Recession' causes. Are any "mainstream" solutions?

Here is the root of the problem pointed out by Marx 160 years ago. Tiny % of population (capitalists) own most of the means of production and appropriate all the added value and fruits of productivity growth. Capitalists treat wage labor as another commodity to buy at the cheapest price, to minimize the consumed quantity of labor, or to substitute labor with cheaper equivalents (machines, automation, or Chinese sweat shop workers, etc.). Maximization of profits requires elimination of "expensive" or even "living wage" labor. Not maximization of the profits is not an option, if it's not you, it's another guy who'll maximize his profits and kick you out of business sooner or later. By eliminating labor, capitalists eliminate their customer base at the same time. Thus - periodic crisises.

In the last 60 years or so this inherent contradiction was dealt with by flooding the system with "cheap" money each time capitalists were about to wipe out significant portion of their customer base. Excess labor squeezed out by essential industries due to productivity growth, mechanization, automation or outsourcing was employed either by government or by new start ups producing mostly non essential, whimsical, silly, fraudulent, wasteful or outright dangerous products and services. This would not be possible without the rise of Marketing (creating new wants) and general dumbing down of populace. Destruction of the social cohesion when one could expect help & "freebies" from neighbors, relatives and friends, hyper individualism if not isolation also contributed to job and GDP growth. Things people used to do for free became a business opportunity.

However, in the times of Marx credit card industry didn't exist. Marx was not visionary enough to predict owning class lending "expropriated" wages back to labor in order to have the best of two worlds (for a while): to maximize profits and to maintain the customer base. Transforming labor from mere commodity into indebted neo peons - priceless. Unfortunately, all good things come to the end. Debt pyramids as Ponzi schemes tends to crumble.

Well, all of the "solutions" above do NOT work as they used to. And here is why:

1) "Cheap" money is not free money, to pay off interest % on the new money created out of thin air to patch up "crisis", economy must continuously grow, new money must be created to pay off old debts. You can imagine what growth it would take to pay off interest on stimulus money Obama pulled from his arse. If that required economic growth will not materialize, guess what? Yup, another crisis, mightier than this one. In essence this is a pyramid scheme. The time will come when pyramid will be too big to maintain.

2) Capitalists destroy their customer base (i.e. maximize profits and wealth) much faster than government, marketing gurus and start ups can repair the damage.

3) You have just 24 hours to consume. There is saturation point for the new (nonessential) goods and services.

4) (Non) essential start ups are not exception to profit maximization rules, they no longer create as many jobs as before.

5) It take HUGE amount of resources (waste and environmental damages) to keep the above insanity going.

So what shall we do? Destroy unions, free "persecuted" corporation from all the rules, taxes and regulations? This way capitalists will maximize their profits and destroy their customer base even faster. It's insane to assume that for businesses exist some kind of minimum "fair" wage they are striving to reason greedy unions into. Nope. Profit maximization will continue even if labor will be forced into Chinese wages.


I think it's not recession, it's distant roaring of fast approaching crisis of the most divinely inspired system under the Sun. Capitalism and mankind are reaching the boundaries of physically possible. Besides, customer base destruction crisis, debt pyramid crisis (which lead to this particular recession) there are looming resource, energy, food, water, ecological, population, etc. crises. Capitalism can only cure itself through growth. Growth automatically exacerbates all the rest of crises. At some point capitalism will not get its growth fix, then what?

 

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To see it another way, consumers are given wages, which equate to a commodity used to maximize their utility or benefit when purchasing products at the lowest price. This labour is produced by minimizing effort or pain. To maximize the output of labour, capital is not always used as a substitute but as a complimentary factor of production to maximize output and thus minimize costs and keep prices low (very few, if any, industries are run completely using capital).

Unionization was an effective and in many cases essential measure during capitalism's infancy. Information asymmetry between the worker and management was biased rather heavily towards management. It required the heavy hand of large numbers of workers to convince management of the benefits of paying workers more in addition to other non-monetary requirements (often due to unsafe conditions - i.e. mining) as opposed to having to incur search costs, training costs and other costs (i.e. picketing or other forms of interference).

