Saving Capitalism From a Painful Demise

Below is my new article in the Winter 2015 issue of the Wharton Magazine. Thanks to editor Matt Brodsky for allowing me to reprint it here!

Retailers Need Consumers

American business leaders rallied around Franklin Delano Roosevelt in 1932 during his candidacy for the presidency, after which he immediately embarked on the most progressive legislative agenda in U.S. history to tackle the Great Depression. From today’s vantage point, it may seem surprising that titans of industry, executives from General Electric to Standard Oil to IBM, not only contributed to Roosevelt’s campaign but helped author many of his famous New Deal reforms. To the men who ran these companies, it was a simple matter of fiduciary responsibility — to current shareholders and to future ones — that they should ensure a more equitable distribution of prosperity, lest their own wealth be dashed to bits on the jagged rocks of a shrinking economy.

Today, we face a similar predicament. The great challenge of business in our time is reversing the destabilizing threat of inequality. While at first this may seem anathema to our profit-maximizing mission, distribution of income lies at the very heart of sustainable capitalism.

For this reason, today’s titans of industry have stepped forward to protest the growing distance between them and the rest of the country. Warren Buffett, Lloyd Blankfein, Stanley Druckenmiller, Bill Gross — legends whose lives and words are studied and idolized at the Wharton School — have all gone public with the wise advice that we steer away from those jagged rocks.

They are not alone in their concern. According to a recent analysis by the Center for American Progress, 68 of the top 100 retailers cite the flat or falling wages of the average American household as a risk to their business — a number that has doubled in the past eight years. A recent poll of small businesses similarly found a strong majority of them in favor of raising the minimum wage.

These business leaders sense an essential truth about our capitalism: Workers are consumers. They spend what they earn — or what they borrow. While the latter may work for awhile, it has limits — and calamitous risks. The only sure way to grow the economy in the long run is to grow consumer spending — and that means growing worker incomes.

In recent decades, workers’ incomes have not grown much, on average. Since the beginning of the Great Recession, the average household has lost 8 percent of its income, after adjusting for inflation. All the growth — and then some — has gone to the richest 10 percent of Americans. And most of that growth — 95 percent of total growth, to be precise — has gone to the richest 1 percent. And most of that growth has gone to the richest 0.1 percent. And so on.

Unsurprisingly, economic growth has been slower since the advent of this new trend. From 1950 to 1980, real GDP grew 3.8 percent per year, versus only 2.7 percent from 1980 to 2010. On the rare occasions when it has approached its previous faster rate, it was fueled by unsustainable borrowing. This is no coincidence. Recent work by economists Özlem Onaran and Giorgos Galanis has shown that most developed countries experience lower growth when the share of their income going to wages (as opposed to profits) declines. In the United States, for example, every 10 percent decline in the wage share causes the economy to shrink by 9.2 percent. In fact, that has been the experience of the global economy as well.

High wages are what economists refer to as a “positive externality.” They generate “spillover effects” that benefit the people who don’t pay for them. When workers receive high wages, they invest more in health and education, increasing their productivity and reducing the costs we all pay for a sicker, less-informed population. They motivate firms to invest in advanced technologies to reduce labor costs, making them more innovative and globally competitive. Workers who receive high wages are less likely to go out on strike, vote against free trade and immigration, protest in the streets, shirk on the job and commit crimes. That’s why, in an analysis of 19 developed nations from 1960 to 2004, economists Robert Vergeer and Alfred Kleinknect found that higher wage growth consistently led to higher productivity growth.

In other words, low wages may be good for one firm, but high wages are better for all firms. Yet many businesses would like to raise wages, but they fear losing ground to their competitors.

The only solution is collective action.

Economists have a collective action for precisely this sort of “coordination failure”: taxing the negative externality and subsidizing the positive. It is time that we recognize inequality for the negative externality that it is, slowing our productivity growth, roiling our markets with volatility, gridlocking our political system, and starving our economy of willing and able consumers. Inequality is a risk to our businesses, and it ought to be treated as such.

