[Corp. Watch] Orthodox economists 'have very little incentive to think for themselves'

[Corporation Watch]

How Economists (and Pundits and Politicians) Helped Steer America Off  
a Cliff

By Joshua Holland

(Alternet, Feb. 12) -- As the economy crashes around us, economist  
Dean Baker's star has been on the rise, and for good reason.

	While most of his colleagues were following the herd, swept up in the  
irrational exuberance of an economy fueled by the growth of a massive  
housing bubble, Baker -- co-director of the Center for Economic and  
Policy Research -- was one of the few voices warning of the housing  
market's impending crash.

	When AlterNet interviewed Baker in mid-2006, there was no talk of  
"sub-prime" loans and "toxic securities," yet he warned that the crash  
of America's "debt bubble" -- mortgages, consumer debt and all the  
rest -- could decrease Americans' average wealth by as much as 40  
percent.

	At the time, he said that he hoped he was wrong, but unfortunately he  
wasn't. In his new book, 'Plunder and Blunder: The Rise and Fall of  
the Bubble Economy', Baker explains the rise of the speculation-fueled  
bubble economy following the relative prosperity of the New Deal era,  
offers insight into how so many of his colleagues could have gotten  
the situation so wrong, and calls out politicians, pundits, and  
corporate America for getting us into a mess that's threatening the  
entire global economy.

	AlterNet caught up with Baker recently to discuss his new book, and  
to find out where he thinks we should be going from here.

Alternet: You describe this virtuous cycle of prosperity following  
World War II, where productivity growth was widely distributed in wage  
gains, which increased consumption, which increased corporate  
investment and expansion, which led to increased productivity growth,  
etc, etc.

	And, you point out that the bubble economy grew in the mid-'90s,  
after two decades in which that cycle was broken and wages were flat  
for most Americans. Briefly, how did that fundamental shift occur, and  
how did it fuel the creation of the bubble economy?

Dean Baker: Well, I'd say what happened was, we had a period -- and  
this is highly debated, and you'll get different people give you  
different answers on this -- in the '70s where things weren't working,  
that we saw an end to that virtuous cycle.

	Several things went on, which I think explain the shift. We had  
extraordinary shocks to the system in the form of much higher food  
prices and much higher oil prices. There was a lot of inflation.

	Now, my view is that if we had kept the same policies, we might have  
gotten back to somewhere like where we were in the '60s, but we didn't  
keep the same policies. Reagan got into office, and he quite  
deliberately set about weakening the power of workers, the power of  
unions.

	He broke the air traffic controllers' strike, which really changed  
labor relations. Before that, companies negotiated with their workers  
when they went on strike. They didn't fire them. But suddenly,  
following the lead of the president, it became common practice in the  
private sector to start firing workers.

	So, there were many instances where you had workers fired when they  
went on strike, and that hugely weakened their bargaining power.  
Suddenly, if they went on strike they had to fear that they'd be fired.

	Also, the National Labor Relations Board became much more hostile to  
unions. Then there was the trade policy. We had a [strong]-dollar  
policy that made it difficult for workers in sectors that are open to  
competition -- most importantly manufacturing -- to keep their wages up.

	At the same time, you had deregulation of many major sectors. The  
airlines, trucking, … telecommunications. Several major sectors,  
employing millions of people with good-paying jobs, were all  
deregulated. And this was quite consciously an effort to reduce the  
power of workers and lower their wages.

	So, I'd say that's really what changed in the '80s. And, as a result  
of that, we stopped seeing wage growth for most workers. And, it  
wasn't until the late '90s, when we did get low rates of unemployment,  
that we began again to see some wage growth for workers.

	But basically, that was brought about by the stock bubble, which led  
to strong [productivity] growth and low rates of unemployment, so  
finally workers were in a position to share in some of the wage gains  
from productivity growth. But, that was after a long period of time in  
a very different environment.

Alternet: And what, if any, is the connection between that long period  
of stagnating wages and the emergence, in the mid-'90s, of this kind  
of bubble economy that started, obviously, with the tech sector?

Baker: Well, I think that because we didn't have strong unions,  
workers had less bargaining power, and there was less fear of  
inflation. This might sound a little perverse, but [Alan] Greenspan  
quite openly said this. He was prepared to have very low interest  
rates, let the economy keep growing, because, he said, workers don't  
have any bargaining power.

