An Interview with Economist James Galbraith

by Matt B. on October 16, 2010

In your writing, you express dismay at the quality and ideological content of American public discourse, particularly around economics. In your view, what’s missing from our public conversations and public understanding of economics?

I think it’s not so much what’s missing, but all the stuff that’s in it that’s demonstrably nonsense. That’s what disturbs me. So although we could take up almost any aspect that you have an interest in, and I could give you examples, [let’s] take up one that’s been what’s on my mind for many years…the study of economic inequality.

Economists very early decided that the major forces were large, impersonal forces which were either beyond the control of workers or matters which they could only handle at the individual level by such measures as investing in training and education. When you examine the data, you come to a substantially opposite conclusion that in fact the rise in inequality had everything to do with the way monetary policy and tax policy are conducted and [the way] broad public policy was designed, just for example.

In the first weeks of our Econ 101 class, professors lay out of series of conditions necessary for the proper functioning of free markets – transparency of information, no monopolies, that kind of thing. I was struck by the gap between this relatively nuanced understanding of what it takes for markets to function and the simplistic way we talk about the economics in the public square.

Well, I think what any sentient undergraduate realizes early on – they may forget it when they get into the second class in economics – but early on in the first class, it’s clear that the conditions for this hypothetical free market to function exist nowhere and never have. It’s a construct which is a pure artifact of the imagination, which raises the question “Why on earth spend time on it?” What’s the function of studying a construct which has no counterpart in human society? As I say, it never has had any such counterpart in human society.

It just seems to me that the function – if there is one; it’s sort of like the effect – is to distract people from the study of actual economies and actual economic problems. I’m not saying that economics classes don’t veer toward the discussion of reality as they develop – at least they used to…you start with perfect competition and move on to imperfect competition and monopoly and so on. You…start with self-contained free markets and move on to a discussion of externalities and public goods, and so on and so forth. Those things may still be in the curriculum.

But the whole structure of theory is strange because it treats every important case as though it were a departure from the ideal, rather than acknowledging the obvious that there are no transactions without externalities, there are no markets that don’t have elements of market power, and there are no sophisticated advanced economic systems that aren’t defined by a functioning effective regulatory structure.

If one started from that point of view, first of all you would not give aid and comfort to a lot of nonsense, but you would also, I think, have a subject which was substantially more worth studying.

You sound frustrated that what you take to be relatively obvious observations about the world haven’t been more readily adopted by economics departments. Why do you think that is?

Oh, economics departments are, broadly speaking – I’m not talking about here, in particular – but broadly speaking, they’re closely aligned with business schools, or their functions are strongly influenced by the political beliefs of backers. They also have become a kind of self-contained and very hermetic fraternity, in which expressing skepticism of the foundations of the subject tends to get you exiled to public policy schools or liberal arts colleges or other lesser spheres in the academic constellation.

Given everything you’re describing, I’d at least hope that you’d make more headway in private conversations with some of your colleagues. Do you get the sense that there’s a gap between the institutional postures that you describe and the individual views of professional economists?

Private conversations with an economist on economic theory – I don’t think I’ve had one of those since graduate school.

Is that right?

I don’t think it happens very much; at least, it doesn’t happen in my circles or with the economists that I have maintained contact with. No, I don’t think there’s a whole lot of interest actually in the formation of economic theory amongst practicing economists, interest in particular problems and the expression of particular thoughts or arguments in the journal literature, particular bits of research that we’ll do. And of course, the economists have gone off in other directions. I mean, many of them have adapted to this in practical terms. Most of them are turning their backs on theory and doing behavioral economics or some other departure that they find interesting.

But that leaves the teaching, the material that you’re describing, in a state which has not been renewed and not subject to, really, a reexamination as a result of the fact that there are very few people who are actually developing and pursuing theoretical work along the lines I was just discussing.