We should therefore see taxes not as penalties but as investments in a better, more equitable, more sustainable system. We should strive to prevent a “race to the bottom” in workers’ incomes; if we don’t, the day will come when no one will be left to pay the profits our shareholders demand. Business schools should teach courses about this issue, and business leaders should address it in their boardrooms. It is not merely a political issue. It is very clearly the business of Business.

Joseph Kennedy thought so when he went to work for President Roosevelt. As one of the nation’s most notorious stock manipulators, Kennedy might have been the last person we’d expect to join Roosevelt’s crew, but when Roosevelt named Kennedy as the first chairman of the Securities and Exchange Commission, he saw it as an opportunity to save the market from itself.

“We of the SEC do not regard ourselves as coroners sitting on the corpse of financial enterprise,” said Kennedy in a radio address to the nation. “On the contrary, we think of ourselves as the means of bringing new life into the body of the security business.”

As Wharton graduates, let us think of ourselves in the same manner, and act accordingly.

The Minimum Wage Shows Why (and How) We Should Vote Today

It is time for the states to lead.

Every once in awhile in the history of this great country of ours, the federal government just can’t get the job done. Partisan gridlock, constitutional uncertainty, public distrust all play a role. But one of the great strengths of the American system is that the states — those laboratories of democracy, as Louis Brandeis called them — can act when Washington will not. Abolitionism, women’s suffrage, health care reform, gay rights: All started at the state level.

This is one of those times. Our national system is inert. Our national leaders are mired in the muck of inaction.

And yet there is hope. For today is Election Day, and on this day, we will elect 36 governors. This is no time to stay home when the polling places are open. This is a time to choose leaders who will act where Washington has not.

I can think of no better example of the choice we face as a country today than the minimum wage.

After World War II, Congress set the minimum wage at approximately half the average wage in the country. In today’s dollars, it was over $10 an hour. Earning the minimum wage, one full-time worker could support a family of three above the poverty line.

Today, the federal minimum wage is $7.25, less than 36 percent of the average wage. It’s so low that it can’t even keep a family of two out of poverty.

Unlike Social Security or Medicare payments, the minimum wage is not indexed to the cost of living. Only Congress can raise it. The last time they did so was 2009. Democrats proposed raising it again earlier this year, but the majority of senators opposed it.

The feds have failed to act. It’s time for the states to lead.

And we have ample evidence that they can. Twenty-three states already have minimum wages higher than $7.25. Five states — Alaska, Arkansas, Illinois, Nebraska, and South Dakota — have an initiative on today’s ballot to increase theirs.

But not everyone is onboard.

“I don’t think it serves a purpose,” said Wisconsin’s Republican governor Scott Walker last month.

“I don’t think as governor I want to be the cause of someone losing their job,” said Greg Abbott, the Republican candidate for governor in Texas, in explaining his opposition to raising the minimum wage. Pennsylvania’s Republican governor Tom Corbett made a similar argument when stating his opposition last year.

At least they pretended to know what they were talking about. When Republican Governor Rick Scott was asked what Florida’s minimum wage should be, he said, “How would I know?”

These men are on today’s ballot in four of our nation’s largest and most influential states.

And they are tragically out-of-step with the lessons of economic history. In a recent study, the economists Hristos Doucouliagos and T.D. Stanley survey the vast research that economists have done measuring the impact of the minimum wage in recent decades — 64 papers in total — and they find “little or no evidence” that minimum wage increases caused job losses.

On the contrary, raising the minimum wage is a clear boost to the economy. In another recent paper, the economist Arindrajit Dube found that raising the minimum wage significantly reduces the poverty rate, a finding that is consistent with the other 12 studies economists have published in recent years measuring the same effect in different ways.

