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Dean Baker on How We Can Make the “Free Market” Work for the 99 Percent

In the post-War era, as a large American middle class emerged, the top 1 percent of households took in 10.02 percent of the nation's pre-tax income. In only eight of the years between 1946 and 1980 did they grab 11 percent or more, and only in one year — 1946 — did they consume more than 13 percent of the pie. After Ronald Reagan arrived on the scene, things began to change. In his final year in office, those in the top 1 percent grabbed 15.5 percent of our pre-tax income. And in the 10 years before the Great Recession hit, households at the top of the pile grabbed 20.3 percent — twice as large a share as they'd enjoyed when the “Greatest Generation” were making their mark on the world. So the reality is that the “other 99 percent” have been sharing an ever smaller piece of our economic output. Was this shift an accident? Did the wealthy get smarter or start working harder? Was it an act of God?

In the post-War era, as a large American middle class emerged, the top 1 percent of households took in 10.02 percent of the nation's pre-tax income. In only eight of the years between 1946 and 1980 did they grab 11 percent or more, and only in one year — 1946 — did they consume more than 13 percent of the pie.

After Ronald Reagan arrived on the scene, things began to change. In his final year in office, those in the top 1 percent grabbed 15.5 percent of our pre-tax income. And in the 10 years before the Great Recession hit, households at the top of the pile grabbed 20.3 percent — twice as large a share as they'd enjoyed when the “Greatest Generation” were making their mark on the world.

So the reality is that the “other 99 percent” have been sharing an ever smaller piece of our economic output. Was this shift an accident? Did the wealthy get smarter or start working harder? Was it an act of God?

Not according to Dean Baker. The economist has been trying for some time to get people to understand that conservatives who claim to have a profound love of free markets have no use for them; professing fealty to the markets is only a rhetorical strategy. They favor policies that distort the market in such a way that income and wealth flows to those at the top, but given that most people who cast votes in our elections are not among that rarified few, they have no desire to defend those policies on their merits. So conservatives claim that this is simply the way the “hidden hand” works, an organic process uninfluenced by policy-makers.

This was the subject of Baker's 2006 book, The Conservative Nanny State, and it's a topic he's returned to in his latest, The End of Loser Liberalism: Making Markets Progressive. (Download a free electronic copy of the book here, or purchase a paper version here.) AlterNet caught up with Baker to discuss his new book.

Joshua Holland: Dean, you really hate it when progressives accuse the right of engaging in “free-market fundamentalism.” You write that “the vast majority of the right does not give a damn about free markets,” and you argue that progressives end up helping them conceal their true agenda. Can you unpack that?

Dean Baker: The right is about getting more money for the wealthy — full stop. This is not true for every person claiming conservative principles, but it is certainly the goal of the political leadership of the right. These are not people who care about free markets, they care about redistributing money upwards. In The End of Loser Liberalism, as well as prior work, I've tried to document how in every area of public policy we see, conservatives are often happy to have the government intervene.

Just to give a couple of examples, in the case of finance, the right never wanted to see the removal of the government from the market. There were few prominent conservatives who were arguing to get the government out when the banks were teetering on the edge of collapse after the Lehman bankruptcy. They wanted the government to come in and bail them out. Similarly, almost no one advocates the end of government deposit insurance or the back-up lines of credit provided by the Fed through the discount window.

What the financial industry wants — and what conservatives generally support— is to have these incredibly valuable government safeguards without restrictions on the banks' behavior.

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A second prime example is government patent monopolies for the prescription drug industry. These government granted monopolies make drugs expensive. Chain drugstores routinely sell generic drugs for around $5 per prescription. In the absence of patent protection, virtually all drugs would be available for around $5 per prescription. Instead, patented drugs average well over $100 per prescription. As a result, the country spends close to $300 billion a year — around $1,000 per person — for drugs that would sell for around $30 billion without patent protection.

In both these cases, the industries are pushing policies that have enormous distributional consequences that have nothing to do with the free market. Yet, they claim that the policies they favor are free market policies, and progressives give them support in this position when they denounce them as “market fundamentalists.”

