Ensuring a Robust Marketplace of Ideas: Antitrust Policy in the Digital Age

Jan 19, 2012Bruce Judson

internet-idea-150Will antitrust laws of the past century threaten the capitalist incentives that encourage important ideas in ours?

internet-idea-150Will antitrust laws of the past century threaten the capitalist incentives that encourage important ideas in ours?

In early December, the Justice Department confirmed that it was investigating the pricing of e-books and the related activities of major publishers and online retailers, such as Amazon.com and Apple. As a print and digital author, participant in the publishing industry, and graduate of the Yale Law School, this naturally caught my eye. It also led me to start thinking about the assumptions that underlie existing antitrust laws.

Democracy is the basis of our form of government. Capitalism is the basis of our economic system. They are distinct systems, and (at least in theory) it's possible to have one without the other. But will the antitrust rules developed to foster capitalism in the previous century inadvertently weaken our democracy in this century? In addition, do pre-digital era antitrust doctrines hinder the development of a fair, robust capitalism in our age? The current Justice Department investigation is a case study for examining these issues.

Lengthy, reasoned arguments (i.e. books) have historically played a central role in the marketplace of ideas. Important books have changed the way we look at our society, altered our political beliefs, changed foreign policy, and moved the nation in myriad ways. In the digital era, we benefit from many new forms of disseminating information, such as blogs and online news sources, all of which add to the marketplace of ideas. Nonetheless, none of these new sources of information has replaced the essential nature of a book (in physical or digital form): a lengthy effort, researched and written over a long period of time, which reflects the author's most thoughtful analysis and reflections on the subject in question.

The research and creation of many significant, important works are funded by advances from book companies. The book company grants the money up front on the basis of a proposal, which allows the author to pursue the project while earning a living. Hypothetically, if publishers stopped offering advances, many important works would never be created. Authors (who are not always academics or paid foundation researchers with a guaranteed salary) simply could not afford to undertake the work. This capitalist, for-profit motive plays an important role in funding important contributions to the marketplace of ideas.

Today, the book industry is struggling to adapt to the digital transformation. At its core, digital information has a tough time establishing value in the eyes of the consumer. If the book industry declines, some authors will undoubtedly self-publish, and it's possible new financing vehicles, for the equivalent of today's advances, will evolve. In essence, a weaker book industry means our society loses a source of funding for important, time-consuming, and extensive research and analysis.

The Justice Department has not revealed the precise nature of the investigation. But it's my understanding that when the Kindle was first released, Amazon.com priced e-books at less than the wholesale cost it was paying publishers. In effect, to boost Kindle sales and the idea of e-reading in general, Amazon was often taking a loss on sales.

A long-held tenant of antitrust law is that vertical price fixing (an agreement between the manufacturer and the retailer to sell a product at a specific price) is often illegal. These restrictions are why manufacturers offer products with a "manufacturer's suggested retail price" ("the MSRP"). The manufacturer is not permitted to formally agree with retailers on the prices consumers pay for products. The retailer is free to set the price offered to consumers, thereby enabling discounts from the MSRP. (Note: In recent years, the Supreme Court has adopted a more flexible approach to the issue or vertical price fixing, adopting a "rule of reason" test, but it remains a central area of antitrust policy.) In addition, competitors cannot work together to restrain price competition in some way (horizontal price fixing).

As the e-book business started to develop, publishers were concerned that Amazon's pricing approach was devaluing their products and (I assume) threatening to destroy hardcover sales at bookstores. In response, publishers developed what is known in the industry as "the agency model." Under this model, the publisher sets the price the consumer pays. In this model the digital retailer is not buying the product at a wholesale price, but acting as a sort of sales agent for the publisher. As the sales agent, the retailer receives a commission on each sale. In effect, digital book purchases become like insurance policy purchases, with Amazon and Apple as the brokers. From the perspective of antitrust law, the actual seller is the publisher, which sells through an agent and no agreement in restraint of trade exists. My assumption is that the Justice Department is investigating whether this agency pricing model violates restrictions on vertical price fixing and whether the way it was deployed by multiple publishers reflects some form of horizontal price fixing.

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It's easy to have a knee-jerk negative reaction to the higher e-book prices that publishers have set under the agency model. But here's where this all gets interesting. As the (now barely existent) music industry and suffering newspaper industry have learned, it's incredibly hard to establish value for digital content. This reflects the competitive marketplace that may make content available for free, consumer perceptions of what they should pay for digital goods, the availability of other revenues streams (such as advertising), and a host of other factors.

