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As I watched Paul Krugman Sunday night on Bill Moyers, I felt a familiar sense of despair. Krugman cares deeply about unemployment and inequality, as did John Maynard Keynes before him. Yet like Keynes, Krugman seems caught in the inequality-free neoclassical paradigm.

I study the "classical" economists, starting with Adam Smith. Inequality loomed large in their world. They divided society into three broad classes: First, the landlords: the original One Percent, the Downton Abbey crowd, the "great proprietors" of vast estates. Then the capitalists: the merchants and manufacturers. Last: the workers. The classical economists asked, what determines the distribution of income between these classes? But around the end of the 19th Century, the "neoclassical" paradigm swept in. Gone were the three social classes with dramatically different wealth and income. There were only consumers -- from old Aunt Esther on Social Security to Donald Trump; producers -- from Harry's Shoes to General Motors; and government. Business cycles were best left to play themselves out.

During the Great Depression, to his credit, Keynes bucked his colleagues by claiming that government spending could revive a depressed economy. But, caught in the neoclassical paradigm, he got the mechanism wrong. Keynes argued, as does Krugman today, that the problem is a lack of consumer demand. Consumers want to save instead of spend. Lacking demand, businesses won't invest. So there's a "savings glut" or "liquidity trap" -- billions in cash sloshing around seeking in vain for investment opportunities. The solution: government should borrow some of that loose cash and spend it, no matter on what: war, high-speed rail, fixing potholes, or education. Deficits be damned.

In my view, we don't have a "liquidity trap"; we have an "inequality trap". What's that? An "inequality trap" happens in a downturn, when the One Percent, big corporations and banks hoard cash, starving small businesses for capital. The greater the inequality and deeper the downturn, the tighter the trap.

The multinationals are indeed awash in cash. In an article appropriately titled, "Dead Money," The Economist reports how major corporations trim real investment -- such as new technology -- while piling up cash. For example, firms in the S&P 500 held about $900 billion in cash at the end of June, up 40 percent from 2008. The Economist dismisses the conservative claim that "meddlesome federal regulations and America's high corporate-tax rate is locking up cash and depressing investment." Why? All big multinational firms have been hoarding cash, not just U.S.-based ones; it's been a growing trend since the 1970s.

The big banks are also awash in cash. For example, JP Morgan's September 2012 balance sheet shows that out of $2,321 billion in assets, JP Morgan holds $887 billion in "Cash and Short-Term Investments" -- over a third! (The "short-term investments" are gambles in the international money markets, but that's a different story.)

To the One Percent, the cash bath may look like Krugman's liquidity trap: a lack of investments yielding the high returns they enjoyed before the 2008 crash. But try telling small businesses there's not enough demand and too much cash! They face drastic "credit rationing" by the banks. The banks are of course super-cautious these days, which is why they pile up cash. But in addition, the collapse in home values has reduced small business owners' collateral for loans. And following the failure of many small banks and the consolidation of giant banks into megabanks, far fewer banks can or will lend to small businesses.

Today's depression is a small business depression. Don't forget, small businesses are the nation's employers, providing far more jobs per dollar of assets or sales. According to Census data, in 2008, the 99.7 percent of U.S. firms with fewer than 500 workers accounted for 49.4 percent of U.S. employees. In 2007, comparing firms with under half a million in sales to those with over $100 million, the small firms averaged 15 employees per $100 million sales while the big ones averaged only three.

I respect and admire Paul Krugman for fighting the good fight. I just wish he would question the inequality-free neoclassical paradigm. An "inequality trap" requires different measures from a "liquidity trap." It requires raising taxes on the One Percent and the big corporations -- instead of borrowing from them and running up the deficit. It requires protecting ordinary workers and small businesses from the impact of payroll taxes like Social Security, for example by greatly increasing the earned income credit. In the short run, it requires avoiding capital-intensive spending like military or high-speed rail. Instead it requires extra spending to maintain education, health care, unemployment insurance and other urgent public services. In the long run, it requires enforcing anti-trust legislation and breaking up the big banks.

crossposted with permission of the author Polly Clevland from http://www.huffingtonpost.com/...

Originally posted to stillman on Thu Jan 17, 2013 at 11:09 AM PST.

Also republished by Money and Public Purpose.

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Comment Preferences

  •  I own a microbusiness. I own a small (2+ / 0-)
    Recommended by:
    jfromga, Ian S

    shop that sells ladies clothing and accessories. Our tagline is "Special things for special ladies." Businesses like mine would average 600 full-time employees per $100 million. In other words we are big employers, but nobody seems to care except for our employees.

    Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

    by hestal on Thu Jan 17, 2013 at 11:28:06 AM PST

  •  Polly Cleveland is wrong. The problem is (5+ / 0-)
    Recommended by:
    psyched, TracieLynn, Ian S, Calgacus, jellyyork

    demand. My store is located on a historic square not far from major metropolitan areas. Tourists are our prime customers. A major portion of our sales come from out-of-towners, not from locals. The same is true of all the businesses around the square.

    I have good data that goes back for years that show the foot traffic that comes into my store. It has not changed appreciably for years. So we get the same number of customers. We still carry the same kinds of merchandise, though fashion frequently changes, and our prices are still in the same relative range with our competitors.

    A sale in our store is usually for more than one item. Our average item count and our average dollar amount is the same as it has always been, adjusting slightly for inflation.

    So, everything is the same except for one thing: we make fewer sales. Our ticket count is down 66% from the end of the term of Bush the Lesser. We are simply making fewer sales. This is true all around the square.

    People still come in the same numbers, though it costs them more to make the trip, and when they buy, they buy the same things at the same prices, but fewer customers buy. The demand is simply not there. The customers either don't have the money or they are afraid to spend.

    If all this were true about only my store, then it could be my problem only. But it is true for all the stores.

    Our square still puts on the same events, the same parades, the same auto shows and they are all well attended. Our town has even added a large convention center and it hosts events that are new for our community. Our town has even added a large sandy beach on the lake that is within easy walking distance from our square. I was skeptical at first but for two years now the beach has attracted crowds, and we have added some items of beachwear to our inventory.

    Furthermore, when I go to market four times a year, I can easily see that the buyer crowds are much smaller. Retailers are just not buying as much merchandise as they did five years ago.

    So Polly Cleveland is wrong. Demand is the problem. Someone should tell her that she is wrong. It may not be too late for her to learn. It may help her career going forward.

    Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

    by hestal on Thu Jan 17, 2013 at 11:44:36 AM PST

    •  How can there be demand when there is no money? (4+ / 0-)
      Recommended by:
      Kevskos, NoMoreLies, TracieLynn, Calgacus

      Whether it is literally lack of money or fear of spending because there is no security that money will continue to be available, the growing inequality gap will continue to decrease demand.

      People can't magically spend money they no longer have.

      And make no mistake, there is plenty - vast piles! - of money; it just isn't in the hands of consumers.

      •  But Cleveland said that small businesses (3+ / 0-)
        Recommended by:
        psyched, NoMoreLies, Calgacus

        are pressed for capital, that banks are not lending. That was not the original problem. Demand was the original problem, but the government refused to enact an adequate stimulus. So demand began to shrink, and profits began to fall, so businesses need capital now, not for expansion to deal with increased demand, but to weather the storm. They want to borrow money just for operating expenses and the banks won't loan it to them, at least not any more. And the reason is that when the businesses begin to fail, the banks can foreclose, and then make money selling the business to fresh new buyers.

        That is happening on our square. Businesses have begun to fail, only to be replaced by new capitalists. And the banks are getting rich because of it.

        So the original problem was demand, and the way to change the economy is to put money directly into the hands of the consumer. Krugman is right, and Cleveland is wrong.

        Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

        by hestal on Thu Jan 17, 2013 at 12:02:02 PM PST

        [ Parent ]

    •  I forgot to say one thing. I don't need (2+ / 0-)
      Recommended by:
      Kevskos, psyched

      to borrow from banks or anyone else for that matter. I have been lucky and I am able to supply the cash that my store needs to keep going. In addition the businesses on the square are small because the buildings are small. So, if all I needed to do was add more merchandise I couldn't. I have the capital, but not the space. So the success of my store depends solely on demand, and demand is way down.

      Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

      by hestal on Thu Jan 17, 2013 at 11:54:36 AM PST

      [ Parent ]

      •  So where is all the money? (0+ / 0-)

        Answer: sacked away in the Cayman or British Virgin  Islands, looking for an "opportunity" to further cheat the taxpayer and to seek rents elsewhere.  It really is that simple.  Per Hernán Cortés, "they suffer from a disease of the heart which is only cured by gold".  What the fuck do the Pete Petersons or the Koch and Barclay brothers of this world need or could usefully do with any further money?  Money is a social construct.  It (or a fraction of it) should be taken from them and put to social use.  In my view.

