Paul Krugman

Welcome to the Hotel (Euro) — You Can Vote “Oxi” Anytime you Like but you Can Never Leave

The recent events in Greece and their ramifications for the European project have been the subject of a good many blogs and news articles lately.  From an economic perspective the most noteworthy are those by Paul Krugman, Brad DeLong, Dean Baker, Yanis Varoufakis who was on the ground as Greece’s Finance Minister, and Joseph Stiglitz, among others.

If one were to read the news in the manner of the U.S. press through its sources of record: The New York Times, Wall Street Journal, Washington Post, not to mention the major news networks with CNN thrown in (avoiding avowedly polemical sources like Fox, MSNBC, and the Huffington Post), one would think that the Greek issue is one caused by a profligate country that borrowed a bit too much and allowed Greeks to live over their heads.  Nothing could be further from the truth.

The bottom line is that Greece and the EU decided to bail out the banks and investors who crossed the line in investing in junk paper by using public funds.  Sound familiar?  Think a Eurozone TARP.  But in the case of the EU the banks and bad paper investment houses–the inmates in this scenario–run the asylum.  With the constant drumbeat from our own oligarchs we have become as a people brainwashed to think that investors and creditors have a right to their money.  Our own more draconian bankruptcy laws imposed by the last financial industry-tainted Congress institutionalized many of these attitudes in law.  But this has not always not been the case and is not part of our legal or economic traditions.  It is certainly not anything like what Adam Smith had in mind.

The operational term in this case is “moral hazard.”  The rhetoric of the moneyed interests and their armies of lawyers have deftly tried to invert the meaning of the concept, but as Steve Waldman clearly explains in his excellent interfluidity blog, “moral hazard” is a concept that overwhelmingly falls on investors and creditors.  It means, quite simply, that you as an investor are responsible for where you put your money at risk–and that risk includes it being completely lost.  There are no guarantees.  This was the original rationale of Glass-Steagall: it was accepted that regular working people don’t have the information, time or resources to place their funds, which are meant for savings, under moral hazard.  Same goes for things like the Social Security Trust Fund.  Play with your own “play” money if you have it, but guaranteed deposits and retirement pensions are off-limits since they are backed by the sovereign currency.  Seed corn is not open to being manipulated by cheap paper–that is, until Glass-Steagall was repealed.

The European condition is a bit more complicated only because the EU has never had a consistent separation between its financial elites and civic institutions, given the differences in national traditions and political systems.  But one should be able to clearly see the connection between what is happening in Europe within the EU and in other places around the world: the attack on democratic legitimacy by oligarchs and economic elites.

As Joe Stiglitz points out in the post cited above, Greece–emerging from years of autocratic rule and third world-like conditions–was doing quite well economically until the financial bubble burst across the developed western world.  Many of the banks that invested in hyper-inflated Greek real estate and other development projects were situated in other countries.  The EU under the Euro project is a currency union, and under the Maastricht Treaty that formed this union there were some economic harmonization rules required, mostly pushed by Germany and France, but there is no lender of last resort, no central banking authority equivalent to our Federal Reserve, no centralized budget authority, nor political or cultural ties that would keep old ethnic or nationalist conflicts from flaring up in a crisis.  As Waldman explains, what these other countries did–in particular Germany–was to bail out the banks and investment houses making the debt on these bad investments public obligations.  This sleight of hand politicized what should otherwise should have simply been written off bad investments.  If the Germans wanted to have their own TARP they should have done so.  But it was so much easier to push the consequences onto the Greeks given their weaker position in the EU.

Jared Bernstein in his Washington Post article following the Greek “no” vote quoted an unnamed German economist asserting: “How do you think the people of Manhattan would like bailing out Texas?”  As Krugman rejoined upon reading the article, Manhattan (and other areas of the country) do that all the time as a matter of course.  It was done during the Savings & Loan crisis that was largely a Texas affair back in the late 1980s.  Anyone who looks at the net benefits of federal tax payments and expenditures by state can see that the southeastern states–in particular those that made up the old Confederacy, including Texas, get more in federal benefits than they pay in.  To Americans this is not a big deal–and my use of the term American to identify my countrymen is at the heart of the question.  I don’t know anyone who in reality is a Floridian.  Only buffoons and idiots identify themselves as Texans over their identity as Americans.

Here we tend to put resources where they are needed, hence the United States of America.  More than two hundred years involving waves of immigrants, over one hundred and fifty years of increasing population mobility, and two major world wars and a cold one–two of these existential in nature–during the 20th century, not to mention 9-11, has militated against the old regionalism.  It is not surprising that the assertion that displays such deep ignorance of our own system and society would come from a German economist.  I mean this as no mean insult.