Today, there are few instances where unions are necessary (at least in the most modern economies). It is why unionization has peaked during the late 1960s and early 1970s and has steadily been in decline as management had found the balance had been pushed too far in the direction of unions. In addition, a better alternative had been in the works (thanks to managers like Alfred P. Sloan and researchers such as Peter F. Drucker). Using good management practices is paramount as a means when the long term positive existence of an organization is the end. Union costs are circumvented and those costs are recuperated and redistributed to the workers.

Where it goes wrong, I suppose, is in the structure of corporations at the management end. Currently, management consists of a CEO appointed by directors who are voted or appointed by shareholders. Depending on the number of shares outstanding, if they are great can make coordination of shareholder's directives difficult and often misguided leaving the majority of the decision making at the board level.

Given that when one has the privilege to weigh in a significant level of say in their pay that they will exercise such privilege is one significant reason as to why CEO pay has been increasing at such high rates over the last few decades.

The other reason is explained via tournament theory. If a company's ambition is to maximize profits, it must hire the most qualified. It is assumed that those qualified to take the position of a CEO or director are from a limited pool and in the bargaining process can demand the maximum amount that the market can supply.
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In reply to your propositions, the market or unions themselves destroy unions. If a union is required, it will take place at the will of the workers subject to the constraints of the economy. They hold a relative influence in the political arena as they do in the economy.

Shareholders' ineptitude or the voting structure of corporate management is one cause that exacerbates the imbalances of pay structures. The other causes are political cowardess and civilian ignorance.

Civilians fail to educate themselves on the issues that affect them if at all they decide to take part in the voting process.

Politicians generally know this and use the media to their advantage in positioning themselves in the best light of the available facts at their disposal. Note that you will seldom have a question answered adequately by a politician regardless of their stripes.

Capitalism goes through its cycles. This is one of the larger cycles and for the most part will be larger than usual. It has also been refined over the centuries for the better. Perhaps, the merits of the free market system have been over-stated to counter the over-stated merits of socialism. As a result, we have been oversold on the idea that the Free Market system regulates itself without intervention from the public or government.

Ultimately, we do not live in an absolute market system. That was destroyed after the Great Depression. We now live in a mixed-market system where the best of Socialism and Capitalist systems have been combined, although it is primarily a Capitalist or Free Market system. Socialism was destroyed for the most part during a major recession of the late 1980s and early 1990s. It collapsed because there was no accountability to the people. They had little or no say as to the productivity or sustainability of a given country. Our current system, however, does but in a weak sense. Any group that circumvents the democratic system (i.e. lobbyists and unions) weakens democracy by diluting the vote structure and clouding accountability and transparency.

At the same time it is the duty of citizens to demand more of government (but less of it) and more of themselves as well as to be critical of their media sources. It is their duty to be as well informed on the issues and to understand that the sources must be as neutral in their bias as possible.

This economic cycle will right itself in time and with the correct policies in place. Heed the perils of Japan in mind. Many economists have been warning North America and parts of Europe that they were headed for a similar fate. We must avoid what the Japanese have done to avoid a painful 25 years (20 + the five or so for recovery the Japanese government are stating that it will take to get themselves out of their financial mess although I think it will take them 30 or more years).

 

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Welcome to Sciforums imwithid
Government as well as labor unions can help to avoid economic collapse the OP describes as is done in Brazil.

If interested in Brazil and its street urchin to President Lula see:
http://www.bloomberg.com/apps/news?pid=20601109&sid=af0ncUKVx.sQ Here are a few quotes from it:

"Bolsa Familia, {cost 0.7% of GDP} pays small cash grants to an estimated 13 million impoverished families. By contrast, the country’s deficit-plagued social security system reaches half that number of people and costs 20 times as much."

