The Wrong Rebound

Armies are notorious for fighting the last war.  Struggling to prepare for new threats, they are blinded by the former threats they faced, the last war they finished learning to fight.

We all tend to have the same problem.  It is the other side of learning from experience.  Once we have learned something, we assume we know it and are locked into familiar knowledge.

Right now, in the aftermath of the credit bubble, governments are mesmerized by the threat of excessive debt – a point that has recently been emphasized by Nouriel Roubini.  Known as Dr. Doom for his predictions that the financial markets, dangerously over-extended three and four years ago were, bound to collapse, he has acquired significantly more credibility today.  Then he was mocked as a Cassandra, out of step with the rest of the financial world.  Now he’s known, like Cassandra, to have been right all along.

Writing on his own website, he notes that we have become preoccupied by the risk of debt, the danger we are still struggling to recover from:  “a combination of high oil and commodity prices, turmoil in the Middle East, Japan’s earthquake and tsunami, eurozone debt crises, and America’s fiscal problems (and now its rating downgrade) have led to a massive increase in risk aversion.”

But, now, the problem we are facing is different:  “Economically, the United States, the eurozone, the United Kingdom, and Japan are all idling. Even fast-growing emerging markets (China, emerging Asia, and Latin America), and export-oriented economies that rely on these markets (Germany and resource-rich Australia), are experiencing sharp slowdowns.”

The result:  “Fiscal policy currently is a drag on economic growth in both the eurozone and the UK. Even in the US, state and local governments, and now the federal government, are cutting expenditure and reducing transfer payments. Soon enough, they will be raising taxes.” (See, “Is Capitalism Doomed?”)

Others have been making a similar point about our need to stimulate the economy.  But “Dr. Doom” has the benefit of having been excoriated in the past for observations and predictions that were as obvious then as they seem to be now.  He not only knows his economics, he knows his mob psychology, and he is not inhibited.

But that doesn’t mean he is being listened to.  Many investors who think they are following the money are actually following the crowd.  And the crowd in this case is focused on the political goals of cutting back government and eliminating services for the poor.  That isn’t always smart economics.

“Hooligans,” Criminals, and Us

We hear it all the time about riots:  “hooliganism” or, as David Cameron put it last week, “criminality pure and simple.”  But riots are complex events, hard to reduce to something as simple as that.

It’s no surprise that established authorities, feeling attacked, see the violent behavior of their citizens in such terms.  They react by becoming dismissive and punitive.  The Chinese government used the same language to characterize student protests in Tiananmen Square, as did Arab leaders recently to describe rebellions in their countries.

And often there is an element of truth in such descriptions.  If you have ever been in mob that was agitated about some injustice, you know how contagious it can be.  Ordinary people, normal citizens, you and me – we get swept up and do things that would be unlikely under other circumstances:  shouting, shoving, throwing rocks, smashing windows, and, yes, even looting.

It usually takes an incident to get a riot started, such as an accident or the police attacking or killing an innocent bystander.  But once it has begun, the raging mob has a life of its own.  Deep-seated resentments, repetitive frustrations and long standing disappointments galvanize people into action.  And the mob provides cover, an anonymity that makes it easier to overcome one’s usual reticence or moral scruples.  One is immersed, engulfed.  And it can become an exuberant experience, a joyful release for long suppressed emotions.  It can also become manic, driven, a means of restlessly seeking new outlets.  Leadership emerges spontaneously and changes rapidly.

It offers a kind of intense belonging, not dissimilar to what spectators feel at a sports event or fans at a rock concert.  But because it isn’t focused on a game or performance, it easily gets out of hand.  Freud described such “mass psychology” in 1924, in the tumultuous aftermath of World War One.  Others have studied it since as a recurrent form of group behavior.

This is not to justify the behavior of the mob, but to recognize that we all can so easily become “hooligans” ourselves.  To be sure, delinquents and petty thieves can easily even join in under the cover the mob provides.  But riots do not rely on criminals or “criminality pure and simple.”

Thinking that way, though, can distract us from the underlying conditions that give rise to such events.  They can be appeals to be heard, when normal channels don’t work.  They can be eruptions of rage, when frustrations boil over.  They can be expressions of hope that things could change.  And they could be all these things – and more.