If you could imagine your most incisive and articulate ideological opponent – and I use the word “ideological” softly – how do you imagine him or her responding to the landscape that you’ve just described?

I have trouble with that question because I generally don’t think of myself as having or representing an ideological position. My work is applied, statistical. If you look at what I publish in the technical literature – there’s actually quite a lot of it – it’s rooted in an evidence-based method. When I speak on policy questions – and we may come to that – people may describe me as a progressive economist, left of center or whatever; I mean, I don’t care what terms people use. But I’m not seeking to represent the point of view of a political community.

I’ve taken certain positions, for example, on the financial crisis, because they seemed to me to represent the only effective way to deal with the crisis. I’m not sure whether my ideological opponent that you describe would be a libertarian or a conventional liberal. In some ways, I might have an easier time finding common ground with the libertarian in some cases

You head an organization called Economists for Peace and Security. Can you describe a bit about the work that the organization does?

Well, first of all, Economists for Peace and Security is an organization of professional economists, a global network of affiliated organizations. Its principal concerns have been with the problem of conflict and the problems of war and peace and armaments spending. Certainly in the time that I’ve been associated with it, it’s put a great deal of effort into raising awareness of the cost of war. Then, of course, the great work on this has been done by Linda Bilmes and Joe Stiglitz, who are closely affiliated with the organization. We’re very proud of the impact that they have made, the exceptional amount of meticulous work, calling attention to new dimensions of the cost of conflict, which simply weren’t there in previous generations and previous wars.

The organization also – I mean, it feels that the members and leadership of the organization had to play a role, as any policy-oriented community of professionals would, when the financial and economic crisis broke three years ago. It’s been very active in organizing discussions about the nature of the crisis and discussions about the direction of policy that we should be taking.

I’m going down to Washington tonight, so that tomorrow we’ll do a symposium focused on two things: One is this question of the long-term budget deficit, what it does or does not mean for policy; secondly, on the role played in the economy by Social Security and Medicare. There’s a great danger right now [that] hysteria over the supposed implications of long-term budget projections will be used as an argument to justify major long-term reductions in Social Security benefits and Medicare benefits. This strikes me, and I think it strikes us, as a very dangerous possibility and we’d like to – certainly I know that some of the people with us tomorrow will be making as strong an argument as we can against doing that.

I read some of your exchange with Michael Kinsley recently –

Yeah, this was an interesting reflection on the state of thinking in the policy community. Mike Kinsley simply accepts as axiomatic, practically, the two basic principles of Washington thinking: One is that the sky is about to fall or will eventually fall as a result of the budget deficit. The budget deficit projections of the Congressional Budget Office are treated as sacred gospel not to be examined by mere mortals. Secondly, that the way you deal with this is by cutting back on those awful, out-of-control entitlement programs.

The reality is, first of all, that the Congressional Budget Office’s baseline projections, which I cannot imagine are a central activity of the CBO, in the sense that I can’t imagine that the underlying structure has been a subject to a careful review by skeptical, competent professionals anytime recently. There’s a mishmash of mechanistic projections which are mutually inconsistent and simply represent a picture of a future reality, which I think anybody looking at them, any economist looking at them in a serious way would say, “No, I’m sorry, that can’t happen.”

I could go on in some detail but just to give you one example, the CBO projects that the share of the interest payments on the public debt will rise to above 20% of GDP – four times the Defense budget – and at the same time projects that inflation will stay at 2%. These two things are utterly mutually inconsistent. As they’re pumping out 20% of the GDP in checks to people, you have to imagine they will spend them and something is going to happen with the underlying total expenditure number, which will be reflected in nominal GDP. This reality just hasn’t clicked inside the CBO, so they’re pumping out something which has a…large terror factor but…reflects an economic future which simply does not withstand scrutiny.

…On Social Security and Medicare, the reality there is that there is nothing unsustainable about a program which transfers resources within the community of elderly people, from people whose families would otherwise support them to the many people who don’t have families who would support them. It’s an internal social transfer mechanism and the notion that we need somehow to curtail it also doesn’t withstand scrutiny.

