment Tax cuts child bonus of 100 euros Increase in certain social benefits Trade-in program for old cars Focused on increasing competitiveness Combined with long-term austerity plan Crisis Countries Portugal, Ireland, Italy, Greece, Spain What is austerity? Policy used by governments to reduce budget deficits during economic hard times Caused drastic cuts in social spending Examples: less vacation time, wage cuts for public servants, pension cuts, healthcare, etc. Eurozone has required these countries to reduce the debt: GDP ratio or face consequences/not receive bailouts Reactions to Austerity Austerity vs. Stimulus? What is the pro-austerity argument? Why Austerity? It all goes back to one paper: Reinhart & Rogoff This paper showed that once government debt exceeds 90% of GDP, the consequences for the economy are disastrous Thus, in a bad economic time, you must cut spending Goes contrary to the prevailing wisdom of John Maynard Keynes Other evidence has also been provided in academic papers—decrease in government Why Austerity? Northern Europe has done well with austerity Example: Latvia, which acted sooner than other countries and saw an economic recovery You need to restore confidence in consumers and investors—stimulus, which increases debt, is hard-pressed to do this It’s easier to cut spending than raise revenue in a crisis Also, it drives reforms by forcing cuts Piling on more debt now limits growth later Austerity vs. Stimulus? Following anti-austerity slides from lecture by Mark Blyth from a guest lecture in 2014 Mark Blyth on Austerity http://www.youtube.com/watch?v=FmsjGys-V qA So why did Anyone ever think that Austerity was a good idea? The “can’t live with it, can’t live without it, don’t want to pay for it” problem of the state John Locke’s fifth chapter Markets as inequality generators States as Magistrates Don’t trust the state since it will rob you blind But you need it to create the markets you want “The Practice of Funding has gradually enfeebled every state that has adopted it” Adam Smith Parsimony, Savings, Investment and Growth Inequality and the Necessity of the State Taxation to the Rescue? Result: Debt perverts parsimony The Result: The “can’t live with/without it and don’t want to pay for it” problem Liberalism’s Neuralgia and the Aspirin of Austerity Keynes (and events) Overturn Austerity Fallacies of composition and non-scalability in labor and money markets Investment expectations as a social multi-person PD “Consumption, repeat the obvious, is the sole end of economic activity” Lessons Learned: Democracy is asset insurance for the Rich Redistribution and Debt is reinsurance for Democracy Other notes on austerity Reinhart and Rogoff paper discredited in 2013 over minor error in calculations which invalidated the entire conclusion Does this invalidate austerity? What have we learned from Europe? A concluding chapter to the course America is #1 in some things Military power (we spend more than next 20 countries combined) Economic power (largest economy of any single country and nearly largest GDP per capita) Cultural influence (Hollywood, English language –though not ours originally!) Integrating immigrants Innovation Patents Silicone Valley / internet Nobel Prizes Medical advances / pharmaceuticals Universities But America is not #1 in terms of other things Social Welfare Poverty/inequality Social insurance (unemployment/ disability) Retirement Health Care High costs Uninsured Infant Mortality / life expectancy Education Best Universities in the world, but… High Drop out rates Mediocre on Comparative Tests (PISA test) Ridiculously expensive university tuition Environmental Protection We’ve got some problems High unemployment Huge government debt 50 million lack health insurance & health takes up 17% of economy Many failing schools / weak in international comparisons High poverty rates In NJ, “1 in 3 children in 2010 lived in a home that could not meet their basic needs without assistance” & 368,173 children on food stamps. ( http://www.nj.com/news/index.ssf/2012/04/newest_kids_count_report_finds.html ) High violent crime and incarceration rates Can we learn lessons from others? Possibly from Europe? And we don’t trust the government to fix them Trust in Government and Satisfaction with government in the US, Pew Research And Americans may have a bad opinion of our politicians… …but Europeans distrust and dislike their politicians too! And they distrust national parliaments Why look abroad? It is always right for one who dwells in a well-ordered state to go forth on a voyage of enquiry by land and sea so as to confirm thereby such of his native laws as are rightly enacted and to amend any that are deficient. Plato, Laws The greatness of the Americans does not simply consist in their being more enlightened than other nations, but in their being able to repair their faults. Alexis de Tocqueville, Democracy in America Those who only know one country, know no country. Seymour Martin Lipset Where to look for lessons? China? OECD countries Why Study Europe? To understand Europe for its own sake… Biggest economic bloc in the world Largest group of democracies Our strongest allies To understand American politics and policy better by learning from other democracies… How do other democracies work? How have European countries dealt with challenges similar to those we face? Health Care Social Policies Environmental Policy Education Pensions etc… To counter misconceptions / myths about Europe in American public debates Excerpt from Hill, Europe’s Promise, p.30 Are we over-taxed? 