When I was on active duty as a young U.S. Naval officer I met a Scottish couple in Spain who worked at the U.K. embassy there.  They were amazed by my nonchalance in moving my family from California to a home base in Virginia as part of my assignment.  “Do you now identify yourself as a Virginian?” they asked.  When I explained that–no–it was all part of the U.S., they explained that they would always identify themselves as Scots, and that within Scotland that people associated themselves with a particular village or region.  This was almost 30 years ago, and I am told that such attitudes are changing, but it does point to a weakness in the “European” project, especially given that in the most recent U.K. parliamentary elections that the Scottish nationalist party was overwhelming elected to the House of Commons.

Given my own expertise in history and political science, my concern is directed more to the consequences of Greece capitulating to the EU’s economically and politically disastrous demands.  Just ten days ago 60% of the Greek people voted against the conditions imposed by the EU, yet their parliament just approved a package that is punitive by any reasonable and objective measure.  Even the IMF has belatedly–and in a largely dishonest manner which I can only explain as some type of EU face-saving approach–clearly stated that the conditions imposed are unsustainable.

The role of Germany is certainly one of the main issues in this condition.  Given the way they handled the bad paper of their bankers, Merkel and her party have backed themselves into a corner.  So they have done what all desperate politicians do–they have demonized the Greeks.  This is all for mercenary purposes, of course, and without consideration for the long term consequences for both the Greek people and the EU.  What they have done is show the contradictory fault lines in the entire “European” project.  German Finance Minister Schaubel, by attempting to co-opt the Greek threat of a Euro exit by making such terms seem disastrous, has inadvertently made such an exit virtually inevitable.  Greece, not wanting to be left out of “Europe” has just voted against its own best interests, its government never really having a strategy for a “Grexit” because they assumed that their negotiating partners were both rational and well-meaning.  The government very well may fall as a result.

For what the Greek crisis has shown is that the European project under the Euro is neither a completely democratic one nor is it “European.”  The elites in Brussels certainly felt that they had no obligation to consider the Greek referendum on the bailout terms.  To them only the banks, the oligarchs, and the political survival of the political parties in the main assemblies of the nations that support them matter.  The “democratic deficit” of the EU, in the words of the late historian Tony Judt, and the damage that it can cause, is now on full display.  It is not yet clear what will happen, given the contradictory impulses of countries wanting to stay within the single market that “Europe” afford them, the cultural and psychological association to be part of the project, and the punishing loss of national autonomy and democratic legitimacy as the price that must be paid. (Aside from the economic depression and poverty conditions imposed by the EU as the Greeks follow the conditions imposed on them).

One final note:  I can’t help but be impressed by the ideological arguments being used as a matter of course for “helping” the Greek people in the long run.  As John Maynard Keynes noted, in the long run we are all dead.  The tremendous amount of suffering imposed by the EU on the Greek people for their own long-term good sounds much like the fabrications of the old Communists of the former Eastern Block countries who inflicted all sorts of horrors on their own populations for the “long term” good of reaching the perfect socialist state.  Now such arguments are deployed in favor of the perfect capitalist state.  It is “reform” turned on its head, like “moral hazard.”

 

 

 

 

Family Affair — Part I — Managerial Economics of Projects, Microeconomic Foundations, and Macro

A little more than a week ago I had an interesting conversation on a number of topics with colleagues in attending the National Defense Industrial Association Integrated Program Management Division (NDIA IPMD).  A continuation of one of those discussions ended up in the comments section of my post “Mo’Better Risk–Tournaments and Games of Failure Part II” by Mark Phillips.  I think it is worthwhile to read Mark’s comments because within them lie the crux of the discussion that is going on not only in our own community, but in the country as a whole, particularly in the economics profession, that will eventually influence and become public policy.*

The intent of my posts on tournaments and games of failure consisted of outlining a unique market variation (tournaments) and the high cost of failure (and entry), that results from this type of distortion.  I don’t want to misinterpret his remarks but he seems to agree with me on the critique but can’t think of an alternative, emphasizing that competitive markets seem to be the best system that we have come up with.  About this same time a good friend and colleague of mine spent much energy bemoaning the $17 trillion debt in light of the relatively small amounts of money that we seek to save in managing projects.  Both contentions fail on common logical fallacies, but I don’t want to end the conversation there, because I understand that they are speaking in shorthand in lieu of a formal syllogism.  Their remarks are worthy of further thought and elaboration, especially since they are held by a good many people who come from scientific, mathematical, engineering, and technical backgrounds.

