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Thursday, April 19, 2012

Relay: Thomas Palley at the National Economists Club, Part 1

Today with a relay from Thomas Palley, speaking to the National Economists Club, From Financial Crisis to Stagnation: The Destruction of Shared Prosperity and the Role of Economics.
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So here is Thomas Palley, very instructive.

February 16, 2012 National Economists Club - "From Financial Crisis to Stagnation: The Destruction of Shared Prosperity and the Role of Economics"
Thomas Palley, Ph.D., Associate, Economic Growth Program, New America Foundation

 Summary of Remarks by
Thomas Palley
Associate, Economic Growth Program
New America Foundation
February 16, 2012
Thomas Palley addressed the NEC and SGE on the topic of his new book published by Cambridge University Press, 2012.

The US economy is still struggling to recover from the 2008 financial crisis. Currently, the country is engaged in a great debate about the causes of the crisis and the appropriate policy response. This debate represents a war of ideas, the outcome of which will have a lasting effect by determining the course of economic policy.
Many economists claim the US faces a “lost decade”, similar to that of Japan.  In fact, the stakes are much higher. What is at risk is the permanent destruction of prosperity. 

The US economy suffered a massive fall of real GDP in December 2007 at the start of the crisis, and the economy remains significantly below potential output. Optimists project a recovery by 2016.  “Lost decade” pessimists say it will be longer, and it is also possible economists may simply lower estimates of potential output thereby achieving “recovery” by redefinition.

The problem with “lost decade” language is that it is fundamentally misleading because it conveys the impression everything will be fine if we can just return to potential output. The reality is the US economy was broken before the crisis and the data suggests we have already had at least two lost decades.
Real wages and compensation of non-supervisory workers have been stagnant for almost thirty years, and the link between wages and compensation was severed in the late-1970s. The labor share of GDP has trended steadily down since 1981, while the pre-tax income share of the top 1%, which had bottomed in 1970, is back to the pre-Great Depression levels. Talk of a “lost decade” implicitly endorses the false notion that things were ok before the crisis.
In the current economic debate, there are three positions: 1) the Neoliberal position, which can also be termed the government failure hypothesis; 2) the Third Way position, which can be termed the market failure hypothesis; and 3) the Progressive position, which can be termed the destruction of shared prosperity hypothesis.
The Neoliberal position maintains the crisis was rooted in the housing bubble, which in turn was caused by failures of monetary policy and government intervention in the housing market that encouraged homeownership beyond people’s means. 

The Third Way position maintains the crisis was caused by inadequate financial regulation, which led to excessive risk-taking by banks. Perverse pay structures also promoted loan pushing rather than sound lending. 

The Progressive position maintains that the crisis has far deeper roots than just regulatory failure. Instead, it was the result of a generalized economic policy failure resulting from adoption of a flawed economic paradigm in the late 1970s and early 1980s.  

From 1945 to 1975, the US had a virtuous circle growth model, the logic of which was as follows. Productivity growth drove higher wages; higher wages fuelled demand growth; demand growth ensured full employment; full employment spurred investment, which in turn caused productivity growth. This economic model held in one form or another globally – in North America, Europe, Latin America, and Japan.
After 1980 the virtuous circle growth model was abandoned in favor of the neoliberal growth model. The key features of the new model were abandonment of commitment to full employment and adoption of policies that helped corporations sever the link between wages and productivity growth. The new model weakened the position of workers and strengthened the position of corporations.

The model can be understood in terms of a policy box that fenced workers via a policy mix promoting small government, labor market flexibility (i.e, anti-union policies), corporate globalization, and abandonment of full employment. Moreover, with the help of the IMF and World Bank the neoliberal model was implemented on a global basis, in North and South, which multiplied its impact. 

The new model gradually undermined the US economy’s income and demand generating structure, but the growing demand gap was filled by borrowing and asset price inflation.  Such a process was always bound to hit the wall as there are limits to debt and limits to how high asset prices can go. However, the process went on far longer than expected, which made the collapse far deeper when it eventually happened. It also means escaping the aftermath is far more difficult as the economy is burdened by debt and destroyed credit-worthiness.

