Economics Must Reading

My friends think I’m nuts and my family seems to like me less for it, but I’ve spent my last two vacations catching up on my Economics.  In no particular order, a few reviews of the Economics must-reads for the times:

Ascent of Money – Niall Ferguson

Ferguson is one of my favorite historians, hands-down.  His hitiographic approach — international history — seems like an optimal one for tracing the thematic emergence of the most important aspects of our modern financial system: banking; bond markets; share ownership in limited liability companies; credit/money markets; risk management systems — insurance and other hedge instruments.  He also does a great job of capturing many of the more colorful characters involved in these historical developments. 

While I do think this is a must-read for anyone interested in the topic, one nit I have with the book is it’s facile jump from historical examination to an explanation of our current, emerging crisis.  To me, the book both failed to tie its various financial themes together in this current events study, and didn’t give this study the depth required to have these chapters stand as one of the most significant parts of the book.

The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means – George Soros

This was a great paper — but a book it should not be.  Soros’ separation of the housing bubble v. the long-term credit/leverage bubble we’re seeing — and the associated de-gearing we’re experiencing — is useful and extremely well argued.  For these reasons this is a worthy read.  That said, his repetitive intro chapters — how many times does a smart person really need to be introduced to the conecpt of reflexivity?! — and overall lack of coherence from section-to-section really make this a good paper bookended by interesting supporting essays.  If you read it as such you won’t be dissapointed.

The Crash of 1929 – John Kenneth Galbraith

The Great Crash.  Galbraith.  ‘Nuff said.  A history most relevant to what we’re seeing: the vagaries of varying government involvement and de-regulation; investor panic; rampant speculation; non-transparency.  Sound familar?  Read this book.

The Theory of Economic Development – Joseph Schumpeter

I admit I tend Schumpterian — even as Keynsianism seems to be sweeping back into favor.  This is a classic, and an expansion on a set of Schumpeter’s essays that I devoured when I read Growth Economics way back when.   Fluidly written, this book separates and rigorously — and interestingly — examines the key components of an economic growth system: Capital; Interest; Capitalists (risk capital lenders); and Entrepreneurs (process and product innovators — separate of Managers).

Social Security – reliant on technological progress

The fate of Social Security in the US relies on economic growth, especially as enabled by technological progress (by which I mean here specifically the type that crops up in a national growth equation).  Michael Mandel addresses this square on in a recent BW post:

Is Social Security a Ponzi Scheme?

Posted by: Michael Mandel on December 28

(This is the first in a series on technology and the crisis)

In the aftermath of the Madoff implosion, quite a few people have pointed out the parallels between a Ponzi scheme and Social Security. Arnold Kling, whom I respect, has written:

I’ve been thinking that Madoff is a perfect analogy for the public sector. The government gives people money, which it expects to obtain by taking the money from people in the future. Even the Center on Budget Policy and Priorities, not known as a right-wing organization, sees the U.S. fiscal stance as unsustainable (pointer from Ezra Klein via Tyler Cowen)—in other words, a Ponzi scheme.

 
Other people have gone farther. Paul Mulshine of the New Jersey Star Ledger wrote a column entitled “The Ponzi scheme that Baby Boomers are waiting to cash in on.” And Jim Cramer has called Social Security the biggest Ponzi scheme in history.
Superficially, these critics have a point, and there is a parallel between Social Security and a Ponzi scheme. But on a fundamental level, they are very wrong, and it’s worth explaining why.

First, the parallel. Social Security taxes current workers to pay Social Security benefits for current retirees. In other words, the new entrants into the Social Security system, the young workers, pay off the previous entrants, the older workers. And despite the fact you have a Social Security “account”, there is no necessary link between what you paid into the system in taxes, and what you receive.

That’s very similar to the structure of a Ponzi scheme, where new investors pay off the original investors. As long as enough new ‘victims’ are brought into the scheme, it keeps growing and growing. But when the new investors runs out, the Ponzi collapses. Analogously, the slowdown in population growth puts pressure on Social Security finances.

But there is one enormous difference between Social Security and a Ponzi scheme: Technological change. Over the past century, new technologies have enabled the output of the country to grow much faster than its population. To be more precise, the U.S. population has more than tripled since the early 1900s, while the U.S. economic output has gone up by more than 20 times.

This long track record of technology-powered growth has enabled the enormous rise in living standards in the U.S. and other developed countries. In fact, this increase in productivity—output per worker—is the key fact which gives us our way of life today.

Assuming that technological progress continues over the next 70 years, and output productivity growth continues over the next 70 years, the finances of Social Security are relatively easy to fix. A fairly minor cut in benefits, combined with a relatively small increase in taxes, will bring the system back into balance again. (the latest Social Security report projects a 75-year deficit of $4.3 trillion. That sounds like a lot of money, but over 75 years it’s roughly $60 billion a year…not chicken feed, but not overwhelming).

But here’s the rub. Ultimately our ability to make good on the “Ponzi-like” nature of Social Security depends on the continued march of technological progress—and in particular, innovation which boosts output and living standards. If we leave the younger generation a good legacy—a sound scientific and technological base, combined with an innovative and flexible economy and an educated workforce—then Social Security is not a Ponzi scheme. The economy grows, and there’s more than enough resources for everyone.

But if instead we—the current generation—invest in homes, flat-screen televisions and SUVs, then we don’t leave the next generation with the technological “seed corn” they need. If the technological progress slows, then Social Security does turn out to be Ponzi-like—with unfortunate consequences for everyone.