I will take the last one first, which concerns macroeconomics, because you can’t understand micro without knowing and understanding the environment in which you operate.  Much of this understanding is mixed in with ideology, propaganda, and wishful thinking.  Bill Gross at Pimco is just the latest example of someone who decided to listen to the polemicists at CNBC and elsewhere–and put his investors’ money where his mouth was.  You have to admit this about the lords of finance–what they lack in knowledge they make up for in bluster, especially when handing out bad advice.

Along these lines, a lot of energy gets expended about federal debt.  There have been cases–which are unique and well studied where countries can hold too much debt, especially if their economic fundamentals show significant weakness, but a little common sense places things in perspective.  Of the $17 trillion in debt, a little over $12 trillion is held by the public in the form of bonds and $5+ trillion held by other government agencies, particularly the trust funds for things like Social Security.  The bonds are exactly the same: assets for an investment portfolio and assets for any other institution that holds them.  U.S. treasury bills are very safe investments and so are traded worldwide, even by other countries.  Some of this is often spun as a negative but given that the U.S. dollar and U.S. securities are deemed safe, it turns out that–short of us doing something stupid like defaulting on our obligations–the U.S. is a stabilizing force in the world economy.

So $12 trillion in debt held by the public is about 74% of Gross Domestic Product, that is, the value of goods produced in the United States in any given year.  This is about the same level that the debt stood relative to GDP around 1950.  In 2007 it stood at about 37% of GDP but we had this thing called the Great Recession (though for those of us who run a business we couldn’t quite tell the difference between it and a depression).  Regardless, the country didn’t go bankrupt in 1950 (or in the 1940s when the pubicly-held debt to GDP ratio was over 100%).  Great Britain didn’t go bankrupt during its period of hegemony with debt to GDP ratios much higher.  When making the comparison of government finances to households, folks like those at the Peterson-funded and Washington Post Fix the Debt crowd speak like Victorian moralists about how no responsible household would have garnered such debt.  Well, household debt in 2014 stands at $11.63 trillion.  Average credit card debt is about $15K and average mortgage debt is $153,500.  Then there are other types of debt, such as student loans, on top of that which averages about $35K per household.  Given that median U.S. household income is a little over $51K, the debt to income ratio of households is 400% of annual income.  Given that comparison our national finances are anything but profligate.** One could make a very good case that we are underinvesting in capital improvements that would contribute to greater economic growth and opportunity down the line.

But there is a good reason for the spike in national debt that we saw beginning in 2008.  In case you missed it, the housing bubble burst in 2007.  This caused an entire unregulated field of securities to become virtually worthless overnight.  The banking and insurance assets that backed them lost a great deal of value, homeowners lost equity in their homes, investors lost value in their funds, the construction industry and its dependencies then tanked since part of a large part of the bubble consisted not only of overvalued real property but extremely high vacancy rates brought on by overbuilding, bank lending seized up, businesses found themselves without liquidity, seeing the carnage around them people who had jobs tightened their belts and the savings rate spiked, and those who lost jobs tapped into savings and retirement funds, which lost a large part of their values.  The total effect was that the economy took a nose dive.  In all about $8 trillion of wealth was wiped out almost overnight.  Yes, those Wall Street, banking, and real estate self-proclaimed geniuses reading their Drucker, Mankiw, and Chicago School books (when not leafing The Fountainhead for leisure) managed to use other peoples’ money and–not only lose a good part of it but managed to sink the world economy.  Millions of people were thrown out of work and businesses–many of which were household names–closed for good.  People not only lost their jobs but also their homes, through no direct fault or negligence of their own.  Most of those who found new jobs were forced to work for much less money.  Though the value of their homes (the asset) fell significantly, the obligations for that asset under their mortgages remained unchanged.  So much for shared moral hazard in real estate finance.

Economic stabilizers that have been in place for quite some time (unemployment insurance, Food stamps, etc.) came into play at the same time that collections from taxes fell precipitously, since fewer people were making money.  The combination of the social insurance stabilizers and President Obama’s combination of new spending and tax cuts to provide a jolt of temporary stimulus–despite polemicists to the contrary–was just enough to stop the fall but was not enough to quickly reverse it.  Even with the additional spending, the ratio of debt to GDP would not have been so marked if the economy had not lost so much value.  But that is the point of stabilizers and stimulus.  At that point it just doesn’t matter as long as what you do stops the death spiral.