So I’m glad you brought up the CBO. I know you worked in the Congress in the late 70s or early 80s, both with the House Banking Committee and the Joint Economic Committee.

I can imagine there’ll be some interest among students of the Kennedy School in understanding the workings of the CBO a little bit better…

Sure. What CBO is there to do is to help members of Congress understand the budget implications of particular pieces of legislation. So you have a proposal, you have the budget impact, you send it to the CBO and they provide cost estimates. In order to do that, they have to have a standard economic baseline, because otherwise, you can get any number you want out of a projection. So they do all of this comparison against a common forecast, and that’s, as far as it goes, a legitimate activity.

The problem comes in treating that forecast as though it represented a plausible economic future and using the numbers for the purposes of analyzing the macroeconomic condition. First of all, the CBO has no particular forecasting competence….It’s not what it does. Secondly, it has, I think, not reviewed its own work in this area for self-consistency and plausibility. As a result, you’ve got a great many people who’ve picked up on this baseline, and because the CBO is non-partisan and professional, they treat it with a great deal of deference. But in fact, it’s an extraordinarily poor foundation for thinking about economic policy.

It’s not just the long-term. One of the things that’s in the CBO model is a concept you might have encountered in an economics class, the natural rate of unemployment. The role of that in the CBO model is that in five years, the unemployment rate is set to fall back to some 5-and-some-percent number irrespective of what policy may be. So if you take that seriously, you never need to react to a crisis, because the model tells you that the economy’s going to grow. That’s in the forecast, no matter what.

Why don’t they hire better forecasters? I mean-

It’s not strictly a CBO problem. This is a problem of economic thought and all forecasters.

It’s a defective forecasting process. You have to be able to make the judgment call at a given moment, that you’re in a crisis of a type you haven’t seen before and this is likely to produce very unsatisfactory results for a long time unless you act. No mechanical forecast is going to get you to that point, because they’re all based upon the last 40 or 50 years of statistical record. So they’re intrinsically unable to go beyond that envelope and to say, “Hmm, we’re just seeing something we haven’t seen since the 1940s. What does it mean?” That’s a problem that the CBO had. It’s a problem the administration had in designing, thinking about its stimulus package.

Before we get to your views on the stimulus bill, I wanted to ask about one of your recent books, “The Predator State.” In that book, you describe a government essentially cannibalized by private interests. Can you say a little bit more about your vision here and whether you think things have improved at all under the Obama administration?

What I set out to do in the “Predator State” was to call attention to the fact that the core institutions of our economy are the support networks that link the public and the private sector. We tend to think, as economists brought up in a tradition of classical political economy and modern economics, in terms of the production and distribution of goods. The reality is that’s an increasingly small part of who we are and what we do. The economy of the United States since the 30s – 60s especially – has revolved around health care, which is not a market-based industry, around education, around housing and housing finance, around the support of people in their old age, the pension system and Social Security.

When you look at these institutions as central rather than peripheral to who we are and how we live, then you come to appreciate that they’re intrinsically public constructions with private elements built in. The educational system is an example. Higher education as an example of that – you have, at all levels, public schools and public universities, and private universities with large tax advantages. The whole system is an ecology which has been fostered by structures of public policy.

My argument was that modern conservatism wasn’t at all about reducing the role of government or getting government out of our lives and out of these systems. It’s simply about recognizing that this is where the real power structures and major resource usage in the economy really is and taking control of it and the view – and this is very clear in the last administration – of passing out the levers of control to political supporters and personal friends and allowing a rake-off, and in a sense, exploiting the public institutions for private benefit.

I mean, let’s take the notorious example, Medicare Part D – the Bush administration’s drug benefit – which alienated many conservatives, a great expansion of federal activity but constructed in such a way so that the pharmaceutical companies could get the maximum benefit out of it. It’s just a textbook case.