Only a politician severely out-of-touch with the modern economy could think otherwise. Today’s corporations don’t have to cut back jobs when wages rise. They have to cut back profits, which are at an all-time high. In the long run, they might not have to cut back anything. Higher wages lead to higher productivity, better health, fewer strikes, lower turnover, and higher consumption, which in turn leads to more demand for their products and therefore higher profits.

Individual companies may not want to raise wages if their competitors won’t, but when everyone does it, everyone benefits.

Trying to save money by keeping the minimum wage low is like trying to improve your health by starving yourself. It’s classic shortsighted behavior, hardly the visionary leadership that we’d like to see in the governor’s mansion.

That’s why today’s election matters. In this age of do-nothing politics, it’s easy to despair, but we must remember the intent behind the design. The same founding fathers who created a federal system that resists radical change also created a state system that encourages experimentation. Today we celebrate their creation, and we direct its attention to the challenges of our time.

If the feds do not act, the states will. We the voters will make sure of it.

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This op-ed was originally published in the Huffington Post.

The Best Monetary Policy Is Strict Financial Regulation

On Wednesday, in her first speech on monetary policy, Janet Yellen, the new Chairwoman of the Federal Reserve, pointed out a discouraging paradox: In recent years, private-sector forecasters have been surprisingly accurate at forecasting changes in the unemployment rate, but they have been equally inaccurate when forecasting changes in the federal funds rate, the baseline interest rate controlled by the Fed.

Since interest rates supposedly have a strong effect on unemployment, how can forecasters be so right about unemployment if they’re so wrong about interest rates?

Three economists at the Bank of International Settlements — Morten L. Bech, Leonardo Gambacorta, and Enisse Kharroubi — have been studying this question, and coincidentally their results were published this week in the journal International Finance.

Bech and his colleagues amassed a dataset of interest rates and economic output for 24 industrialized countries from 1960 to today. Over that time period, these countries experienced 78 recessions, of which 34 were the result of financial crises like the one we experienced a few years ago. In each recession, the BIS economists measured how much the central bank lowered interest rates to stimulate recovery — and then how long it took for the economy to recover its lost output.

Unsurprisingly, they found that “normal” recessions — the ones without a financial crisis — were much less severe. On average, they resulted in an output loss of 1.9 percent, which it took the country 3.8 years to recover. Financial crises, on the other hand, resulted in an output loss of 8.2 percent, which it took 5.1 years to recover.

Monetary Policy in Different RecessionsWhat was perhaps more surprising was the fact that “accommodative” monetary policy — i.e. lowering interest rates — had no effect on the economy after a financial crisis. This wasn’t the case with normal recessions. Typically, the more the central bank lowered the interest rate, the faster the economy recovered its lost output. But not so with financial crises.

In times like these, interest rates simply don’t matter as much as they normally do.

That doesn’t sound like good news for Janet Yellen. What’s a central banker to do?

Fortunately, the BIS economists did find one thing that accelerated recovery from financial crises: private-sector deleveraging. After a normal recession, it doesn’t seem to matter whether households and firms pay down their debt, but after a financial crisis, it significantly speeds up economic growth.

As luck would have it, the Federal Reserve has a tool at its disposal that can reduce the economy’s reliance on debt. It’s called the “capital requirement,” and it refers to the difference between what a bank owns and what it owes.

When a recession strikes, asset prices fall, and since banks own a lot of assets, their value goes down. If they go down too much, they can fall below what the bank owes to its lenders and depositors, meaning it’s basically bankrupt. It doesn’t own enough to pay what it owes.

So the Fed sets a minimum capital requirement. The more capital a bank is required to have, the more it has to own relative to what it owes. It’s a buffer. The bigger the buffer, the more room asset prices have to fall before the bank becomes bankrupt.

Unfortunately, banks don’t like high capital requirements. They want to rely on debt. Why use your own cash when you can use somebody else’s cash? Lower capital requirements are cheaper — but they’re also more dangerous because it’s easier to go bankrupt when you owe so much relative to what you own.