	You don't have to worry about inflation. He wouldn't have done that  
if we'd been back in the '70s world. So, it was only because you had  
broken down that pattern of wage growth that Greenspan allowed for the  
sort of low interest rates that are conducive to the growth of a bubble.

	Just to be clear, I don't have a problem with low interest rates. I  
think they're great. I think it was great the economy did have good  
growth in the late '90s. But on the other hand, I do have a problem  
associated with the bubble, because that's not going to last. It's not  
going to be enduring, and it has very bad consequences, as we see.

Alternet: Now, we've heard that all of [the current crisis] was  
impossible to see [ahead of time]. And of course, we saw during the  
run-up of the stockmarket bubble, the price-to-earnings ratios of some  
of these companies were just absolutely ridiculous.

	And then, the stockmarket bubble burst and we saw a run to the  
housing market, because people thought, 'Well, OK, we can live in our  
houses.' You mention in the book that there was this idea that, as  
there was less security in the stockmarkets, people ran to the housing  
market. And again, we saw this huge bubble rise up.

	When I interviewed you several years ago, this was something you were  
talking about. And yet, at the same time, virtually no economists --  
none who have a bully pulpit in our media, who get a lot of attention  
in the press -- were talking about this. Why is that?

Baker: Well, I think economists have very little incentive to really  
think for themselves. If you just say the exact same thing as everyone  
else, there's not really a downside to it. So just think of the  
incentives.

	Think about economists the way economists would -- or should -- think  
about [why people do things]: People respond to incentives. And in  
this scenario, their incentives are all just to repeat the same exact  
same stuff as Alan Greenspan and everyone else is saying, and [not to]  
think about it.

	Because if you step out of line, if you get out there and say,  
"There's a real big bubble. It's going to be real bad news. It's going  
to wreck the economy, and we're going to have the worst recession  
since the Great Depression," well, you're taking a real big risk.

	Because obviously you don't know for sure that you're right. You  
might think you're right, but you don't know for sure. And if you're  
wrong, well, everyone's going to laugh at you. You'll be humiliated.  
You'll be ignored. No one's going to take you seriously. You won't get  
promoted. Who knows? You could even get fired.

	So economists shouldn't be trusted to ever step out of line, they  
shouldn't be trusted to think originally or creatively, because  
there's no reason for them to. It's all risk and very little upside.

	So, what we should expect is that all these economists, including  
many highly paid economists, are going to say exactly what every other  
economist will say, whether they agree with it or not. It doesn't even  
matter, because that's the incentive structure.

Alternet: At the same time, you had the raw data. I mean, home prices  
rose [at the same rate as] wages and inflation for 100 years,  
essentially. And then, between 2002 and 2006, you point out in your  
book, [inflated-adjusted] home prices rose by 70 percent.

	And, at the same time, you pointed out years ago -- when we spoke  
about your last book -- that there had always been a close  
relationship between rental prices and purchase prices, but that  
relationship got totally blown up in the early 2000s.

	And it's just very difficult to grasp how it is that not only the  
media and economists, but also policymakers, could have ignored this.  
It's almost like there was this institutional desire to stick one's  
head in the sand.

Baker: Well, I would certainly agree with that. You know, whenever I  
suggest that some people from the Clinton administration who are very  
much associated with these policies that brought us this disaster --  
who thought the stock bubble back in the '90s was cool -- shouldn't  
have gotten top positions in the Obama administration, people think  
I'm being vindictive.

	To my mind, though, well, they messed up in a really big way. That  
should affect their career. It's a reasonable thing. But that's not  
the way it works. It's more like a fraternity. Once you're a member,  
you're a member, and it really doesn't matter what you do. And that's  
the story.

Alternet: We hear an enormous amount about a credit crunch. And this  
is supposedly a problem -- articulated by George Bush and Hank Paulson  
and many others -- where even qualified individuals and qualified  
firms are unable to access capital.

	And you have been pointing out repeatedly that the real story here is  
quite different. Tell me what's going on today, in terms of the credit  
markets.

Baker: Well, you know, I have to be careful there. I wouldn't say that  
there's no issue of firms not being able or having difficulty getting  
credit. Obviously, some are. And some of them are relatively healthy  
firms.