2011 Are we over-taxed? Taxes in US have fallen dramatically over past 30 years 1978 top fed tax rates: 70% individuals, 48% corporate; 40% capital gains 2011: 35% individuals, 35% corporate and 15% capital gains Is it any wonder the federal budget deficit is skyrocketing? Taxes that are too high (coupled with poor gov’t services) can stunt growth, but some of the most prosperous governments in the world have some of the highest taxes (e.g. Denmark, Sweden, Belgium, Netherlands and Norway) Taxes Tea Party VS. Occupy Wall Street http://www.nytimes.com/2 012/04/17/business/for-e conomists-saez-and-piket ty-the-buffett-rule-is-j ust-a-start.html?_r=1&pa gewanted=all For Two Economists, the Buffett Rule Is Just a Start by Annie Lowery “The United States is getting accustomed to a completely crazy level of inequality,” Mr. Piketty said, with a degree of wonder. “People say that reducing inequality is radical. I think that tolerating the level of inequality the United States tolerates is radical.” “In a way, the United States is becoming like Old Europe, which is very strange in historical perspective,” Mr. Piketty said. “The United States used to be very egalitarian, not just in spirit but in actuality. Inequality of wealth and income used to be much larger in France. And very high taxes on http://www.nytimes.com/2012/04/ the very rich — that was invented in the United States,” he 17/business/for-economists-saez -and-piketty-the-buffett-rule-i said. s-just-a-start.html?_r=1&pagewa nted=all Europeans pay more taxes, but some of them get more US households pay ~ 31% of health costs out of pocket ($2,306/year) Americans spend 3x as much private money as Europeans for old age care. In Europe, you don’t need to save for your child’s college tuition. Universities are publicly funded (i.e. by tax revenues) ‘Overtaxed’ French and Germans have far higher savings rate than Americans (12-14 % vs. 0% in America prior to recession) & Americans have far higher credit card debt, college debt and borrow against houses. So are they being taxed to death? Or spending too much? What can we learn from Europe You get what you pay for… • …and you need to pay for what you get, or you end up in huge DEBT! • IS US acting more like Greece or Netherlands? Regulation: Too hot, too cold and just right? Regulation: Too hot “It was [in 2011] that Greek wannabe businessman Fotis I. Antonopoulos, a successful Web program designer here, decided he wanted to open an e-business selling olive products. Luckily, he already had a day job. It took him 10 months — crisscrossing the city to collect dozens of forms and stamps of approval, including proof that he was up to date on his pension contributions — before he could get started. But even that was not enough. In perhaps the strangest twist of all, his board members were required by the Health Department to submit lung X-rays — and stool samples — since this was a food company.” http://www.nytimes.com/2012/03/19/wo rld/europe/in-greece-business-rulescan-puzzle-entrepreneurs.html?pagewa nted=all Too Cold World Bank – Worldwide Governance Indicators What can we learn from Europe? There is no such thing as a completely ‘free market’ All actual markets exist within a legal framework that is ultimately backed by government Regulation can strangle markets (like in Greece), but lack of regulation can lead to catastrophe (like on Wall Street). When people say they want a market deregulated, ask yourself ‘cui bono’? (in whose interest?) What can we learn from Europe? Government is not “the problem” Bad government or too much government is a problem But absence of government is a problem too In many economically successful European countries, government spending as a % of GDP is far higher than in the US and taxes are far higher In the US, absence/weakness of government has contributed to major crises What can we learn from Europe? Viewing Europe’s problems may highlight our strengths (or warn us of problems that we may face in the future) Our advantage in integrating immigrants Our more youthful population What can we learn from Europe? US will never be Sweden! Many things that work in Europe can’t simply be imported to the US A slight increase in taxes on wealthy or in regulation of financial markets does not equal a ‘slide into socialism’ What can we learn from Europe? Never believe your own propaganda. Studying European experiences forces us to question our own assumptions Maybe we are the ‘greatest country on earth’ but we should be able to demonstrate that through clear-headed analysis, we shouldn’t just assert it. What I hope you’ve learned… If you forget everything else, remember to compare. When facing a public policy challenge, ask: How do other countries deal with that? Which countries are most successful? Which countries are the biggest failures? Why? What, if anything, can we learn from their experiences? ...
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