Of course, it sounds much better to be fighting for free market principles, than to be fighting to increase bank and pharmaceutical industry profits. Progressives do the right an enormously valuable service when we imply that they are committed to free market principles instead of just making the rich richer.

JH: I think progressives are wary of embracing free market arguments because of the widespread belief that you can't have a free market and a robust safety net. Now, that strikes me as a false dichotomy. We can distribute tennis shoes via the market and also provide public goods that the market has no incentive to provide — you can't get rich offering poor kids free lunches. Is there really a tension between the two?

DB: I really don't see any tension whatsoever. There are certain guarantees that almost everyone thinks should be provided to the population. At least in principle you will find that this view is held over a fairly wide range of services among a broad segment of the population. For example, almost everyone believes that the country has a responsibility to educate its children, to provide some limited level of health care and to provide pensions to workers in their old age. Views on how these services should be provided may differ as well the extent to which individuals may be expected to contribute, especially with the latter two, but the notion that society bears some responsibility in these areas is almost universal. Even conservatives support Social Security and Medicare by overwhelming margins.

Our fights on these issues usually are over the best way to provide these services. The right generally claims that they can better provide these services through the private sector. In 20 years of debating Social Security I don't think I have ever come across a conservative who argued that workers should just be on their own – invariably they would say that their private mechanism for providing Social Security was better than the public system.

This could be shown not to be true. Privatized systems have administrative expenses that are 10-40 times higher than the extremely efficient Social Security system in the United States. And unless the private system comes with government backing, it cannot provide the same sort of guaranteed income flow as Social Security. But this is where the argument should be. The right is not trying to get rid of Social Security out of a commitment to the market. They are trying to restructure the system in a way that will provide enormous profits to the financial industry.

Here again, I can see no reason why progressives would want to argue about free market principles. Most people like the free market. Why not just rely on the truth — conservatives want to destroy an efficient public system and replace it with a private system that will take money from their retirement income and give it to the financial industry.

Conservatives might win an argument about giving workers choice. They will not win an argument about taking away workers' money for the benefit of the financial industry. This is what is actually at issue, let's keep the debate there.

JH: So how do you think these ideas — that conservatives are champions of free markets, that there's an inherent tension between a “free market economy” and a robust safety net — became so deeply entrenched, so pervasive? Is it just the power of repetition?

DB: I think it is in large part a historic legacy dating back to when the right argued against establishing a welfare state based on market principles. One outcome of this is that many progressives embraced this framing and took our enemy to be the market.

Of course we also have a whole tradition of the left embracing socialism in which it was felt that public ownership of the means of production was an end in itself because the market was inherently corrupt and inevitably led to socially undesirable outcomes. There are few on the left who would still argue that large-scale public ownership of industry is desirable, but I think the dichotomy of government being “good” and market being “bad” still persists.

If there is one thing that I hope people would take away from my book, it's that we can get very different market outcomes, depending on how we structure the market. The right has been very deliberate in rigging the markets in ways that redistribute income upward. They absolutely do not want to own up this this rigging; they want to pretend that Bill Gates' and Angelo Mozilo's incredible wealth just sort of happened.

This is of course not true. When we just complain about the outcome, rather than the structures that led to the outcome, then we are in the realm of loser liberalism. We want to take from the winners to give to the losers. It is also likely to be a losing political strategy. Our focus has to be on reversing the rigging so that the benefits of the market are shared widely instead of just going to a wealthy elite.

JH: OK, let's dig into a few specifics. Help us understand why progressives are, as you write, “rooting for the other team” when they cheer a run-up of the stock market? What's wrong with that? Isn't a strong stock market essential to a healthy economy?

DB: This is really Econ 101. (It would be great if economists knew it!) In principle, the value of the stock market is supposed to be the current value of future profits. If we accept this definition, then when the stock market goes up, it means that the expected amount of future profits has risen. This could be good news if people are expecting higher profits because they expect better economic growth and corporations will share in that growth.