	But the point I've made is, that that's not the big problem. The big  
problem is that we have a lack of demand, because we've lost on the  
order of $6 trillion in housing wealth and perhaps $8 trillion in  
stock wealth.

	And you'd expect, even if our banking system was totally capitalized,  
totally solvent, that that would cause big problems. That's what  
happens when you lose many trillions of dollars of wealth. People stop  
consuming. And that's really where our big problem is.

	But the second point is that there are issues where people can't get  
credit. But in many cases, that's because they're a bad credit risk.  
They weren't [properly considered] bad credit risks two years ago, but  
they are today.

	And this shows up very clearly in housing. If you look at the number  
of applications for home mortgages, again it's one of these simple  
statistics that just tells you about everything you need to know. If  
you look at the number of applications for home mortgages -- new  
mortgages -- those haven't risen.

	The reason that's so important is, if we believe the credit crunch  
story -- that there's all these good credit risks out there who simply  
can't get credit because banks are hoarding their money and sending  
everyone away -- then we'd have a lot of people going to the bank to  
get a mortgage, and being turned down.

	Even though they've got a solid credit rating, put down a reasonable  
deposit, and they're paying a reasonable price on a home, the bank's  
turning them down. So they go to a second mortgage company. And then  
they go to a third, and a fourth.

	If we believe the credit crunch story, there's real simple test [to  
see it it's true]: There should be a huge rise in the ratio of  
mortgage applications to mortgages issued, which correspond roughly to  
the homes sold.

	Well, there isn't. There's no perceptible rise at all. I haven't done  
the arithmetic, but I could eyeball it. There's no uptick at all. In  
fact, mortgage applications have been trending downward, and pretty  
much been following the rate of house sales. So, there's no evidence  
at all that people [who are creditworthy] are having difficulty  
getting mortgages.

	Now, there's lots of people who owe $300,000 on a home that today is  
worth $200,000. They go to the bank and they say, "I want to  
refinance." They can't get it. No bank in its right mind's going to  
lend someone $300,000 on a home that's worth $200,000. That's not a  
credit crunch. They'd never do that even if they were stuffed to the  
gills with capital.

	But that really has nothing to do with the strength of the banking  
and the financial system. Banks, as a general rule -- we had an  
exception for the past couple of years -- don't like to make loans to  
people they don't think are creditworthy.

Alternet: If this credit crunch story is not the primary issue, but  
rather a secondary issue to this massive loss in wealth and the fact  
that people are sitting in homes that are worth significantly less  
than their loans, is there another approach that might seem more  
obviously effective?

Baker: Well, I think first off, in terms of how we look to boost the  
economy, it's going to have to be primarily through fiscal policy.  
We're going to have to spend a lot of money, and we're going to have a  
big stimulus.

	I think the one that President Obama worked through with Congress is  
a good start. It should give the economy a boost, but we'll need more  
than that. The other problem, when we come to the banking sector, [is  
that we] have to fix it. I mean, you do have a situation where you  
have a large number of banks that are insolvent -- they're bankrupt.

	But the fact that there's no imminent credit crunch does mean two  
things: 1) We have more time. And 2) We could think this through. We  
could structure it in a way that we don't just end up giving money to  
the shareholders who took a bet and lost. In a market economy, if you  
take a bet and lose, you're out of luck. That's the way it's supposed  
to be.

	So 1) We don't want our money going to the shareholders. And 2)  
Perhaps more importantly, we don't want it to go to the bank  
executives. And we have the time to sit down and work this out to make  
sure that what we do doesn't reward the people who got us here.

	In any case, we certainly have the time today, and there's absolutely  
no reason on earth to be designing new plans that are going to end up  
rewarding the banks, rather than simply sustaining the financial  
system. Because, again, that's what we care about.

	There's no reason on earth that taxpayers should be coughing up their  
tax dollars to help out the shareholders and the executives at these  
banks.

Alternet: Now, you talk about moving beyond the bubble economy, and  
you lay out a number of things that you think need to be done. Dean  
Baker, [assume] you're president for life, without a Congress to worry  
about. You're a dictator. What are you going to do to keep the next  
bubble from rising?

