Gary Becker: We’re Not Headed For A Depression
Kurt Brouwer October 8th, 2008
Gary Becker is a Nobel prize-winning professor of economics at the University of Chicago. He wrote a lengthy piece for today’s Wall Street Journal on the economic contraction [emphasis added]:
We’re Not Headed For A Depression (Wall Street Journal, October 7, 2008, Gary S. Becker)
In order to promote a much smoother functioning of the financial system, it is paramount to distinguish between the immediate steps needed to cope with the present crisis and the long-run reforms needed to reduce the likelihood of future crises. Let’s start with the short-run fixes.
First of all, the magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s.
Polls indicate that many Americans think a depression is already here or is on the near-term horizon. Though I disagree with this thinking, in all fairness, it is true that we have lots of problems and conditions are pretty scary. Banks, investment banks, insurance companies and even government enterprises such as Fannie Mae and Freddie Mac have folded. Senior government officials seem to be competing to say either the scariest or the most stupid thing. Despite all these known problems, Professor Becker does not see an actual economic depression on the way.
…Taxpayers may be stuck with hundreds of billions of dollars of losses from the various government insurance provisions and government purchases of assets. Although the media has made much of this possibility through headlines like “$700 Billion Bailout,” such large losses are highly unlikely except in the low probability event that the economy falls into a sustained major depression. Indeed, with efficient auctions, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many savings-and-loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, the government may have a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvement is wise, but the likely losses to taxpayers are being greatly exaggerated.
In this case, Becker is correct that the government is not likely to spend $700 billion in this bailout (see House Passes Economic Stabilization Act). However, there are plenty of other government programs underway that have big price tags too. Examples are the Fannie and Freddie bailouts ( Bill Gross Was Correct — Treasury To Take Over Fannie & Freddie) and the AIG guarantee (U.S. To Take Over AIG). Becker continues:
…it is difficult to propose long-term reforms. Still, a few reforms seem reasonably likely to reduce the probability of future financial crises.
- Increase capital requirements. The capital requirements of banks relative to assets should be increased after the crisis is over in order to prevent the highly leveraged ratios of assets to capital in financial institutions during the past several years…
- Sell Freddie and Fannie. The government should as quickly as possible sell Freddie Mac and Fannie Mae to fully private companies that receive no government insurance or other help. These two giants did not cause the housing mess, but in recent years they surely greatly contributed to it, partly through congressional pressure on them to increase their purchases of subprime loans…
- No more bailouts. The “too big to fail” approach to banks and other companies should be abandoned as new long-term financial policies are developed. Such an approach is inconsistent with a free-market economy…
Is this a final “Crisis of Global Capitalism” — to borrow the title of a book by George Soros written shortly after the Asian financial crisis of 1997-98? The crisis that kills capitalism has been said to happen during every major recession and financial crisis ever since Karl Marx prophesized the collapse of capitalism in the middle of the 19th century. Although I admit to having greatly underestimated the severity of the current crisis, I am confident that sizable world economic growth will resume before very long under a mainly capitalist world economy.
Obviously, the 1998 ‘Asian contagion’ was not the final crisis of capitalism despite Soros’ prediction. In fact, I suspect pundits will still be discussing the pending demise of capitalism a hundred years from now. Becker continues:
Consider, for example, that in the decade after various predictions of the collapse of global capitalism following the Asian crisis, both world GDP and world trade experienced unprecedented growth thanks to the power of market competition on a global scale. The South Korean economy, for example, was pummeled during that crisis, but has had significant economic growth since. World economic growth will recover once we are over the present severe financial difficulties…
Professor Becker does not see a depression coming. And, he thinks the U.S. economy and the world economy will again experience growth in the not too distant future. I agree with him on both points. For those who want further insights from Professor Becker, you can check out his blog here.
During a financial crisis such as this one, it is very difficult to look ahead with any degree of perspective, much less optimism. Yet, those of us who have suffered through several such downturns over the past 30 years, have also seen the subsequent recoveries, which were strong.
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Economists don’t know jack. Irving Fisher, An esteemed economist from an Ivy league institution said in 1929, “we’ve reached a permanently high plateau”. The nice thing about Irving was at least he had skin in the game. He lost $10,000,000 in the ensuing depression.