However, people may expect higher profits because they think that workers have little bargaining power and therefore profits will rise at the expense of wages. They may also anticipate that corporations will be able to use their political power to win tax breaks. Therefore their profits will rise due to a lower tax bill, but this will shift the cost of government services to everyone else. In both of these scenarios, higher stock prices would imply a bad story for most of the country. They would only be good news for people who own lots of stock. And, even with the growth of 401(k)s, only about a quarter of the population owns anything that could be considered a significant amount of stock — at least $25,000 worth.

It's also important to understand that there is little feedback from stock prices to investment. A higher stock market may lead to a modest increase in investment, but companies rarely finance investment by issuing stock. In fact, a rising stock market will primarily affect consumption, as people spend more money based on their stock wealth. So the main economic impact of a higher stock market is that people with lots of stockwill be driving up house prices as they buy more and bigger homes, driving up college tuitions since they can afford to pay more for college and crowding the rest of us out restaurants. If this is something to celebrate, I sure can't see why.

JH: One of the threads running through the book that stood out for me was that, because progressives don't necessarily have a great grasp of these mechanisms by which the markets are rigged, we end up devoting a lot of time and effort sweating the small stuff rather than tackling what you might call the core inequities in the system.

And you discuss the role of the Federal Reserve bank, which I think gets a lot more attention from the right than it does from the left. Can you just briefly give me a sense of how Fed policies have shifted since Ronald Reagan came into power, and how that's impacted the outcomes of working people?

DB: In the book I identified the value of the dollar and the Fed as two central fulcrums of economic power. In both cases, progressives barely pay any attention.

In the case of the dollar, suppose the dollar increases in value against other currencies by 20 percent. Holding everything else equal this effectively means that U.S.-produced goods rise in price by 20 percent compared with goods produced elsewhere in the world.

This is going to kill workers in industries that are subjected to international competition, most obviously manufacturing. However, it will be good news for doctors and lawyers and other workers who are largely protected. Since they are protected, their own wages will be little effected. However the price of all the goods they buy will fall by 20 percent. This should be a huge issue, but how many progressives could tell you anything about the trends in the value of the dollar?

The Fed is the other huge lever. The Fed, if it chose, could focus on creating more jobs even if it risked higher inflation. It chooses not to do this. It places a huge focus on keeping inflation under control and is prepared to cause a lot of unemployment to achieve this goal.

Very few progressives understand the Fed's role in determining the unemployment rate and many of those who do think it's inappropriate for political figures to attempt to influence the Fed. The flap around Governor Perry's comments about Bernanke when he entered the president race were very instructive this way. Certainly it is inappropriate to imply that you are going string up the Fed chair if enters Texas because you don't like his monetary policy. And the substance of Perry's criticism was way off base. But there is no reason whatsoever that someone running for the presidency should not be saying that they disapprove of the Fed's conduct of monetary policy and would appoint people who would take it in a different direction.

The right understands this. They do pressure the Fed. If progressives just ignore this incredibly important policy making body we are ceding one of the key levers of economic policy. We can run around playing with jobs programs begging politicians for few billion dollars here or there, but if the Fed is raising interests to slow the economy and prevent inflation, then we are just wasting our time. The Fed absolutely can keep people from getting jobs if this is part of its low-inflation strategy and nothing Congress might do will offset the Fed action.

JH: OK, I think we need to step back and explain that a bit. Can you just touch on this idea that the Fed ostensibly has a dual mandate, and explain what people mean when they accuse it of holding an anti-inflationary bias?

DB: The Fed has two vaguely defined goals: price stability and full employment. The former means containing inflation, while the latter means keeping the unemployment rate low. To my mind, the focus should be overwhelmingly on the latter. Unemployment involves enormous suffering, especially in a country like the U.S. with a minimal welfare state. In many European countries it is possible to maintain a decent standard of living while unemployed since health care is covered and benefits tend to be far more generous.