Baker: Several things. First off, I'd rein in the financial sector. We  
have to understand that the financial sector is a drain on the  
economy. That's not a moral statement -- it's [what's known as] an  
"intermediate good". It isn't like recreational activities or  
healthcare, goods that make us better off as an end in itself. It's an  
intermediate good, like trucking.

	If we suddenly saw that more and more of the economy's resources were  
being used up by the trucking sector, we'd be inclined to say, 'What's  
going on there? Why do we have 10 percent of the economy in trucking?'

	Of course, we have about 1 percent in trucking, but suppose it jumped  
to 10 percent. We'd think, 'We have a really inefficient trucking  
sector.' And that should be the same way we should look at the  
financial sector.

	We need the financial sector so we can get the money to buy a house,  
start a business, or send our kids through school. There's all sorts  
of reasons that we need a good, working financial sector. But when you  
see it growing exponentially, as it had over the last three decades,  
that should have set off all sorts of warning lights. That's a real  
problem.

	So we want to rein in that sector, and I think the best way to do  
that is with a modest financial transactions tax. They have one in  
England. They tax stock trades a quarter of 1 percent per trade. I  
think we should have something like that.

	We could raise a ton of revenue. I did some calculation with my  
friend [University of Massachusetts economist] Robert Pollin a few  
years back, and we found it could easily raise over [$]100 billion a  
year in revenue. That's real money. And it [has the added benefit of]  
reducing the size of the financial sector.

	If we want to regulate the financial sector effectively, I think we  
have to have it be smaller, because part of the story that we saw  
during the bubble years was that the financial sector used its  
political power to prevent effective regulation.

	There were people at different points in time, and in different  
places, who wanted to rein in some of the abuses that we saw. But they  
were prevented from doing so by politically connected people who were  
tied to the financial industry.

	There are other issues. We're way behind the rest of the world in  
healthcare, first and foremost. Our healthcare system's just  
incredibly dysfunctional. We spend more than twice as much per person  
as the average of the other wealthy countries, all of whom have longer  
life expectancies than us. So, we have to get our healthcare system in  
order.

	You have all these people running around with these projections that  
we have a deficit of $60 trillion. Real scary numbers. And that whole  
story is healthcare. If we had our healthcare system fixed, we  
wouldn't have a deficit problem, or at least not a serious one.

	We may have to raise some taxes here or there, but no one would be  
running around the country talking about this nightmare story if we  
had our healthcare system fixed.

	We also have to improve the bargaining position of workers. One of  
the bills that will be before Congress in this session is the Employee  
Free Choice Act that will allow workers who want to organize unions  
the opportunity to do so without the fear of being fired.

	If we could do things that will increase the bargaining power of  
workers so they're better able to ensure themselves a share of  
productivity growth, and that would help to restore the sort of  
virtuous cycle that we had in years past.

Alternet: You discuss in the book these hedge funds, the massive kind  
of house of cards of derivatives that sprang up, actually as a result  
of deregulation, and other unregulated tools of capital that are out  
there. How would you address that issue?

Baker: The transactions tax would take a lot of the profit out of  
[speculation]. Part of the story with the transactions tax, and one of  
the reasons why I think it's so nice, is that it basically directly  
discourages the activity you want to discourage.

	[The average person] looking to save up money for their retirement is  
going to buy shares of a stock, or buy a mutual fund, whatever it  
might be, and they'd pay the [transactions] tax when they buy in, and  
they'd pay the tax when they sell much later. They'll be happy to pay  
a quarter of a percent. It's just not going to be a big deal to them.

	On the other hand, if we're talking about people who buy at 1 o'clock  
and sell at 2 o'clock, well, a quarter of one percent on each side is  
going to end up being a big deal. Because if you make a one percent  
gain by buying at 1 o'clock and selling at 2 o'clock, you're happy --  
you made 1 percent in an hour. I mean, that's a fantastic return.

	[With the transactions tax], if you have to give up a half percentage  
point in taxes, your gain's cut in half. And, of course, a lot of  
those deals don't promise you a gain of 1 percent. So, it suddenly  
becomes a really big-risk proposition to buy at 1 o'clock and sell at  
2 o'clock, which means you have many fewer people doing it.

	It's not going to put the hedge funds out of business. It's not going  
to shut down the speculators. I don't know we'd want to do that -- but  
you certainly would reduce the amount of money that's going to that  
sort of speculation very substantially.