One undeniable effect is that the Internet inherently drives the value of digital goods down. Instant price comparisons, easy access to lower-priced alternative options for digital information and entertainment, and illegal file sharing all contribute to this phenomenon. Traditional publishers also face challenges in making the digital transition. Importantly, a host of new competitors that help authors create digital books have arisen, and authors can also publish on their own. So the competitive dynamic for digital books, with far easier access to low-priced and free alternatives as well as all kinds of new types of publishers and distribution models, is very different than the dynamic that existed when vertical pricing restrictions were first developed.

There is a second, more fundamental issue at work here. The digital world makes the bundling (whether explicit or implicit) of intellectual property far easier than the physical world. Companies can make their profit in one place and break even or lose money on other products to support this activity. The problem is that this kind of activity destroys the perceived value among consumers of the bundled products. Amazon, for example, may be making money on the Kindle and not the e-books, but still profit in the long run.

The basic point here is that in the digital world it's possible to imagine instances where it's profitable for retailers to destroy the perceived consumer value of e-books and the associated hard copy titles.

Our society is best served by a robust e-book industry. As e-book prices declines, fewer and fewer authors are able to make a living expressing their ideas, whether they are political, socially insightful, or a form of entertainment.

With so much new competition emerging, and so many unknowns for the publishing industry itself, my strong bias is not to stretch interpretations of antitrust laws developed for a different era-and to allow the industry to do what it feels is best for its long-term survival. If the violations of the laws are clear-cut, then perhaps the Justice Department should seek to have the laws changed before beginning an enforcement action. If no violations are clear cut, then the Justice Department should have the wisdom to leave well enough alone. The worst possible outcome would be for the Department to attempt to extend the doctrines of the antitrust laws to cover the agency model, working from the mistaken belief that this would benefit our society.

Here are two takeaways:

First, the creation of information in our society has always been recognized as playing a central role in building a healthy democracy, with the attendant benefits of the best aspects of capitalism. This recognition is embodied in the first amendment. As we move to a digital era, there is increasingly less ability for information creators to profitably fund the creation of "expensive" information (i.e. books requiring extensive research and interviews, investigative journalism, and the like). Our democracy, and ultimately the operations of a robust, fair capitalist system -- based on the best possible information -- are poorer for this loss. To the extent that any of our existing laws inadvertently destroy the remaining infrastructure that profitably supports the creation of such information, they must be reexamined.

Second, the ability for retailers to make money on one product (such as the Kindle or the iPad), while cutting prices on digital products, is something new to our era. We need to stop and think about how the distribution of products that spread ideas may be affected by antitrust laws. We must ensure that our laws are not furthering the destruction of a robust marketplace for ideas.

Full Disclosure: I have published books with several publishing houses and worked as a paid consultant to several book and magazine companies.

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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The Most Popular Post of 2011: Who are the 1% and What Do They Do for a Living?

Dec 23, 2011Mike Konczal

Editor's note: As the year comes to a close, New Deal 2.0 is highlighting our most read post from the year. Our regular posting schedule will resume in January. See you in 2012!

mike-konczal-newThere's good reason to focus on the top 1%: they're distorting our economy.

Look, a crazy anti-capitalist anarchist carrying a bizarre sign incompatible with the basic tenets of liberals:

Or not.

Editor's note: As the year comes to a close, New Deal 2.0 is highlighting our most read post from the year. Our regular posting schedule will resume in January. See you in 2012!

There's good reason to focus on the top 1%: they're distorting our economy.

Look, a crazy anti-capitalist anarchist carrying a bizarre sign incompatible with the basic tenets of liberals:

Or not.

A lot of emphasis is on the "99%" versus the "1%" in these protests. But who are the 1% and what do they do for a living? Are they all Wilt Chamberlains and Oprahs and other people taking part in the dynamism of the new economy? Nope. It's same as it ever was -- high-level management and the financial sector.

Suzy Khimm goes through the numbers here. I'm curious about occupations. I'll hand the mic off to "Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data" by Bakija, Cole, and Heim. This is the latest and greatest report on occupations and inequality. Here's a chart of the occupations of the top 1%:

distribution_1_percent

Inequality has fractals. Let's go into the top 0.1% -- what do they look like? Here's the chart of the occupations of the top 0.1%, including capital gains:

It boils down to managers, executives, and people who work in finance. From the paper: "[o]ur findings suggest that the incomes of executives, managers, supervisors, and financial professionals can account for 60 percent of the increase in the share of national income going to the top percentile of the income distribution between 1979 and 2005."