A lot of energy then gets expended at this point about private vs. public expenditures, who received or deserved a bailout, etc.  Rick Santelli–also one of the geniuses at CNBC who has been consistently wrong about just about everything–had his famous rant about bailing out “losers” (after the bankers and investors got their money) without blushing.  This is because, I think, that people–even those well educated–have been convinced that political economy is a “soft” science where preferences are akin to belief systems along the lines of astrology, numerology, and other forms of magical thinking.  You pick your side; like skins vs. shirts.

This kind of thinking cannot be more wrong.  It is wrong not only because our scientific methods have come along pretty far, but also because the “ideological” thinking that has been sold in regard to political economy undermines the ability of citizens in a democratic republic to understand their role in it.  “A nation is great, and can only be as great, as its rank and file,” said historian and later president, Woodrow Wilson.  This proposition is as true today as it was a hundred years ago.  More urgently, it is wrong because after the world’s experience with disastrous semi-religious ideologies and cults of personality in the 20th century capped off by Radical Islam at the start of our own century, the last thing we need is more bigotry and stupidity that demands sacrifice and revolution, harming millions in the process, in the name of some far off, Utopian future or to regain some non-existent idealized past.

On the everyday level, it is important to end the magical thinking in this area because that is the only way for those of us who are not the masters of the universe–with a billion or so in the bank with politicians and media clowns willing to backstop our bad decisions–can survive.

Fallacy Number One: our economic structure is based on “private enterprise” with public action an imposition on that system

I begin refuting this fallacy with this image:

U.S. dollar

Notice that our currency is issued by a central bank.  This central bank is the Federal Reserve.  George Washington, our first President, is on the $1 bill.  Other dead presidents are on our other denominations.  On the front of the dollar bill it clearly states “The United States of America.”  That is because U.S. currency and the economy on which it is built is a construction of the U.S. government.  The rules that govern market behavior are established within guidelines prescribed by the government of the United States or the various states.  The People of the United States, as in “We the People of the United States…” that begins the Preamble to the Constitution, establish the currency and good faith and credit of the country.  J.P. Morgan Chase, Bill Gates, the Koch brothers, Bitcoin, and every other participant in the economy are subject to the will of the sovereign–in this case the People of the United States–that establishes this currency.

This is important to know when talking about such things like the debt.  For example, once the economy is back to growing at trend, should we still consider the debt level too high, we can marginally raise taxes to balance the budget and even pay down the debt like we were doing just 13 years ago.  It is also important because it allows us to use our critical thinking skills even though we may not be professional economists when faced by specious claims, like that of the debunked study by econmists Reinhart and Rogoff that purportedly showed a link to economic stagnation when countries exceeded 90% debt to GDP ratio.  For example, since the Federal Reserve is the central bank, should we find that there is a magic point at which we are concerned about debt as a percent of GDP, the Fed can buy its own bonds back at low prices that it previous sold at higher prices, thereby reducing the debt to GDP ratio simply by swapping paper.  Of course this would be ridiculous.  The important metric is understanding if we can make the annual payments and the percent of interest against GDP.

Understanding this essential nature of the economy in which we operate, combined with our critical thinking skills, can also inform us regarding why the Fed bought securities to provide cash to the economy–what is known as quantitative easing (QE).  Paul Krugman, the Nobel economist and New York Times columnist, has also posted some useful slides here.  This was done in several stages by the Federal Reserve because the economy was in what is called a liquidity trap with short term interest rates near zero.  Thus, there were not enough liquid assets (cash), to keep businesses and banking going.  The housing market and other businesses dependent on liquidity and low interest rates were also deeply depressed.  In project management, start-up costs must oftentimes be financed.  Businesses don’t have a vault of money sitting around just in case they get that big contract.  The bank of last resort–the Fed–used its authority to buy up existing bonds to prime the pump.  Rather than some unheard of government intervention in the “private” economy, the Fed did its job.

As to political economy, Thomas Paine, the publicist of the American Revolution, put it best in Agrarian Justice, and the common sense that he expressed over two hundred years ago is still true today:  “Personal property is the effect of society; and it is as impossible for an individual to acquire personal property without the aid of society, as it is for him to make land originally…Separate an individual from society, and give him an island or a continent to possess, and he cannot acquire personal property. He cannot be rich.”  Private property in the definition of Paine and Adam Smith, who was a contemporary, is defined as real property or the means of production, not private possessions.  We are long past the agrarian economies observed by Paine and Smith, where wealth was defined by land holdings.  But Smith did observe in one mention in The Wealth of Nations that the systems he observed–those markets that existed in his day–acted as if controlled by an “invisible hand.”  Much cult-like malarkey has been made of this line but what he was describing is what we now know of as systems theory or systems engineering.

Given this understanding, one can then make two essential observations.