Newsweek reminded us last week of something about the recent riots that many politicians would prefer not to think:  “If there’s one underlying condition that these movements share, it has to do with unemployment and bitter poverty among people who desire to be part of the middle class, and who are keenly aware of the sharp inequality between themselves and their country’s wealthy elite.”

Distracted by the flames and the looting, we can easily forget that these are, as Newsweek put it:  “social revolutions with a small ‘r,’ protests against social conditions that have become unbearable. (See, “Why Riot Now?”)

And Outsourcing Oversight

Only a handful of bankers or brokers have been indicted for criminal actions during the frenzy that led up to the credit crisis, and yet there is widespread agreement that hundreds if not thousands are to blame for having over-valued securities, ignored the signs of risk, misled investors,  and compromised their integrity in overseeing the behavior of colleagues.  Now, however, private lawsuits are seeking some redress.

The New York Times reported that A.I.G., the insurance giant, is suing Bank of America for ten billion dollars, and it looks like many other such lawsuits are on the way.  The management team that presided over its collapse is long since gone, leaving the new mangers to act like the aggrieved victims of a Ponzi scheme.  The irony is that A.I.G., following its bailout, is largely government owned today. (See, “A.I.G. to Sue Bank of America Over Mortgage Bonds.”)

Clearly, those who have been injured are entitled to seek redress.  But in practice that option is only open to those who can afford to recruit the army of lawyers needed to challenge massive corporations.  Individual small investors don’t have the resources to do due diligence before making their decisions – or to pursue justice afterwards.  That’s why we all rely on government to do the job.

Yet in this the government has been inert, inactive, ineffective, and that leaves us, in effect, dependent on the privatizing of justice.

Clearly Washington is gridlocked, but has government become irrelevant?  To be sure, Republicans in congress have a bias against regulation.  The Wall Street reform bill comes nowhere near protecting investors against greedy bankers, much less guaranteeing that another financial crisis won’t happen.  Yes, the Consumer Protection Agency has been established, but it still remains to be seen if it will have the political will or the funds it needs actually to protect investors.

The underlying problem is that it is caught in a contradiction.  The same people who brought us financial disaster three years ago are largely still in charge, and government is relying on them to get the system going again.  If they are needed, they can hardly be prosecuted.  Besides, they remain a major source of contributions to political campaigns.

But that leaves the rest of us feeling confused if not betrayed.  If we feel that government is not doing the job we rely on it to do, where do we turn?

A retired congressman, Tom Davis, former chairman of the National Republican Congressional Committee, put it bluntly:  “The political system, Republican or Democrat, over the last decade has delivered two failed wars, an economic meltdown, 20 percent of homes underwater, stagnant wages.”  (See, “Voters Want a Change Politicians Can’t Deliver.”)

He concluded:  “Voters look at the political system as a whole as just not giving them anything.”  Such an attitude will lead to either depressed withdrawal or extreme and possibly violent reaction.  The riots in London may be giving us a foretaste of what is in store for Americans.

Exporting Myths

According to a recent report in Newsweek: “In the last decade layoffs have become America’s export to the world.” It’s a quick and dirty way for businesses to cut back on expenses, but like many quick fixes it conceals a host of unintended costs.

The author of the report, Dr. Jeffrey Pfeffer, Professor at the Stamford Business School, goes on to write: “At a conference in Stockholm a few years ago, business executives told me that to become as competitive as America, Sweden needed to make it easier to lay people off. In Japan, lifetime employment, which never applied to most of the labor market, is under attack. There are daily calls for European countries to follow the U.S. and make labor markets more ‘flexible.’ But the more you examine this universally accepted tactic of modern management, the more wrongheaded it seems to be.” (See, “Lay Off the Layoffs”)

In some cases, of course, layoffs are justified by serious long-term declines in business activity. But Newsweek noted: “these staff reductions were a response to a temporary drop in demand; many of these firms expect to start growing (and hiring) again when the recession ends.”

That may be because management sees other advantages to firing workers. With a reduced workforce, they can put in place automated systems or robots. They can restructure, pile the work on others without increasing any wages, and they can outsource to other countries where labor is cheaper.