In the United States, being unemployed for any substantial period of time virtually guarantees a near-poverty-level existence. People lose their homes, families break up, kids get dragged from school to school as their parents move in search of housing or jobs.

It's also important to remember that unemployment disproportionately hits the disadvantaged. When we see the unemployment rate rise, most of the people who lose their jobs are likely to be retail clerks, factory workers and custodians. They will not be doctors and lawyers. As a rule of thumb the unemployment rate for African Americans is twice the overall rate and for black teens it is six times the overall rate. So higher unemployment for the population as a whole is really bad news for disadvantaged segments of the population.

So what this policy amounts to is subjecting certain segments of the population to high unemployment in order to depress their wages. That will then contain costs and reduce inflationary pressure. This means, in effect, that we are saying that because we can't think of a better way to contain inflation we will throw a lot of people without college degrees out of work (disproportionately African Americans and Hispanics) in order to put downward pressure on those who still have jobs. That is not a good thing for the government to be doing.

JH: Let's turn to a subject that's on the minds of many these days, as the Occupy Wall Street movement spreads: reining in the banks. You talk about how banking is an “intermediary good,” like trucking, but the sector has become hugely bloated. What is the impact of that on the economy, and how might we “rein them in”?

DB: There are two issues here. The first is that the financial sector can actively distort the economy insofar as it ends up financing speculative bubbles, as was the case with the housing bubble. In this situation, money that could have gone to productive uses instead was diverted into housing speculation. We had hundreds of thousands of housing units built that probably made no economic sense. Many of these are still sitting empty — new developments at the outskirts of places like Phoenix and Las Vegas. Of course the run-up of house prices led to even larger distortions, causing people to spend based on the bubble-generated wealth in their homes. When this wealth proved to be ephemeral, homeowners found themselves heavily in debt and the economy lost the bubble-driven consumption, which had been a major engine of growth.

The other issue is simply that the sector itself consumes a vast amount of resources. The share of the private sector devoted to the narrowly constructed financial sector (investment banking and securities and commodities trading) has quintupled over the last three decades. This means that we're paying five times as much for their services relative to the size of the economy. It is not clear how the productive economy is being better served by this sector now than it was in the '50s and '60s.

Remember, this sector exists to allocate capital from savers to those who want to borrow and invest. It seems hard to contend that capital is being better directed to its best uses in 2011 than in 1961. Nor does it seem credible to claim that we are more secure in our savings than was true 40 or 50 years ago. To take the trucking analogy, this would be as though the share of the workforce employed in trucking had quintupled, but goods were not getting from point A to point B any quicker or more reliably. If this were the case, any serious person would be asking what is wrong with our trucking sector. Similarly, we should be asking what is wrong with our financial sector.

There are several obvious steps that should be taken to rein in the sector. One is to break up “too big too fail” banks. These have no economic justification. The logic is that these banks can borrow at lower costs because everyone assumes that the government will come to their rescue if they get into trouble. This encourages excessive risk-taking and in effect is a taxpayer subsidy to the shareholders and top executives of these banks.

It also make sense to restore the separation between investment banking and commercial banking from Glass-Steagall. The logic here is that the government is insuring the deposits of commercial banks. If a bank wants government insurance, then it should not be taking big risks with the money that is insured. Commercial banks were restricted to a relatively narrow set of loans — business loans, home mortgages, credit card debt — in principle these could be easily monitored and the risks controlled.

By contrast, investment banking means underwriting stock and bonds issues and other activities that are inherently risky. Government insured deposits should not be tied up in more risky activities that can be less easily monitored.

The third and perhaps most important mechanism for containing the financial sector is a modest financial speculation tax. The idea is that a modest tax on financial transactions — sales of stocks, bonds, credit default swaps and other derivatives — would discourage excessive trading in these assets. In a paper I wrote with my friend Bob Pollin, we suggested a rate of 0.25 percent on each side of a stock trade and 0.005 percent on each side of most derivative trades. This would have almost no impact on people who are buying these assets for productive purposes. However, this tax would make the sort of short-term trading that dominates markets today much more risky, since there would be a much larger cost hurdle to overcome.