Talk is cheap. How much skin have YOU got in the game Mr. Becker?
one solution to the mortagages financing crisis be one that clasiffies the kind of mortgages by economy sector, Banking and Gopvernment parity funds, links to new programs that can have effective economical tactic and strategy application. For this America needs a good think tank with people out the known elites.
Sherman — that’s a pretty broad swipe at a group of academics that is notorious for having divergent views. Trying to pigeonhole economists is impossible. Just consider the range of opinions between Paul Krugman, Tyler Cowen, Greg Mankiw and Don Boudroux. Professor Becker didn’t share his net worth statement and he did not make a Pollyanna type statement as Prof. Fisher did. Instead, he pointed out that times are tough, but also very different from the Great Depression.
Here is an article about the fed chairman during the time of the Great Depression and what he thought caused it. The same thing is happening again for the same reasons. Please read:
In Review: America’s Most Egalitarian Banker
Marriner S. Eccles, Beckoning Frontiers: Public and Personal Recollections. New York: Alfred A. Knopf, 1951.
At the start of the Great Depression, Marriner Eccles hardly seemed someone who might lead a charge against the economic orthodoxies that justified grand hoards of private fortune. By the early 1930s, after all, the Utah-born Eccles had become the top banker in the Mountain West, the organizer of the first multibank holding company in the United States.
But Eccles had also come to understand, after watching the great speculative bubbles of the 1920s pop into massive misery, that prosperity — to endure — needs to be shared. Eccles began speaking out on that theme, shortly after the Great Depression began, and soon caught the attention of the early New Dealers.
In 1933, Eccles would become an assistant secretary of the treasury. A year later, Franklin Roosevelt would appoint him to the Federal Reserve Board. He would become Board chair in 1935 and remain in that central position for the next 13 years. No one individual, over those years, had more of an impact on economic policy in the United States.
Looking back on those years, in his 1951 memoir Beckoning Frontiers, Eccles would do his best to explain the impact he set out to make. Mass production, he noted at the outset, demands mass consumption, but people can’t afford to consume if the wealth an economy generates is concentrating at the top.
In the years leading up to the Great Depression, that concentrating was accelerating. A “giant suction pump,” charged Eccles, “had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth.”
“In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands,” Eccles observed, “the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”
Sound familiar? The decade of the 1920s that Eccles describes in his 1951 memoir comes across today as eerily familiar. Then as now, the U.S. economy was floating on a sea of debt.
Then as now, inequality was hollowing out the nation. Eccles put the matter bluntly: “Had there been a better distribution of the current income from the national product — in other words, had there been less savings by business and the higher-income groups and more income in the lower groups — we should have had far greater stability in our economy.”
How would Eccles have reacted to our current debt-ridden, war-torn economy? We can’t, of course, know for sure what Eccles would do. But we do know what he did. In 1942, during World War II, a high-powered team of New Deal officials that included Eccles proposed to President Roosevelt that “a ceiling of fifty thousand dollars after taxes should be placed on individual incomes.”
In our current dollars, this $50,000 ceiling would equal about $700,000. What did FDR do with the Eccles proposal? He turned around and asked Congress to place a 100 percent tax on all individual income over $25,000.
Congress would eventually set the nation’s top tax rate at 94 percent on all income over $200,000, and that top tax rate would hover around 90 percent for the next two decades, years that would see the greatest period of middle class prosperity in U.S. economic history.
In 2005, the latest year with statistics available, America’s leading hedge fund managers and the rest of the nation’s top 400 income-earners faced a top tax rate of 35 percent. They actually paid, after loopholes, just 18.2 percent of their incomes in tax.
Marriner Eccles would not approve.
Stat of the Week
In the two decades between 1986 and 2005, America’s top 1 percent of taxpayers saw their share of the nation’s income jump from 11.3 to 21.2 percent. Over those same years, the federal income taxes the top 1 percent paid dropped by an equally stunning margin, from 33.13 percent of total personal income in 1986 to 23.13 percent in 2005, the most current year with IRS stats available. Taxpayers needed to report at least $364,657 in 2005 to enter the top 1 percent.
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Thanks for the interesting article.