"{Lula's} policies lifted more than 17 million people -- 9 percent of the population -- out of poverty from 2003 to 2007 alone. Lula also leveraged a timely run-up in world commodity prices to accumulate $200 billion in foreign- currency reserves, a decisive factor in Standard & Poor’s decision in May 2008 to grant the country’s debt its first-ever investment-grade rating. Brazilian stocks have surged 352 percent during Lula’s two terms -- 37 percent this year{2009} alone as of June 2. ..."

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“Prior to the just announced expansion only11.0 million were receiving Bolsa Familia. With the increase in the school allowance and members, the program will cost R$549 million more each year and have a total cost of 11.95 billion Reais. The opposition parties are already saying this is an “election measure” – Lula has huge popularity (about 80% over all approval rating) but among the really poor it is nearly 100%. It is really ironic. The Real got very weak prior to his first election (more than 4 required to buy a dollar as the rich tried to get their wealth out of Brazil when it looked like Socialist Lula would win.) Now they are worried because the constitution will not let him have a third term. He is so popular some are suggesting the constitution be changed.

Even expanded, Bolsa Familia’s 12 billion is much less than the 200+ billion of reserves and a relatively minor expense in Brazil’s budget – AND one that at least “breaks even” if not more than pays for itself in immediate saving and increased taxes with more people in the cash economy buying plus giving huge long term benefits, like the GI bill did. - Prior to Bolas Familia, most of these very poor families now receiving it had their kids working in the fields as soon as they could read and write (poorly) and do some simple math. I.e. they typically quit school during fourth grade. Lula did not go to high school, speaks only Portuguese (and not correctly, so I am told – mine is much worse so I cannot directly tell.). He got his first shoes at age 12. – He knows the value of Bolas Familia better than anyone, but economist in some other poor countries are trying to get their governments to copy it.”

The above is two paragraphs from my post at: http://www.sciforums.com/showpost.php?p=2154610&postcount=76

Today’s paper tells the Brazilian government is working on a new law that will require all but very small businesses to distribute to their workers 5% of the annual profits. Lula is planning this, no doubt to make his party more popular in the October elections, but if it makes good economic sense to have the higher up managers given stock options with deeply discounted cost, why not incentize the common workers to save the company money too? For example, if a metal worker cutting out sheet metal parts takes a few minutes to see how to best lay them out to avoid waste, turns off power to machines not in use, etc.

As the OP points out, when the system is designed to concentrate wealth – it eventually collapses. Bolsa Famila and this 5% to the workers plan help to redistribute purchasing power. Like progressive tax rates some means of redistribution is NECESSARY to avoid eventual collapse. “Social solidarity” is why Brazil’s real economy was hardly touched by the current economic crisis as the GDP is 87% based on the domestic economy. (The price of stocks fell greatly as foreigners pulled their money out in a swing to “risk aversion,” but that is not the “real economy” of domestic GDP Brazil.) The US badly needs to learn from Brazil how to manage it economy (or recall that Henry Ford did make a mass production economy possible by tripling the typical worker’s salary – so they could afford to buy cars, etc

It is really just the math of compound interest. If there is no redistribution of wealth, it will all end up in the hands of one or two people as the rich get richer faster than the poor due to the math of compounding earnings.

 

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And when something else is the end - such as making lots of money for the execs or shareholders - good management practices will be differently understood.

On what planet did that happen?

On this one, labor costs are "circumvented" and those costs recuperated and redistributed to upper level executives and investors.

 

Because I will fucking kill as many people as I can before I live like an Asian slave.

 

Thanks Mr. T. I was hoping to find a forum that includes a wide range of topics with individuals who bring with them a broad range of knowledge (hopefully not too far on the fringe of conspiratorial or conjectural nature -- I'll respectfully avoid those). It was one of your posts on The Economist that brought me here.

That said, your point is well made. It addresses the agency problem that I had so poorly managed to bring to the fore (amongst the many points I wished to bring to address the OP's points).

I think it is a great idea to offer (all) employees shares in the (publicly traded or otherwise) companies that they work for. It is an essential component of good management. It gives them a share in ownership and as such an incentive to improve that property through themselves or through other means. It gives them membership akin to unions but ensures that the costs saved are paid out through dividends, capital gains or a say through voting (or some combination of the aforementioned).