Banks argue that high capital requirements restrain lending because they can’t borrow as much debt to fund their loans, but another paper published in the latest issue of International Finance debunks this myth. In it, the German economists Claudia M. Buch and Esteban Prieto study the behavior of German bank lending for the past 44 years, and they find that banks with higher capital actually issue more business loans.

This doesn’t come as a surprise to those of us who understand how banks actually operate. They don’t lend based on how much debt they can borrow. They lend based on how many loans they can sell. The more, the better. The only question is, will they fund the loans with cash or debt?

Janet Yellen may have her work cut out for her in this post-financial-crisis economy, but there is a way to stimulate the economy and prevent future crises. It all starts with financial regulation.

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This op-ed was published in today’s South Florida Sun-Sentinel and Huffington Post.

My New Book Has Been Published! Just in Time for the Holidays…

Letter to the One PercentAvailable in hardcover from Lulu Press, Inc:

Support independent publishing: Buy this book on Lulu.

Available in e-book format from Lulu Press, Inc:

Support independent publishing: Buy this e-book on Lulu.

Available in Kindle format at Amazon.com:

Buy from Amazon.com!

 What It’s All About…

Letter to the One Percent is exactly what it sounds like: a letter to the richest one percent of American households. It is a call to action, a plea for compassion, and a manifesto for the future. It tells the story of their extraordinary success — and how the other 99 percent of Americans missed out. It explains how this divergence caused household income to stagnate, forced millions of Americans into poverty, and triggered the worst financial crisis since the Great Depression. It appeals to the better angels of their nature to bear a higher burden — by paying higher taxes, empowering labor, and cracking down on white-collar crime — in order to reverse the damage done in the past three decades.

No other writer has dared to speak these truths directly to power. Every other mainstream book preaches to the choir. Only Letter to the One Percent is brave enough to challenge the rich to do what the country needs them to do. It is not an attack. It is not class warfare. On the contrary: It is a challenge to end the class war that the One Percent has been winning and the 99 Percent has been losing.

No other political subject is as timely as this one. No other economic trend is as pivotal. From the financial crisis in 2008, to Occupy Wall Street in 2010, to the presidential election in 2012, the divergence between the One Percent and the 99 Percent has been the most talked-about issue in American current events. And yet, no one has synthesized the causes and consequences of it in a succinct, yet comprehensive, book. No one has translated the protests and the politics into the simple pocketbook impact that it has had on the average American household. This is the biggest story of our time, and Letter to the One Percent is the first book to tell it fully, accurately, and unflinchingly.

Advance Praise for Letter to the One Percent

“In just 85 pages, the brilliant young economist Anthony W. Orlando analyzes the events of the past thirty-five years and thoroughly explores the rise of the One Percent at the expense of the rest of us. It is truly a manifesto for the 99 Percent and should be read by every one of us.”

— Reese Schonfeld, founding President and CEO of CNN

Letter to the One Percent is an excellent primer and refresher course on macroeconomics. It helped me understand why the U.S. is experiencing the current economic state of affairs. It is also a compassionate call to action. At first, one may not agree with the basic thesis, but it makes complete sense. I am now a believer and highly recommend this read.”

— Mark Itkin, Co-Head of Worldwide Television at William Morris Endeavor

“Anthony W. Orlando has written a short dossier and critique of America’s descent into a very troubled and vulnerable society. He presents it in the original form of a letter chastising the One Percent for these policy failures and urging them to get hold of themselves and opt for decency and long-run survival. But he also provides a small storehouse of ammunition for the 99 Percent to use in their self-defense.”

— Edward S. Herman, Professor Emeritus of Finance at the Wharton School of the University of Pennsylvania, bestselling co-author of Manufacturing Consent: The Political Economy of the Mass Media

“Anthony W. Orlando has the unique ability to translate complex economic phenomena into everyday, nuts-and-bolts language. He speaks for a brave new generation with a voice that deserves to be heard.”