First, that our problems where bogeyman numbers are used ($17 trillion!) aren’t so scary when one considers that we are a very large and very rich country.  We can handle this without going off the rails.  Is there a point where annual deficits are “bad” from a systems perspective?  Yes, and we can measure these effects and establish models to inform our decision making.  Wow–this sounds a lot like project management but on a national scale, with lawyers, lobbyists, and politicians involved to muck things up and muddy the waters.

The other observation is that we can also see how government policy was responsible for the manner in which it exposed its manufacturing workers to foreign competition, undercutting the power of domestic unions, not some natural order dictated by “globalization.”  It demonstrates how the shrinking of the middle class since 1980 was also the result of government action, and how the slow recovery, with its lack of emphasis on either job creation or wage protection, was also the result of government action.

Those who throw up their hands and say that there is nothing to be done because the rich always find a way to avoid responsibility and accountability not only are wrong from an historical and legal perspective, they also commit the sin of an act of omission, which is unforgivable.  That is, when you let something bad happen due to cynicism, indecisiveness, or apathy.

This then leads us to Fallacy Number Two:  Capitalism Is Necessarily Complimentary to Competition and Democracy

Mark Phillips’ on-line comment paraphrased Churchill’s observation that our system is one that, while imperfect, is the best we’ve found.  But Churchill was not speaking of free market fundamentalism or our current version of capitalism.  The actual quote is: “Democracy is the worst form of government, except for all those other forms that have been tried from time to time.”  (Churchill, House of Commons, November 11, 1947).  It is hard to believe today that the conflict in Western thought before the Second World War, and the topic on which Churchill was reflecting, was not between Democracy and Totalitarianism and its ilk.  For most Europeans, as documented extensively in Tony Judt’s magisterial work Postwar: A History of Europe Since 1945 (2005), the choice was seen as being between Fascism and Communism, liberal democracy being viewed as largely ineffective.

Furthermore, the democracy to which Churchill was referring in both the United States and the United Kingdom at the time, was much more closely organized around social democracy, where the economic system is subject to the goals of democratic principles.  This was apart from the differences in the types of democracy each was organized:  the U.S. on a constitutional, representative bicameral legislature, and presidential system of checks and balances; and the U.K. on a parliamentary, constitutional monarchy.  The challenge in 1947 was rebuilding the Western European countries, and those on the Asian periphery, to be self-sustaining and independent based on democratic principles and republican virtues as a counter to Soviet (and later Chinese) domination.  The discussion–and choice–had thus shifted from systems that assumed that people were largely economic actors where the economic system dictated the terms of the political system, to one that where a political system based on natural rights and self-government dictated the terms of the economic system.

Mark comments that competition is the best system that we have found in terms of economics, and I don’t necessary disagree.  But my level of agreement or disagreement depends on how we define competition and where we find it, whether it approximates what we call capitalism, and how that squares against democratic processes and republican institutions.

For example, the statement as it is usually posited also assumes that the “market picks winners” in some sort of natural selection.  Aside from committing the logical fallacy of the appeal to nature, it is also a misunderstanding of the nature of markets, how they work, and what they do.  As a government contract negotiator, contracting officer, and specialist for a good part of my career, understanding markets is the basis of acquisition strategy.

Markets set prices and, sometimes, they can also reflect consumer preferences.  In cases where competition works effectively, prices are driven to a level that promotes efficiency and the drive for newer products that, consequently, produce lower prices or greater value to the consumer.  Thus, competition, where it exists, provides the greatest value to the greatest number of people.  But we know this is not always the case in practice.  Also, just to be clear, what markets do not do is naturally elect someone, reward merit, define “makers” or “takers,” nor select the best ideas or the most valid ones.  It often doesn’t even select the best product among a field of competitors.  Markets focus on price and value, and they don’t even do that perfectly.

The reason for this is because there are no perfect markets.  Under classical economics it is assumed that the consumer has all of the information he or she needs in order to make a rational decision and that no supplier or buyer can dictate the terms of the market.  But no one has complete information.  Most often they don’t even have sufficient information to make a completely rational selection.  This was von Hayek’s insight in his argument against central planning before we discovered its tangible evils under both Soviet and Chinese communism.  This same insight speaks against monopoly and domination of a market by private entities.  This is called information economics.

Given that there is no such thing as a perfectly competitive market (since we do not live in a universe that allows for perfection), information economics has documented that the relationship among the independent players in a market is asymmetrical.  Some people have more information than others and will try to deny that information to others.  Technology is changing the fundamentals of information economics.