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For fun, there are more than twice as many people listed as "Not working or deceased" than are in "arts, media, sports." For every elite sports player who earned a place at the top of the income pyramid due to technology changes and superstar, tournament-style labor markets that broadcast him across the globe, there are two trust fund babies.

The top 1% of managers and executives often means C-level employees, especially CEOs. And their earnings versus the average worker have skyrocketed in the past 30 years, so this shouldn't be surprising:

How has this evolved over time? Can we get a cross-section of that protest sign above?

Same candidates. There's a reason the protests ended up on Wall Street: The top 1% and top 0.1% comprises all the senior bosses and the financial sector.

One of the best things about Occupy Wall Street is that there is no chatter about Obama or Perry or whatever is the electoral political issue of the day. There are a lot of people rethinking things, discussing, learning, and conceptualizing the kinds of world they want to create. Since so much about inequality is a function of the legal structure known as a "corporation," I'd encourage you to check out Alex Gourevitch on how the corporate is structured in our laws.

The paper notes that stock market returns drive much of the manager's income. This is related to a process of financialization, something JW Mason has done a fantastic job outlining here. The "dominant ethos among managers today is that a business exists only to enrich its shareholders, including, of course, senior managers themselves," and this is done by paying out more in dividends that is earned in profits. Think of it as our-real-economy-as-ATM-machine, cashing out wealth during the good times and then leaving workers and the rest of the real economy to deal with the aftermath.

Both articles mention chapter 6 of Doug Henwood's Wall Street; anyone interested in how things have changed and where they need to go would be wise to check it out. It's even available for free pdf book download here.

There's good reason to focus on the top 1% instead of the top 10 or 50%. There is evidence that financial pay at this elite level is correlated with deregulation and the other legal changes that brought on the crisis. High-ranking senior corporate executives' pay has dwarfed workers' salaries, but is only a reward for engaging in shady financial engineering practices. These problems require a legal solution and thus they require a democratic challenge and a rethinking of how we want to structure our economy. Here's to the 99% and Occupy Wall Street helping get us there.

Mike Konczal is a Fellow at the Roosevelt Institute.

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The Paternalism of the Holiday Car Ad

Dec 19, 2011Bryce Covert

Husband buys wife a car with their combined income, without her permission. Happy holidays!

Husband buys wife a car with their combined income, without her permission. Happy holidays!

Ah, the holiday car commercial. You know the one. What did dad get mom? Just a little box… with a key in it to a new car! The family rushes to the yard, where a shiny new car waits with a big red bow on it. Apparently the tradition was started by Lexus in 1998, when it began its yearly “December to Remember” campaign that promotes a new car as the perfect gift. And it’s been successful: December Lexus sales are traditionally better than any other month. Other car companies have followed suit.

Some of these ads now feature girlfriends buying boyfriends cars for the holidays, but the most traditional form seems to be a husband buying one for his wife. There’s something wrong with this picture. As Annie Lowrey tweets in parody of these ads, “Husband buys wife a car! Wife expresses horror that he made a major financial decision unilaterally, on impulse!” It is strange to think that a man would up and buy his wife a car without consulting her, particularly as most married couples combine their earnings. But it hearkens back to a time when women didn’t have their own earnings, couldn’t buy their own cars, and actually did have to rely on husbands to buy them a new set of wheels.

Take a look at this vintage holiday car ad:

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Look familiar? Or take this non-holiday ad:

Why do these women have to beg their men for cars? Because many can't afford to buy cars outright, but before the 1970s, women, minorities, and low-income families were excluded from credit products. Women in particular were denied loans based on social biases such as the idea that their salaries weren’t dependable because they would become pregnant and stop working. Not to mention that many women didn’t even have their own incomes; in 1950, only 34 percent of women were in the workforce.

These days, women make up almost half of the workforce. Thanks to the Equal Credit Opportunity Act, they can take out as many car loans as any man. And while only four percent of husbands made less than their wives in 1970, by 2007 that percentage had risen to 22. A quarter of households are headed by women. Yet even with women having made such strides in income and the ability to make purchases equally with their husbands, this ad celebrates a man who buys his wife a car without permission as if she is helpless to do so.

Nothing says "happy holidays" like some old timey sexism that assumes women can't buy themselves a car when they want one.

Bryce Covert is Editor of New Deal 2.0.

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Starting a Social Venture: What's a Do-Gooder to Do?