I have to say, you know, making this point – and the subtitle of the book is “How Conservatives Abandoned the Free Market and Why Liberals Should Too” – I got a great deal of favorable reaction from conservatives, from philosophical conservatives, you simply point out to them that the Bush administration is not a small government conservative, and nobody could dispute that argument. This was an administration of the captains of the industry in particular sectors lined up one after the other to take control of the regulatory structures.

And particularly disastrous – I mean, it’s harmful everywhere you see it – but the particularly disastrous instance of the “Predator State” was in the financial sector. It’s a very clear line of causation from the relaxation of regulation in the financial sector, takeover of regulation by people who are permissive about underwriting standards, regulatory enforcement. This goes back to Clinton, but particularly in the Bush years. It’s what led to the takeover of the health and finance industry by what was effectively a large criminal network.

The police were taken off the beat in a literal sense. Right after 9/11, 500 FBI agents who had been assigned to financial fraud were reassigned to counter-terrorism, which is understandable, but they were never replaced. One could go on. The list of activities that led to de-supervision of that sector is very long.

So what happens in this situation is that when the players lose confidence in the integrity of the markets, realize that they have been corrupted, markets collapse and it’s extremely difficult to restore them. It’s extremely difficult to restore them because when a market is infested with counterfeits, you can’t tell a counterfeit from the genuine article, so you can’t tell what’s a good or bad credit so the market for everything collapses. That’s the fundamental problem that we face.

Now you asked whether the Obama administration improved matters. I think the Obama administration has been working diligently on a number of areas to improve regulation. But in the financial area, they made, I think, a fundamental mistake or decision early on to continue the post-crisis policies of Paulson and Bernanke, fundamentally, and of Tim Geithner as president of the New York Federal Reserve, which was to preserve the institutions at all cost and to continue the cover-up of the extent to which they had been ruined by the toxic assets, and to fail to conduct the kind of thorough cleansing of the leadership of the toxic institutions that might stand a chance of restoring them to some basic and healthy function.

Having failed to do that early on, they now confront a situation where the banks have been propped up but are doing nothing for the economy. This is, I think, the cause of the rather grim political outlook that we now face.

So if you were sitting on the Council of Economic Advisers or the National Economic Council, what would you be telling the President to do now?

I’ll answer it in two parts: what they should have done and what they could do now. In February or March 2009, the new administration could and should have turned over the most endangered, crippled, compromised banks – especially Citigroup and Bank of America by all accounts – to the FDIC. They would have been closed on Friday, reopened on Monday under new names. The top management would have been removed and you would have had audits. The regulators would have gone in and gradually decided, figured out how to restructure, downsize, split them up. You would have put in an insurance fund to make sure that there was no run.

Life would have gone on, but the financial sector would have been reduced in size and you could have dismissed the lobbyists and you would have had much less difficulty with financial reform, and you could have set up and enforced an effective compensation model, so you wouldn’t have these institutions essentially paying themselves whatever they like while serving no useful economic function.

But now you’re in the situation where you have allowed them several years of making lots of money with no effort, borrowing from the Federal Reserve at zero and lending back to the Treasury at 4%. This is good work if you have a bank charter. I think that in the banking sector, clean audits and appropriate criminal referrals would still have a very important positive effect. But that’s not an answer to the question, “How do you deal with the problem of the economy, given that your major strategy, which was to get the banks lending again, has failed?”

Right now, if you wanted to intervene decisively, the first place to do it is in the foreclosure crisis. Again, there is an important legal issue at stake here. We are now, as we are now seeing in the press, an environment, where someone described if for me as “the getaway car for all the financial fraud is a vast industry of foreclosures,” foreclosures which are being carried out in many, many instances without proper documentation, without proper due diligence, in many cases with documents that have been faked and forged just as the original mortgage is forged. Judges in Florida and elsewhere are either confronting this fact or ignoring it, and you can see it in the papers in their courts.