Compounding reality is that there are also different levels of competition that define the various markets, depending on vertical, product, industry, niche, etc. in the United States.  Some approximate competitive environments, some are monopolistic and others oligopolistic.  There can also be monopolistic competition among a few large firms.  Markets where competition is deemed destructive to the public interest (predatory competition) or is a result of a limited market for public goods (monopsony) are usually highly regulated.  How these markets develop is documented in systems theory.  For example, many markets start out competitive but a single market actor or limited set of actors are able to drive out competitors and then use their market power to dictate terms.  Since we operate in a political economy, rent-seeking behavior (seeking government protection through patent, intellectual property, copyright, and other monopolies as well as subsidies) is common and is probably one of the most corrupting influences in our political system today.

Thus, there is a natural conflict between our democratic principles and an economic system, which is established by the political system, that is based on economic rewards meted out in a hierarchical structure based on imperfect markets and rent-seeking.  This is why capitalism can morph itself and coexist in Leninist China and Autocratic Russia.  Given this natural conflict our institutions have passed laws that modify and regulate markets to make them behave in a manner that serves the public and ensures the positive benefits of competitive markets.  They have also passed laws that play into rent-seeking behavior and encourage wealth concentration.

A good example of both types of law and the conflict outlined above is the U.S. health care system and the Affordable Care Act (that I’ve previously written about), also known as Obamacare.  There are several aspects of the new law, and sections of the omnibus bill that passed under its rubric read almost as if they were separate laws with conflicting goals.

For example, the ACA, under which it is also known, established the healthcare exchanges on which plans could be purchased from private insurance providers.  This aspect of the law set up a competitive marketplace with information about each plan clearly provided to the consumer.  In addition, the ACA passed what had previously been known as the Patient’s Bill of Rights, which established minimal levels of service and outlawed some previously predatory and unethical practices.  This structure is the real world analogue of a competitive market that is regulated to outlaw abusive practices.

At the same time other portions of the bill prohibited the federal government from using its purchasing power to get the best price for prescription drugs, and also prohibited competition from Canadian drugs.  This is the analogue of rent-seeking.  When combined with laws that establish drug patent monopolies which allow companies to keep prices 300 to 400 percent above marginal cost, it is no wonder why per capita expenditures on healthcare are almost twice any other developed nation, though the cost seems to be coming down as a result of the competitive market reforms from the healthcare exchanges.

Revisiting our discussion earlier on debt, were our healthcare expenditures in line with other developed countries, we would be seeing budget surpluses well into the future.  The main driver of deficits is largely centered in Medicare.  Aside from cost cutting, other methods would be to expand, instead of shrinking, the pool of middle class workers which make up the broadest and largest source of revenue, with wages and salaries at least keeping pace with productivity gains.

In sum, competition is a useful tool and delegation of economic decisions is largely in line with our republican virtues.  But, I think, it is clear that there are hideous market distortions and imperfections that, in the end, undermine competition.  Many of these distortions and imperfections come about from competitive markets, which are then undermined once a market entity has gained control or undue influence.  Systems theory inform us about how markets behave and how we can regulate them to maximize the benefits of competition.

But the obscene fortunes that are held by a very small percentage of individuals–and the power that attends to them–represents in very real terms a danger to the institutions that we value.  So whether we can think of a better system is not the issue, taking incremental steps to reestablish republican virtues and democratic values is imperative.

Fallacy Number Three:  Microfoundations Determine Macro

Given the multiplicity of markets–and the mathematics and modeling that attend systems theory–it is clear that aggregation of microeconomic dynamics will not explain macroeconomic behavior–at least not as it is presently understood and accepted by the academic field.  Economics is a field that need not be “soft,” but which failed miserably to anticipate the housing bubble and resulting bursting of that bubble, and the blind alleys that some economists advocated that misled policy makers in the wake of the crisis exacerbated human suffering.  Europe is still under the thumb of German self-interest and an “expansionary austerity” ideology that resists empirical evidence.  Apparently 20% unemployment is just the corrective that peripheral countries need despite Germany’s own experience of the consequences of such policies in the 1930s–and extremist parties are rising across Europe as a result.

As a complex adaptive system, macroeconomic policies changes the behavior, structure, and terms of a market.  For example, ignoring antitrust legislation and goals to allow airlines and cable companies to consolidate encourages rent-seeking.  “Deregulating” such industries establish oligopolistic and monopolistic markets.  These markets dictate the behavior of the entities that operate in it, not the opposite way around.  The closed-loop behavior of this system then becomes apparent: successful rent-seeking encourages additional rent-seeking.  The consumer is nowhere in sight in this scenario.