        Tony.

        quis custodiet ipsos custodes -- Juvenal VI, 347-8

        by golem on Thu Jan 17, 2013 at 04:26:22 PM PST

        [ Parent ]

    •  chicken or the egg (3+ / 0-)
      Recommended by:
      psyched, NoMoreLies, Calgacus

      demand fell when people lost money, most people have seen their real disposable income go down, including small business people as well as people who are someone's employees.   So they buy less of any good they don't absolutely have to have, like gifts in a tourist/convention oriented retail market.

      So if the government were to stimulate the economy, so that more ordinary employees at a work related convention and small business people at a trade convention, and just ordinary tourists had more disposable income to spend, instead of less, your business would probably see demand return to pre-recession levels.

      But if 1-2% of all potential consumers see their incomes rise and no one else does, and the government continues to pursue policies that foster that inequality, nothing can create enough demand for your business unless your business meets only the luxury market demand.

      •  No, the egg always come first. (2+ / 0-)
        Recommended by:
        NoMoreLies, Calgacus

        The common foundation upon which all economic theories are built is that nothing good happens until somebody sells something to someone else.

        Some people, egoists mainly, think that the salesman is key. They think that a good salesman can sell a refrigerator to Santa Claus. But that is not the case.

        A real world example of this is the old Bible company that used to be in Nashville, TN. This company would recruit college students to sell Bibles door-to-door throughout the Bible Belt. I went to Baylor University and I knew many ministerial students who would sell Bibles in the summer. They helped pay for their education that way.

        One of them told me that during the training sessions they were told that there is no such thing as a bad territory. That a good Bible salesman could sell Bibles anywhere. They were taught all about how to sell Bibles of all kinds: Family Bibles, personal bibles, in many colors and with covers of many materials, some had gold zippers, others were illustrated, and there was always a collection of children's books telling Bible stories. So the trainees were sent out to sell Christian story books to adults and children alike. There was no such thing as a bad territory.

        But, at the end, the trainers said, "By the way, here is a special book that will pay for all your expenses during the summer, and it will enable to keep everything you make from selling Bibles when you go home. This special book is called, The Family Doctor."

        So, my friends who went through all this discovered that there was such a thing as a bad territory. It seems that a great many of the People in the Bible Belt, MS, GA, AL, FL, NC, SC, etc. already had all the Bibles they would every need. Sure, there was a slight demand for such books, but, my friends learned, that if all they had to sell was Bibles they would have starved. What turned the summers into successes was the Family Doctor. Lots of people in the rural south did not have ready access or cash for doctors. There was a great demand for home doctor books.

        So, this company sent thousands of young college students out to sell. And across the board, it was found that the best sellers were best sellers because the demand was there. The other books were not best sellers because there was no demand for them. But the same salesmen sold, or tried to sell, both books.

        So, all economic theory is based on the fundamental fact that demand drives everything.

        This is a lesson that runs at large, you can take it, it's free, no extra charge.

        Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

        by hestal on Thu Jan 17, 2013 at 01:06:22 PM PST

        [ Parent ]

        •  I don't think I said (3+ / 0-)
          Recommended by:
          NoMoreLies, congenitalefty, Calgacus

          that demand wasn't the driver,   in fact, I pretty much think I said that.   But in terms of naming the current lack of demand, liquidity trap or inequality trap, I'm not sure that the name matters.   Because the fact is that demand has been stifled,  people still show up at your store, most of those people see things they like, they just have zero dollars in their pocket to spend.   So ultimately, yes, that is a lack of demand.  But not because you are trying to sell bibles to people that already own them, it is not a bad or glutted market where demand simply won't exist,  it is that demand cannot exist because people can't spend money they don't have.   So I have no fancy term for demand thwarted by falling wages/incomes while rich people and corporations sit on hoardes of cash, hide it from the tax man overseas to avoid taxes, etc.   But that is what we have right now, and as the diary said, it  is actually pretty much a world wide phenomenon of tax shelters and cash hoarding.  So is it really an inequality trap?  Is that as good a description as any?  

  •  I agree with your observations. but, I think (2+ / 0-)
    Recommended by:
    Kevskos, psyched

    Krugman knows this but can't say it or he'd be called a communist.