On the other hand, the conventional wisdom of managers may well be entirely wrong. “There is a growing body of academic research suggesting that firms incur big costs when they cut workers.”

“University of Colorado professor Wayne Cascio lists the direct and indirect costs of layoffs: severance pay; paying out accrued vacation and sick pay; outplacement costs; higher unemployment-insurance taxes; the cost of rehiring employees when business improves; low morale and risk-averse survivors; potential lawsuits, sabotage, or even workplace violence from aggrieved employees or former employees; loss of institutional memory and knowledge; diminished trust in management; and reduced productivity.”

And the benefits are often illusory: “contrary to popular belief, companies that announce layoffs do not enjoy higher stock prices than peers—either immediately or over time…. Layoffs don’t increase individual company productivity, either. A study of productivity changes between 1977 and 1987 in more than 140,000 U.S. companies using Census of Manufacturers data found that companies that enjoyed the greatest increases in productivity were just as likely to have added workers as they were to have downsized. The study concluded that the growth in productivity during the 1980s could not be attributed to firms becoming “lean and mean.”

“Another myth: layoffs increase profits…. An American Management Association survey that assessed companies’ own perceptions of layoff effects found that only about half reported that downsizing increased operating profits, while just a third reported a positive effect on worker productivity.

The facts seem clear. Layoffs are mostly bad for companies, harmful for the economy, and devastating for employees.

Why then does the myth of layoffs have such force? I suspect that management increasingly views workers as their least desirable, most troublesome cost. Not only are workers less reliable than automated systems, and less adaptable, unlike machines they resist change and often fight back. They can undermine new initiatives that make them anxious and expose them to failure. Moreover, they require recognition for their achievements. Worst of all, they seek financial security in the form of higher wages, health care benefits, and pensions.

Managers are human too, of course, all too able to understand what workers want and why. But this only makes them more likely to seek alternative ways of getting work done — and to believe that it makes common sense to economize by downsizing.

(I’m indebted to Prof. Howard Stein at the University of Oklahoma for calling my attention to the Newsweek essay.)

The Politics of Blame

While the media are obsessed with the prospect of a debt default, very few people in America take it seriously.  Even financial markets are calm.  The New York Times put it this way over last weekend, commenting on yet another  collapse of a potential deal:  “The breakdown of negotiations Friday has jolted that sense of equanimity, wrenching the worst-case scenario from unthinkable to merely unlikely.” (See, Default Seen as Unlikely, but Markets Prepare.”)

Yes, “unlikely” – but not for any inability to imagine financial catastrophe.  Most people think default would be disastrous, if only because it would dramatically increase the cost of borrowing and that, in turn, would increase the debt.  But that outcome just doesn’t jibe with our intuitive grasp of U.S. politics.  We feel, correctly, it can’t happen.

It’s not because our governing institutions and political parties will, in the end, put the national interest ahead of their own special aims.  It’s because our politics have become all about blame, and the risk of being the party stuck with the blame is just too great.  This dance is all about determining which party will be seen to be at fault.

Obama has done a brilliant job of positioning himself as the Great Compromiser, willing to give on the issues central to his own party, standing above the fray.  In fact he has risked angering many Democrats with his compromises on Medicare and Social Security.  I suspect that is why the Republicans walked away from the latest deal.  The President would get too much credit for it – and they, in turn, would seem petty by comparison.

On the other hand, the Republicans have positioned themselves as Anti-tax, always a popular position among American voters.  Yes, the tea-party extremists need to be accommodated by the Republican leadership of the House, but if a compromise were to fail because they could not agree to raise taxes on the wealthy, the voters would blame them.  Ideological purity goes only so far with the electorate.

But, then, if Obama is forced to act without Congressional support – as some say he has the legal authority to do – no doubt the Republicans can then blame him for increasing the debt on his own.  He, in turn, can blame them for being unwilling to cooperate, etc.

We need to reach the point where the chances for blame are equal and “fair.”  Then action is possible.

At this point it is not possible to see the shape of the deal that will ultimately be agreed to in Washington.  But it is not too soon to know that there will be one.