Thus, we can trace the macro behavior of each system and then summarize them to understand the economy as a whole.  But this is a far cry from basing these systems on the behavior and planning of the individual entities at the microeconomic level.  Our insights from physics and tracing other complex systems, including climate, inform our ability to see that macro behavior can be summarized given the right set of variables, traced at the proper level of detail.

This then leads us to the fundamentals of the Managerial Economics of Projects, which I will summarize in my next post.

 

*I usually try to steer from these types of posts, especially since those that skirt politics and polemics tend to be contentious, but the topic is too important in understanding the area of managerial economics that involves projects and systems dynamics.  A blog, after all, is a public discussion, not a submission of an academic paper.  For those unfamiliar, my educational background is based in political science, economics, and business (undergraduate work and degree), and my graduate work and degrees focused on world and American history, business, and organizational behavior.  This is apart from my professional and other activities in software engineering, systems engineering, project management, group psychology, and the sciences, including marine biology.

**So the reader will not be scared of the big number for household income to debt ratios, keep in mind that the largest of these liabilities (and assets) is long-term.  For most mortgages this is 30 years.

Why Can’t We Be Friends — The Causes of War

Paul Krugman published an interesting opinion piece in the Sunday New York Times entitled “Why We Fight Wars” in which he attempts to understand why developed, relatively affluent countries still decide to wage war, despite the questionable economic costs.  Many websites seconded his observations, particularly those that view social systems and people as primarily rational economic beings.  I think the problem with Mr. Krugman’s opinion–and there is no doubt that he is a brilliant economist and observer of our present state of affairs with a Nobel to his name no less–is that he doesn’t fully comprehend that while the economic balance sheet may argue against warfare, there are other societal issues that lead a nation to war.

Warfare, its causes, and the manner to conduct it was part of my profession for most of my life.  My education was dedicated not only to my academic development but also to its utility in understanding the nature of civilization’s second oldest profession–and how to make what we do in waging war–at the tactical, operational, strategic level–that much more effective.  In the advanced countries we attempt to “civilize” warfare, though were it to be waged in its total state today, it would constitute post-industrial, technological mass murder and violence on a scale never seen before.  This knowledge, which is even recognized by peripheral “Third World” nations and paramilitary organizations, actually make such a scenario both unthinkable and unlikely.  It is most likely this knowledge that keeps Russian ambitions limited to insurgents, proxies, Fifth Columnists, and rigged referendums in its current war of conquest against Ukraine.

Within the civilized view of war, it begins with Clausewitz’s famous dictum: “War is the attainment of political ends through violent means.”  Viewing war as such we have established laws in its conduct.  The use of certain weapons–chemical and biological agents for instance–are considered illegal and their use a war crime; a prohibition honored throughout World War II, Korea, Vietnam, and most other major conflicts.  Combatants are to identify themselves and, when they surrender, are to be accorded humane treatment–a rule that has held up pretty effectively with notable exceptions recorded by Showa Japan, North Korea, and North Vietnam and–tragically and recently–by the United States in its conduct in the War on Terror.  War is not to be purposely waged on non-combatants and collective punishment as reprisals for resistance are prohibited.  There are also others that apply, such as Red Cross and medical persons being protected from attack.  In the U.S. military, the conduct of personnel at war are also restricted by the rules of engagement.  But in all cases the general law of warfare dictates that only the necessary amount of force to achieve the desired political ends is to be exercised–the concept of proportionality applied to a bloody business.

Such political ends typically reflect a society’s perception of its threats, needs, and grievances.  Japan’s perception that the United States and Western Europe was denying it resources and needed its own colonial possessions is often cited as the cause of its expansion and militarism under Showa rule.  Germany’s economic dislocations and humiliation under the Allies is often blamed for the rise of Hitler, rabid nationalism, and expansionism.  In both cases it seemed that at the societal level both nations possessed the characteristics on the eve of war that is typically seen in psychotic individuals.  Other times these characteristics seemed to behave like a disease, infecting other societies and countries in proximity with what can only be described as sociopathic memes–a type of mass hysteria.  How else to explain the scores of individuals with upraised hands in fealty to obviously cruel and inhumane political movements across the mess of human history–or the systematic collection and mass murder of Jews, Gypsies, Intellectuals, and other “undesirables”: not just in Germany but wherever the influence of this meme spread across Europe, Africa, and Asia?