— Susan M. Wachter, Professor of Real Estate and Finance at the Wharton School of the University of Pennsylvania, former Assistant Secretary of the U.S. Department of Housing and Urban Development

“…this well-researched, carefully cited book is a valuable resource for understanding how the country got in such a perilous position and what can be done about it. Using a clear, authoritative writing style,…Orlando…manages to present an impressive number of facts without overwhelming readers. In particular, the statistics he presents are startling, even for those who closely follow the state of the economy.”

— Kirkus Reviews

The Fault Lies Not in the Stars But in Our Politicians

As I predicted on this page at the beginning of the year, the housing market has turned the corner.

The Zillow Home Value Index experienced the first year-over-year increase since 2007, the fourth consecutive month of increasing value. The Federal Housing Finance Agency also reported the fourth straight month of rising home prices in May.

At their current rate, new home sales are on track to beat last year’s numbers by 17 percent. Compared to a year earlier, the inventory of unsold existing homes has been declining for sixteen consecutive months. In fact, this month we saw the biggest drop in inventory ever reported.

Last month, housing starts reached their highest level since October 2008. This month, home builder confidence reached the highest level since March 2007. Foreclosures in distressed markets like California have reached their lowest level since 2007.

In other words, our long national nightmare is over.

And yet, our malaise has only deepened. Output growth is weak, unemployment remains stuck at 8.2 percent, and the twin engines of growth — exports and manufacturing — have stalled. If the cause of our discontent has reversed course, what fresh hell is holding us back?

Some of the blame belongs to the European Union, whose weakness has driven the euro down, making the U.S. dollar more expensive. As a result, exports have flatlined, along with the manufacturing sector that depends on them.

But the real sand in the wheels has been the cutbacks in Washington.

No, that’s not a typo. Despite all the news you’ve heard about the big bad budget deficit, the truth is that the government has been retreating, leaving the private sector to fend for itself.

In the two and a half years since the end of the recession, government spending, adjusted for inflation, has fallen by 2.6 percent. Government purchases have also fallen by 2.6 percent. Government employment has fallen by 2.7 percent.

Compare that to the two and a half years after the end of the 1982 recession, over which Ronald Reagan presided. By this point in Reagan’s term, government spending had increased by 10.2 percent, government purchases had increased by 11.6 percent, and government employment had increased by 3.1 percent.

Or we could compare to George W. Bush. From 2000 to 2007, government spending grew faster than it has from 2007 to 2011.

Any way you measure it, government spending growth has been very weak.

From 1980 to 1984, real government spending increased over 14 percent. From 2008 to 2012, in contrast, it has increased only 6 percent. And, since the beginning of last year, it has turned negative. In fact, this year, real government spending per capita is falling faster than it has since the aftermath of the Korean War.

But the real bloodbath is yet to come. On January 1st, $110 billion in automatic spending cuts are scheduled to kick in, followed by over $1 trillion more in spending cuts and tax increases over the next decade — unless, of course, Congress enacts a new law to postpone them.

Republicans are particularly concerned about this so-called “fiscal cliff,” not only because they abhor tax increases, but especially because half of the spending cuts will come from the Pentagon. Democrats are equally concerned about the possible extension of the Bush tax cuts for the rich, which are scheduled to expire at the end of the year.

So Democratic Senator Patty Murray made them an offer: We will agree to postpone the “fiscal cliff” if you will agree not to extend the Bush tax cuts for household incomes above $250,000.

Senate Democrats held up their end of the bargain on Wednesday, passing a bill to extend all the Bush tax cuts below $250,000. But Washington insiders say that the bill is as good as dead in the Republican-controlled House.

House Republicans, it seems, are determined to hold the economy hostage to the selfish interests of the rich — yet again.

But it doesn’t have to go down like this. Weak economic growth is not a fait accompli. The fundamentals of our economy are improving. The recovery will accelerate…if the government steps up like it did in previous recoveries.

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This op-ed was published in today’s South Florida Sun-Sentinel.