There are many companies that currently utilize these tools as an incentive to workers and a cost savings in employee retention.

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In reply to iceaura, I think you missed my point by repeating the problem that I had stated. It is in the interests of shareholders to maximize their benefit (dividends and capital gains) under the management of the board of directors (CEO included). It is the fragmentation of shareholders (uneven distribution of goals - some want short term or immediate gains, others are in it for the longer term) that causes a schism of sorts that allows the CEO primarily and the directors secondarily to take advantage of the situation to pay themselves most or guarantee their pay regardless of potential pitfalls (this is why CEOs leave companies with large sums even though those same companies lost great sums or folded such as Home Depot (Mr. Nardelli - 2007) and Lehman Brothers respectively).

As to the second point you address, you are correct. This has never happened, although in theory my intent was to emphasize the cost savings in avoiding a third party form of enforcement (the union). It comes closer to that Pareto optimality within the company structure of minimizing human resources costs while simultaneously rewarding employees and/or maintaining a work environment that is competitive and conducive to productivity within the constraints of a given industry.

 

you mean like the japanese auto companies did in the 80's?

 

yeah but some of the methods they use would require constitutional amendments to use state side.

 

Brief note to Imwithid:

Glad one of my post in The Economist brought you here. I agree that giving the common workers some shares of the company (like the higher ups get) can be good for the company, but it is much more efficient and powerful if instead of shares, it is a share of the profits (like the 5% Brazil is planning).

For example assume stock price of $100 and $2 of annual profit prior to worker getting a 5% share of the profits. After that the profits (by worker's cost reduction efforts) become $4 / share. That is doubling but unlike to move the share price to $200/ sh. It is even possible in a "down or bear market" that despite the $4/sh profit the share price goes to $80 making the worker think "why try?"

I.e. It is the profit (bottom line) which is connected most directly to the worker's efforts at cost reduction, improved production efficiency, etc.

I am not very favorable to stock options - too many things not in the employee's control change their value. Give a share of the profits instead to the workers. That would solve the "big bonus" problem too - when there are no profits there are no bonuses but even in a good year the max bonus should be small compared to the salary (say 7%) so that the future is not sacrificed for this year’s profits.

 

kmguru,

It's interesting that you mention the State of the Union address and particularly President Obama's mention of increasing exports.

Although this is what the country needs to improve its trade balance, this will require (correct me if I'm wrong) either:

(a) Subsidies (bad if prolonged - price distortions / unfair / subsidizing foreign purchasers of domestic goods) or tax breaks (which will eventually require increasing to pay for debt and debt servicing over the medium run, that is 5-10 years).

(b) A significant depreciation of the dollar (your classic Marshall-Lerner condition) resulting in the relative price of exports being less expensive, although this will come at the cost of higher import prices. Depending on which is more inelastic in substitutability (if a given import can be produced domestically at a similar price and in a short period of time) will result in a net effect, that is a lower trade deficit.

Given the trend over the past 25 years, I doubt that it will be in positive territory any time soon.

In addition, I think that the farm policies in many countries are in need of reform (recall the Doha round of talks a couple of years ago and the massive farm bill passed costing over $200 billion). Aid in this market towards increasing exports is money poorly allocated.

 

Thanks Billy T.

I agree with your point. I think this will help employees to an extent.

I remain fixated on one subject, however, and that is the management of companies. In cases like the collapse of Lehman Brothers, employees lose more than their jobs, they lose their shares and in some cases some of their pension funds (Mr. Fuld was perhaps one of the few who can live comfortably after the collapse if he transfers his assets prior to any civil suits, that is). It is a subject I find of interest and every now and then an article or section is put together in The Economist but I find their analysis passive in tone and insufficient in explanation.

This, perhaps, belongs in a new thread topic.

 

This is not "wrong" but overlooks fact that exports can be significantly increased if certain existing subsidies are REDUCED.