How the crisis is explained will shape the US policy response.  The neoliberal hypothesis recommends further deregulating markets, deepening central bank independence, and shrinking government while imposing fiscal austerity.  The Third Way hypothesis recommends financial reform and temporary fiscal stimulus. But other than this it recommends continuing with the policies enshrined by the neoliberal box.
The progressive hypothesis recommends a fundamental change of policy direction. This involves replacing the neoliberal model with a structural Keynesian model that “repacks the box” by taking workers out and putting corporations and financial markets in. The new box would restore the goal of full employment; promote a social democratic concept of government; promote solidarity-based labor market policies in place of labor market flexibility; and replace corporate globalization with managed globalization.

Each hypothesis carries its own policy recommendations. The explanation that prevails will therefore influence the policies adopted. At the moment debate is dominated by the Third Way and neoliberal positions, represented by the Obama administration and Republican Party respectively.

If the neoliberals win the war of ideas the result will be depression. If the Third Way wins the result will be stagnation. Either way, it is likely we face an end to shared prosperity via further entrenchment of corporate power, evisceration of remaining worker power, and destruction of public safety nets, public education, public health, and public pensions. 

However, just as happened in the Great Depression of the 1930s, it is possible the ugly reality of stagnation will force a shift in ideas and politics toward the progressive position. The one thing we can be sure of is any such shift will be politically contested as powerful elites have an interest in preserving the current economic paradigm. 

Dr. Thomas Palley is an economist living in Washington DC. He holds a B.A. degree from Oxford University, and a M.A. degree in International Relations and Ph.D. in Economics, both from Yale University. He has published in numerous academic journals, and written for The Atlantic Monthly, American Prospect and Nation magazines. Dr . Palley was formerly Chief Economist with the US-China Economic and Security Review Commission. Prior to joining the Commission he was Director of the Open Society Institute’s Globalization Reform Project, and before that he was Assistant Director of Public Policy at the AFL-CIO. 

Rapporteur: Meg Doherty

National Economists Club
P.O. Box 19281
Washington, DC 20036


  1. Thomas Palley writes very well. This talk was a very concise and well laid out summary of basic economic principles applicable to the real world. Saying it with a British accent just made it seem all that much more impressive. I bought his book too.

  2. Enjoy your reading. If you have some substantive reactions, be sure to drop me a line.

  3. David Lazarus writes:

    The lost decade pessimists are probably being too optimistic. Thirty years of debt will take a lot longer to unwind than ten years, especially when Europe has barely started yet. Japan has taken more than twenty years to stabilise the economy, and they had the money to do so. The US does not have that luxury. Europe has the money but not the leadership. The US has still a lot further to go, even though it has already paid down more debt than Europe, so is in a marginally better position to start with.

    As for the path I doubt that a progressive path will be taken because of the influence of neo-classical economists whose models do not see the need for such policy. It will only be after the complete failure of policy will they even look at alternative policies. So it is really a choice between stagnation or depression for the next few years at least. The crisis has not taught policy makers anything as they are still trying to reflate the old bubbles and cut corners that way. The progressive path is a non starter with the policy makers in power and the neoclassical economists running policy.

    I am more optimistic about Europe even though it is the epicentre of the crisis right now. Sovereign debt was lower than the US and if the bank debts are eliminated through bankruptcy then the debt burden will plummet and growth would be possible. Also Europe still has many Keynesians who can guide the continent back. The US has the problem of gridlock and complete blocking within Congress which will undermine all efforts by the Democrats. Though I suspect that further stress will lead to even more deregulation and then eventually another spectacular financial crisis. That process has already started with the delay of the Volker Rule for another two years. Two years within which the banks can lobby for its never being imposed.

    The solutions are out there and I have seen recent ideas that can create a stable economy with out the problems that we face now. Even full employment could be possible, rather than the "6% unemployment is full employment" fudge from neoclassical economists.