Dec 1, 2011Joseph Shure

Many Millennials have noble ambitions, but starting an organization that can achieve their goals requires patience and research.

Many Millennials have noble ambitions, but starting an organization that can achieve their goals requires patience and research.

A couple of national news outlets have published stories recently (like this one and this one) that suggest today's young people are uncommonly entrepreneurial. Meanwhile, well-known groups like Echoing Green, the Clinton Global Initiative, and the Hitachi Foundation are offering big rewards to young people who apply their enterprising minds to ridding the world of social ills. These efforts facilitate and respond to Millenials' penchant for starting "social ventures." They create organizations -- for-profit or non-profit -- that deploy businesslike efficiency in addressing unmet needs in a community or society.

It makes sense that starting social ventures has become popular among young people. After all, institutions that once attracted droves of ambitious college students -- like investment banks and government agencies -- have lost their luster. Newly-minted lawyers find their schooling has left them ill-equipped for the real world. Even big charities connote bureaucratic sloth to young people skeptical of large institutions.

It's important to note, though, that although starting social ventures is in vogue, it is not always the best approach to addressing the issues that irk young people. In many cases, working for an existing organization or advocating for a policy change offers a better shot at meeting their goals.

Anyone who thinks about starting a social venture should ask three questions before proceeding:

1. What does success look like?

In 2008, a college classmate named Rohan Mathew and I started the Intersect Fund, a New Jersey nonprofit that offers business training and loans to low-income entrepreneurs. Our goal is to be a strong ally for individuals in our state who want to start a business but lack the resources to do it. Having set up a system to make a lot of small loans, we see no reason why we can't eventually lend to all "micro-businesses" (those with five or fewer employees) in our state that need our services.

We would view such deep market penetration as a success, but we could have taken a different approach to economic development. If our goal, for instance, were making loans easier to get throughout the country, the best approach may have been to advocate for a stronger Small Business Administration more attuned to the needs of nascent microbusinesses. If there had been a well-regarded microlender already working in our area with our target market, we might have sought to join forces with them, perhaps helping them to adopt some of the technology-based solutions that have become such a big factor in our work.

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2. Am I capable of marketing and delivering the service I seek to offer?

Keep in mind that need doesn't necessarily equal demand. When we got started, for example, we knew our city had high rates of poverty and unemployment. We also had a sense that many residents tried to start a business but failed due to a lack of money and accounting skills.

Given these conditions, we thought people would be beating down our doors for financing. To our surprise, the first year was pretty quiet. A steady stream of clients enrolled in and enjoyed our business training course, but we disbursed only three loans. It wasn't until we gained a reputation in the community and recruited staff who could speak our borrowers' language (this one seems pretty obvious in hindsight) that we were able to ramp up our lending.

We learned later than we should have that without capacity and connections, good intentions are useless.

3. Is anyone else already doing what I want to do?

Think hard about this one. If young entrepreneurs know of an effective organization in their community that already delivers the service they want to provide, they should try to work with it. If they try to start a competitor, they'll struggle to secure funding and community partners.

However, if the other organization is proving ineffective, it may be fair game for competition. If young entrepreneurs think they have a better approach than the one their competitors use, or that they could do the work just as well but with less overhead, they may want to give it a shot.

If no organization does anything remotely similar to what they want to do, they should ask themselves why. Consider the old example of the shoe salesmen sent to scout out new country for a potential expansion only to find that its residents wore no shoes. One wrote back, "There's a great opportunity here, everyone needs shoes!" The other was pessimistic: "It's hopeless, no one here even wears shoes."

Optimism is essential to starting any venture, but so is market research. It's important for young entrepreneurs to speak with community stakeholders and offer a scaled-down version of their service to gauge demand before launching a full-scale effort. The issues they seek to address are no doubt worthwhile. They owe it to themselves and their potential clients to approach it the right way.

Joe Shure is a Roosevelt Institute | Pipeline Fellow and co-founder and associate director of the Intersect Fund.

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Why Atlas Shrugged

Nov 18, 2011Bruce Judson

ayn-randAyn Rand's Objectivism glorified wealth-creators over moochers, but Wall Street traders might be surprised to learn which category they're in.

ayn-randAyn Rand's Objectivism glorified wealth-creators over moochers, but Wall Street traders might be surprised to learn which category they're in.

As the dysfunctional nature of our economy becomes increasingly apparent, the media is appropriately focusing on whether the ideas of economic thinkers from earlier eras can help to solve today's problems. Recently, NPR devoted a segment to the thinking of Ayn Rand.