This tax could also raise a vast amount of revenue, close to $150 billion a year, or 1.0 percent of GDP. The great aspect to this is that the money would come almost entirely from eliminating the waste in the financial sector. Our tax rates were intended to roughly double the cost of financial transactions. There is a far bit of research on how trading volume responds to changes in the cost and most find that it is fairly responsive, implying that if trading costs double, then the volume of trades will be reduced by roughly 50 percent.

If we assume that this will be the response to our set of financial speculation taxes, the implication would be that people would be paying twice as much for each trade, but they would cut their trading volume in half, so that they would be paying no more in total for their trades than they were before the tax. So the stock portfolio in our 401(k)s may flip over less frequently, but we would be paying no more for the churning of stock then we did before the tax was put in place.

If this turns out to be the case, then the full amount of the money raised through the tax effectively comes out of the hide of the financial sector. We will see fewer transactions, and therefore fewer resources, devoted to the sector. This is a great way to make the sector more efficient, eliminating a vast amount of waste in the sector.

There is also the possibility that this tax will make the sort of speculative bubbles that have distorted the economy in the last three decades less likely. The evidence on this point is inconclusive. All we know for sure is that it a financial speculation tax will raise a huge amount of revenue directly from the hide of the financial industry.

JH: I think this brings us to the key question, and the subject of the final part of the book: how do we end this “loser liberalism”? You're not telling progressives to start aping the right and talk about how the free markets can cure all of society's woes. What do you advocate? Tell us a little about your prescriptions.

DB: First we have to understand how the market is being rigged. This is essential. Knowing the importance of the Fed and the value of the dollar doesn't mean that we can do anything about either, but we have to at least know how the game is played. Otherwise, it's like playing football without knowing that the way to score points is to get the ball into the other team's end zone. That makes it pretty hard to win.

Also, once we understand that the issue is the way that the market is structured and not a question of the government bureaucrats and their patrons trying to overrule the market we are on much sounder political grounds. It is understandable that many people will dislike the idea of taxing the winners to benefit the losers; it is much harder for the right to make a case for rigging the market so that income flows upward. That's what our politicians have done for the last three decades and the public must understand this fact.

The key battles over Fed policy, dollar policy, and trade policy will be long and difficult, but we may have many small victories along the way. For example, just last year there was an alliance of the left and right to require the Fed to disclose the loans that had been made through its emergency lending facilities. The Fed, supported by all sorts of respectable types, insisted that the world would end if it had to let the public know who it had lent money to. However, as a result of the pressure from both the left and right, a provision requiring disclosure was included in Dodd-Frank.

The Fed has since released data showing that it made trillions of dollars in below market loans to the largest banks in the country. This might have been embarrassing to Goldman Sachs, Citigroup and the Fed, but it didn't have any of the negative fallout that the Fed claimed. This is the sort of small victory that we can achieve even now and then use them to build for bigger victories.

There are other areas where transparency — a simple good government demand — can make a big difference. How much are the Wall Street boys being paid to manage public pension funds? If that is not always easy find, it should be. Do shareholders know all the terms of their CEOs contracts. For example, did they know the guy who nearly drove Hewlitt Packard to ruin would get paid $20 million for his effort?

We also have to be creative about using the market to be in the face of the elite. Every country in the world has much cheaper drugs and health care than the United States. Let's get people to take advantage of this fact. Does our government want to arrest cancer patients who get lower cost drugs that can save their life from Canada? Why shouldn't state and local governments attempt to negotiate deals where Medicaid patients and public employees have the option of going outside of the country for major operations — and split the savings with the government? We can also push to have our government use open software and open textbooks in their schools. The potential savings are enormous.

The other side has been working for more than three decades to devise ways to rig the market to the disadvantage of most of the population. There are at least as many opportunities to devise ways to rig the market in the other direction. The market is an incredibly powerful tool. Progressives have to start thinking about we can use the market to bring about the outcomes we want.

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