    To any wingnut: If you pay my taxes I'll give you a job.

    by ban48 on Thu Jan 17, 2013 at 11:48:59 AM PST

  •  I don't see it as and either/or (4+ / 0-)
    Recommended by:
    NoMoreLies, jfromga, bmcphail, Calgacus

    I accept your point and Krugman's as well.  I have come to believe that the problem for people who formally study economics is their desire or need to have a one word or phrase descriptor of a problem.  

    Like you I see inequality as being at the root of the problem.  And I think the notion that  a savings glut is producing a savings glut, or liquidity trap, has merit.  But I believe that there is a problem in trying to apply any term to just one economy.  I see two distinct economies in the US: one each for the haves and have-nots.  

    There is a lot of fallacy in the statement that "Consumers want to save rather than spend." Not true for those in poverty, the poor, or those living paycheck to paycheck.  They are not saving and therefore not contributing to any liquidity trap.  That covers close to half our population. let's call them the 47%. Other factor in these folks lives have been flat or stagnant wages for decades, and increasing costs of health care, energy, college, college loans, food, etc., The portion of income from this population available to feed demand has been shrinking for decades, absent borrowing, and the recession and high unemployment have made it even worse.

    At the other end, those doing really well be they corporations or individuals, are having to decide where to spend their money. Small businesses that compete for cash from the population in our lower economy are at a disadvantage because lenders understand the 47% are currently in a death spiral.  And while the 5% or so at the top are doing very well, they do create the small business demand needed to offset the decline in demand of the 47%.

    So knowing this, why would any lender, who I assume would be part of those doing well, want to invest in small business that they don't see as serving existing demand, or at a minimum a growth market?  Businesses whose target markets largely rely on demand from the 47% are in a zero sum game at best, or more likely are facing a future of competing for a dwindling disposable income pool.

    In short, a liquidity trap absolutely exists among those, corporations and individuals, in the higher echelons of the economy.  And there is a demand problem within the much larger population of the 47%+. Unfortunately, the success of the well to do has no bearing, no trickle down, on the 47%.  And the decline of the 47% has no bearing on the success of the well to do.  I, and others I suppose, believe that without a linkage between these two it is foolish to pretend we have a single economy. Understanding our problem, and coming up with a name for it, requires explaining exactly how it is that the vast, previously unimaginable accumulation of wealth by the well to do coincides with the greatest decline among the poor and middle class.  The answer is obvious.

    I say we are in a "Looting Trap".  I define this as the state of the economy wherein the rich and powerful have co-opted the forces of government to work on their behalf, both in the transfer of wealth and in the prevention of prosecution.

    Forget Keynes (although not entirely), and I don't know Adam Smith but to me his class model sounds closer to our problem, but I think you need to find the great economist who studied banana republics because that is the closest model I see, ours just happens to be on steroids.

  •  By and large, I agree . . . but mention risk (1+ / 0-)
    Recommended by:
    psyched

    the only caveat is that investment in civil engineering -- transportation improvements and repairs, green energy -- needs to continue in part in order to prevent these things from becoming prohibitively expensive and damaging.

    There is enormous pent-up demand -- but people have no choice but to hold back when risk has been dumped on the individual to such an extent.  The critical thing is to ensure that people aren't going to be subject to excessive risk.  In other words, risk of losing their job, risk of losing health coverage, risk of having various circumstances turn their commute into a nightmare, risk of penury in retirement.

    And, what has happened over the past 30 years is that, in order to finance tax cuts for the rich and runaway defense spending, risk has been downloaded to the people least able to carry it.

    Demand will return if and only if this is properly reversed.

  •  I'm not going to address all the arguments (2+ / 0-)
    Recommended by:
    Calgacus, hestal

    in the diary, but want to say I wish Polly had not made out high-speed rail to be a bad investment:

    In the short run, it requires avoiding capital-intensive spending like military or high-speed rail. Instead it requires extra spending to maintain education, health care, unemployment insurance and other urgent public services.
    High-speed rail IS an urgent public service, just as is development of renewable energy and other climate-change mitigators.

    In actuality, Modern Money Theory tells us that the U.S. government has plenty of money to spend on all the projects that would make life better for its citizens, but it can't do so at present because it is constrained by political walls and stupidly misguided legislation.

    One wonders whether the confluence of so many critical economic, social and planetary problems will be finally enough to break the dam of ignorance in leaders' heads and allow the world to proceed toward improvement rather than destruction.

    .


    For the first time in human history, we possess both the means for destroying all life on Earth or realizing a paradise on the planet--Michio Kaku.

    by psyched on Thu Jan 17, 2013 at 04:10:50 PM PST

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