The Doha round is trying to boost trade, but fails mainly because of the special interest groups that receive farm subsidies in the US. They cannot compete with foreign producers without these subsidies, which would need to be removed or greatly reduced before the protection barriers against US manufactured goods are reduced by foreigners.

The export of high value added manufactured items, which typically provide many more US jobs than agricultural production, is being hurt by the existence of these farm subsidies. (A few rich corporate farmers, like Cargill*, have huge the political power because of the campaign contributions they give.) Thus, Joe American has fewer manufacturing jobs, pays higher prices for his food and fiber (than if more of it were imported form cheaper producers) and pays higher taxes so that a few rich get even richer, faster.

Fortunately, the US cotton subsidy was ruled illegal by the WTO last year. Brazil, who brought the case several years earlier, won the right to retaliated against the US by raising tariffs against US exports to Brazil. At present it has not done so, but is using the threat of dong so to negotiate a reduction in the illegal cotton subsidies.

** I know this because years ago, when I read how much they were collecting as price supports or to not grow certain crops etc, I wanted to buy stock in them. (They were sitting on a taxpayer funded gold mine paid for not planting etc.) Cargill stock does not exist (unless they had an IPO I failed to notice).

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*Cargill does not even have stockholders to distribute its gains to.** It was, and still may be, the largest privately owned company in the USA.

 

You mention some very interesting points.

As soon as I hear the word "tariff", I become skeptical and worried. Seldom does such a practice work for improving trade or quality and ends up causing a retaliatory cycle in international trade that hurts domestic production, consumer choice and quality, etc.

Let's take the auto industry example of the 1980s. Import quotas of foreign autos and domestic plant production (partnerships - think NUMMI) requirements were put in place to protect the auto industry. This had a limited impact on initial quality and durability subject only to the plants that were directly co-managed with foreign auto companies. Furthermore, GM was hours away from bankruptcy in 1992 despite these almost decade long tariffs. Over 15 years later the inevitable takes place and the Big Three are gone.

The auto industry discovered too late, the required initiative to improve production company wide (70s, 80s, early 90s - perhaps at the constraint of its unions or willingness of management - it is arguable either way) and product mix and finances (late 90s and 2000s - arguably management).

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To address your points,

I'll argue that American engines are quite exceptional today as are their transmissions (which you'll find in other cars made by such producers as BMW). I'll also defer to initial quality and durability studies of the past five years as well as trend lines showing the quality of domestic producers GM and Ford matching and in some cases exceeding the Japanese and European producers (refer to JD Power & Associates).

This is a result of more open trade. Competition requires companies to be innovative or fail. Subsidies and tariffs support and protect, respectively, the weak and are a hindrance to innovation. Firms, by definition, should be able to stand on their own without the visible hand of government with the exception of the rarest of exceptions and these only for periods that are temporary (short term - i.e. < one year).

As to food, imports and exports to and from the US, China, Chile, Canada, etc. are an all way street. Examples such as potatoes from PEI and oranges from Florida, grapes from Chile and strawberries from the US are but a few. I suppose we can find a way to grow Durians in the US instead of importing them from China but at what cost? Variety is an important reason for trade just as it is to minimize costs due to relative advantage. If anything the Farm Bill subsidy may help farmers increase exports but that leads to a discount in the price so that these exports are cheaper for consumers in other countries. I'm sure Canadians will thank the US for helping to pay for some of the fruit that they enjoy.


Generally, the points I wish to make are the following:

1. Entrepreneurs make that which they do best despite their national interests.

2. Nations that institute subsidies, tariffs and other trade barriers, create distortions in the market resulting in additional costs and complication to trade that hurts both domestic production and foreign producers.

I'm quite certain that bricks, cement, glass, and a significant amount of steel is still produced domestically. As for oil, that is a complicated issue that addresses energy policy, agricultural policy and taxation. Oil is relatively cheap in the US as compared to Europe, Japan and even Canada. Perhaps this is indicative of the consumption side of the economy that needs to be addressed rather than trade.