Nations can also fool themselves in learning the wrong lessons from history.  Our own self-image of righting the wrongs of the Old World go back to our anti-colonial roots and the perceptions of our immigrant ancestors who were either rejected by or rejected that world.  Along these lines, the example of Munich in the 20th century has been much misused as a pretext for wars that have ended disastrously or created disastrous blowback resulting from the fog of war simply because the individuals assessing the strategic situation told themselves convenient stories gleaned from an inapplicable past and ignored the reality on the ground.  We have seen this in my lifetime in Vietnam, Iraq (twice), and Afghanistan.

For all of the attempts to “civilize” warfare and lend it rationality, there comes a time when its successful prosecution requires the rejection of rationality.  This is why soldiers and combatant personnel use euphemisms to dehumanize their enemy: it is easier to obliterate a person who is no longer seen as human.  Correspondingly the public is inflamed, the press becomes a tool of the war party, and dissent is viewed with suspicion and penalized.  This is why warfare cannot be interpreted as an extension of neo-classical or–any–economics.  There are no rational actors; at least, not as it is presently conducted by modern nation-states no matter their level of economic development or the maturity of their political systems.  War is unhinged–part of the savagery found in all of us from our primate pasts.

One of my most effective professors when I was seeking my Masters in Military Arts and Sciences was the brilliant historian Dr. Roger J. Spiller–a protégé’ of T. Harry Williams.  “We are always learning,” he would say in repeating a familiar refrain in the military profession, “the lessons from the last war.”  For students at the Army Command and General Staff College it was the critique that doctrine (and therefore the organization and construction of the force) was based on the 1967 Arab-Israeli War; probably the only analogue that could be used in Iraq and–unfortunately for Russia–if they decide to turn their armor on Ukraine or any Article V NATO countries.

Aside from these few exceptions, however, the American way of total warfare that we learned first in our own Civil War and then perfected on the battlefields of Europe and Asia–and our success in its use–has rendered it largely obsolete.  It has been obsolete for quite some time because warfare has changed; its practitioners have evolved.  It has changed because its present incarnation is being prosecuted by people and groups that have no significant power and so use violence to destroy power.  This is the purpose of the terrorist.  Even the strength of this new form of warfare–Low Intensity Conflict–is transient–evident only in tactical situations.  What it cannot do is establish legitimacy or power.  Thus, meeting violence with violence only exacerbates the situation in these cases because power is further eroded and–along with it–legitimacy.  We see the results of the vacuum caused by this inability to adjust to the new warfare in the political instability in both Iraq and Afghanistan–and the rise of ISIS.

While I would argue that the use of economic balance sheets are not what we need in assessing the needs to ensure global stability and peace, we do require a new theory of war that infuses greater rationality into the equation.  Clausewitz–and his intellectual successor Antoine-Henri Jomini–in looking at the guerilla warfare in Spain against French rule, simply admonishes war’s practitioners not to go there.  It is not until T. E. Lawrence and Mao Zedong that we have a modern theory to address this new, societal form of “revolutionary” warfare and then only from the perspective of the revolutionary that wishes to establish neo-colonial, authoritarian, or totalitarian regimes.

Thus, we possess the old templates and they no longer work.  With the specter of nuclear weapons still held over the head of humanity we can ill afford to view every situation as a nail, needing a hammer.  We must, I think, follow the lead as advocated by Hannah Arendt, who distinguished the differences between power, strength, force, violence, and authority.  There is, as John Dewey observed, a connection in consequences between means and ends.  The modern form of violence through terrorism or paramilitary revolution has all too often, in the last quarter of the 20th century and the first decades of the 21st century, led to new oppression and totalitarianism.  This has probably been inevitable given the indiscriminate brutality of the struggles.  Diplomacy backed by credible power and sufficient military force to counteract such violence is the new necessary face of achieving stability.  Contrary to the assertions of neo-cons at the time, the very thing we needed in the wake of 9-11 was an effective police action in lieu of chaotic regional warfare.

Interestingly, the insight between means and ends in warfare was perceived early by George Washington when he won his struggle over the conduct of the war against the methods of Nathaniel Greene.  Greene’s irregular methods of warfare were designed to win the war but to unmake a nation, while Washington’s method–the existence of the disciplined continental army as the strategic center of the revolution–was designed to make a nation once the war was over.  Unfortunately for the French and the Russians, there was no George Washington to see this important distinction in their own revolutions.

So too in the 21st century is this connection between means and ends in the handling of conflict–and terrorism–important.  The years since the fall of the Soviet Union seem to have turned the clock back to 1914 for the pressures and conflicts that were held in check by a bi-polar world: the Balkans, the Middle East, Eastern Europe all have been engulfed in conflict.  The tragedy that can result given the new technologies and approaches for inflicting violence and chaos on civilization require that we not apply 1914 methods in meeting them.