Alternet: One of the things that I think is so important about your  
contributions to all of these debates is that you take really complex  
issues and make them rather accessible. Tell me a little bit about  
strong-dollar policy, trade, and how that has played into the  
development of the bubble economy.

Baker: The strong-dollar policy has been a really important part of  
this story, and it's unfortunate that its implications are rarely  
talked about. We have a very large trade deficit. It's come down in  
the last year, but until very recently, we had a trade deficit that  
was close to 6 percent of GDP.

	It peaked out at over $800 billion in 2006. And that was a direct  
outgrowth of the strong dollar. Because that's what determines whether  
someone buys an imported good or not. An, what we want to do, at least  
to my mind, is bring the dollar down a lot so that we could get the  
trade deficit down somewhere closer to balance.

	Now, the reason why this fits in with the bubble story is that when  
we start importing a lot, and we export less, we run the big trade  
deficit, because there's less demand in the U.S. economy. We used to  
produce cars, steel, whatever it might be. All these goods we used to  
produce domestically, creating jobs domestically.

	Now we're no longer doing that. We're buying the goods from abroad.  
So we end up with much more unemployment, much more slack in the  
economy, and that's a scenario in which you end up lowering interest  
rates to try and fill that gap.

	And that's exactly what the Federal Reserve Board did, certainly in  
the late '90s, and again in this decade. They kept interest rates very  
low, with the idea of letting the economy expand. Low interest rates  
encourage house-buying, of course, along with other forms of  
consumption.

	So, to a very large extent, you could say that the bubble economy --  
or I should say, the conditions for the bubble economy -- were an  
outgrowth of the trade deficit, which was in turn the direct result of  
the strong-dollar policy.

	If we had had a lower dollar, we wouldn't have had so much excess  
labor, so much unemployment. And, there wouldn't have been an  
environment in which Greenspan and the Fed would have looked to lower  
interest rates to try to boost the economy in the same way.

Alternet: What should be done with the banking system going forward?

Baker: I'm very concerned right now that there's a lot of talk about  
creating a so-called "bad bank" that would buy up all these bad loans  
from the troubled banks. People should understand what's going on  
here, because what that would almost certainly mean is we'd be paying  
too much money for bad assets, taking them off the bank's books.

	Because when we're buying bad assets at an inflated price, we're  
handing money to the banks. If you have a car that's worth $5,000, and  
we give you $10,000, well, that's a way of handing you $5,000. And  
that's, in effect, what these proposals are doing. We'd be talking  
about paying too much money for the bank's bad assets.

	And, people have used the analogy ... they've been comparing this to  
the savings and loan [collapse] in the '80s. The key point in the  
savings and loans crisis is that we put the failed banks out of  
business. We put them into bankruptcy.

	We took over their assets, and we sold them off in a separate pool to  
recover money for the taxpayers, and we then took the banks  
themselves, stripped of their bad assets, and sold them back off to  
the private sector. And that makes perfect sense, but that's not what  
they're talking about right now.

	What they're talking about right now is leaving the banks operating:  
Citibank, Bank of America, Wells Fargo, and all the others that have  
hundreds of billions of dollars of bad assets -- perhaps trillions of  
dollars between them. We just pay them more for their bad assets than  
they're worth, and we let them keep operating as though nothing had  
happened.

	And that's just a huge hand-out to the shareholders of these  
companies, as well as to executives, because they'll be able to keep  
their high-paying jobs. And so people should be aware of that, and  
they should be screaming bloody murder if anyone tries to go through  
with those plans.

Alternet: Should we be thinking about nationalizing these banks?

Baker: Well, in effect, that's right. And again, we need to understand  
what's going on. They should be going into bankruptcy. This isn't a  
communist takeover: They should be in bankruptcy -- that would be the  
market outcome.

	But we don't actually want the market outcome, because these  
[institutions] are too big to fail. We don't want Citigroup going into  
bankruptcy and having a judge sort through trillions of dollars of  
loans and assets. It would just be a nightmare.

	Now, at least to my mind, I really don't want the government to own  
the banks. But they put themselves in that situation, where they're  
effectively bankrupt. So, for a period of time, yeah, I think we do  
have to nationalize them until we could get them reorganized and sold  
off again to the private sector.