So if you wanted to make an intervention which would have an effect on people’s lives and help change the political climate, put the government on the side of the middle class instead of the banks, this is the issue right now.

In terms of jobs, the critical error in the articulation of strategy in the early Obama administration was the use of the word “stimulus” – a dreadful term which implies that everything’s going to be okay in a couple of years. You know, get the engine going again and things- just in that one word, you have a massive misunderstanding. Not to say that the bill was a bad thing to do, the bill was a good thing to do, but the impression it conveyed – and this I fault the leadership, I fault Larry Summers and Tim Geithner, I fault the press, I fault practically everybody for instinctively using the term when they should have had a message, which conveyed the fact that we had suffered a major crisis and the solution had to be long-term and strategic.

The President has now, I think, got this. The word “stimulus” is no longer being used. They are now talking in terms of the strategic direction. This is a very important constructive step, but they should have had heads knocked together on this two years ago, but nevertheless-

Job creation, some of which can be public but most of which has to be in the private sector, needs to be structured by a strategic vision of what it is that the American economy is trying to achieve. We’ve had this in the past. In much of the post-war period, it was middle-class prosperity. We built houses, roads and so on. In the 90s, it was information technology. If you go back to the Clinton and Gore administration, the President and Vice President talked about this practically every day. Now, rightly or wrongly, it was kind of a national obsession. At the end of that period, vast amounts of money were flowing into this sector – again, rightly or wrongly – but there was a vision about what it was the economy was going to do. It was kind of a pole of attraction, if you like.

But it’s clear – it seems to me or to anybody who’s alive at this moment in the 21st century – that the need, the demand, the obligation, is to deal with energy and climate change. We have to reconstruct the country, the consumption and production of energy, in such a way as to meet that challenge. Beyond prevention, there’s mitigation, because climate change is happening and is going to have extraordinarily damaging effects for which we need to be prepared. Well, that’s something from which we can construct a framework that would motivate both public action and private investment for decades, and that’s what we need to do. That’s the first point about jobs.

The second point is that a great many people have lost their jobs – who are my age or older – and who are not going to find new work. But [as] jobs are restored, they are going to go to younger people, people who are freshly educated, and people who are healthier and who need the jobs more because they’re setting out, they’re starting families. The last thing you want is to have young people leaving high school or college and waiting ten years before they get a steady employment.

So we should recognize this reality and move as many people – I’m now talking about ordinary working people – older ordinary workers out of the labor force as we can. The way to do that is to make their retirement option more comfortable. So what I’ve called for is a reduction for, let’s say, three years in the Social Security retirement age, so that you would be able to retire with full benefits at 62. If you’re ready to retire, you’ve been standing up behind a check-out counter for 25 years, many people in that situation would love to be able to get out. Let ‘em get out.

Similarly, reduce the age of eligibility for Medicare, so that you have a great many people who – I don’t know what the numbers are, but every time I raise this, there’s applause in the audience, so it’s not insubstantial who are holding on to their jobs because they can’t afford or are afraid to give up their employee-based health insurance. Again, let those people out. Those are exactly the people who least want to be going to work every day, and when they vacate those jobs, they’re vacancies for other people to fill.

James Galbraith teaches economics and a variety of other subjects at the LBJ School and UT Austin’s Department of Government. He holds degrees from Harvard and Yale (Ph.D. in Economics, 1981). He studied economics as a Marshall Scholar at King’s College, Cambridge, and later served on the staff of the U.S. Congress, including as Executive Director of the Joint Economic Committee, before joining the faculty of the University of Texas. He held a Fulbright Distinguished Visiting Lectureship in China in the summer of 2001, and was named a Carnegie Scholar in 2003. His recent research has focused on the measurement and understanding of inequality in the world economy, while his policy writing ranges from monetary policy to the economics of warfare, with forays into politics and history.

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