The NPR segment quoted from an extensive television interview with her conducted by Mike Wallace in 1959, now available on YouTube.  As the segment noted, Rand is a hero to many Washington  politicians who advocate free markets. In the Wallace interview, Rand said, "I am opposed to all forms of control. I am for an absolute, laissez-faire, free, unregulated economy."

The Washington establishment has, in fact, misinterpreted what Rand valued and what she would advocate today.

At this moment, what's relevant to our nation is not  the laissez-faire policies Ayn Rand advocated in the late 1950s as an outgrowth of the philosophical system she called "Objectivism," but what the philosophy itself considered important, how these principles should be applied to our modern economy, and whether we believe implementing these ideas would aid the economy.

The central statement Rand stressed repeatedly in her interview with Wallace is that entrepreneurs and businessmen are the producers who create the goods and services that make our economy run. They deserve their wealth, are her heroes, and no one including the government has the right to take their property. As NPR notes, "In Atlas Shrugged, which Rand considered her masterpiece, the wealthy corporate producers are the engines of the American economy." In this fictional tale, the economy starts to stagnate when these producers go into hiding, leaving behind what she calls "the moochers."

In effect, an important aspect of Rand's philosophy supports the central tenet of a functioning capitalist economy: Those who create the greatest societal wealth should be the most highly compensated.

This is a fundamental notion in any capitalist economy. It underlies one aspect of the American Dream and also explains the historic admiration of the American people for rich people. In general (and before the Occupy Wall Street movement), the prevailing ethos in America has been that rich people deserve their wealth because they have created societal value for all of us. Indeed, I suspect the vast majority of the American people do not begrudge the wealth earned by successful, risk-taking innovators like Michael Dell, Jeff Bezos, the late Steve Jobs, or Ross Perot.

This leads to the conclusion that Rand's philosophy is only anti-regulation because it is ultra-supportive of the capitalist ideal: The people who create the most societal wealth should receive the benefits of this contribution.

From this perspective, Rand's philosophy points out that real capitalism is no longer enforced in America; not because of welfare programs, taxes, the social safety net, or government regulations, but for a very different reason: The highest paid people in America today create no real wealth for the society.

The financial industry, comprised of traders, hedge funds who exploit arbitrage opportunities, and "quants" who develop mathematical models to take advantage of minute inefficiencies in trading markets (for stocks, derivative securities of all types, commodities, and more) are now earning seemingly inestimable sums. Hedge fund owners earn billions of dollars annually while traders who earn less than several million dollars a year are not, by Wall Street standards, real successes. Yet they are all gambling in "a heads I win, tails you lose" game. The outcome of all their efforts are high profits, but little, if any, new societal wealth.

Real societal wealth is anything that enhances the lives of those in our society, starting with basics such as food, shelter and medicine, but also including almost any property a person can own or anything a person can experience, such as entertainment or greater convenience. Real wealth can be eaten, used, shared. or experienced.

Profits cannot be eaten and they do not provide shelter. As a consequence, it's essential to recognize that the creation of profits is often confused with the creation of real societal wealth. They are different. Profits are an accounting proxy we use for indicating whether wealth is created. But like all proxies, this one sometimes falls short. With regard to the financial industry, this proxy has failed the nation spectacularly.

The current issue of Foreign Affairs describes how a Wall Street firm spent $300 million to construct a fiber-optic cable connecting the Chicago Mercantile Exchange and the New York Stock Exchange to shave "three milliseconds off high-speed, high-volume automated trades-a big competitive advantage." And huge sums are now being spent to use technology to earn these profits. High frequency (i.e. computer-driven) trading is now estimated to account for 75 percent of all buying and selling of U.S. equities. Does any of this add to our societal wealth?

Some economists openly wonder whether our financial services sector actually destroys, instead of creating, societal wealth. In December 2008, Paul Krugman wrote in The New York Times (emphasis added):

The financial services industry has claimed an ever-growing share of the nation's income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it's not just a matter of money: the vast riches achieved by those who managed other people's money have had a corrupting effect on our society as a whole....

We're talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America's G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing - and it probably was - we're talking about $400 billion a year in waste, fraud and abuse.

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By 2009, Krugman noted that this view was now widely shared.

Yes, many financial economists have concluded that high speed trading and hedge fund arbitrage add to the efficiency of these markets. But I wonder if they have quantified the value to our society of these benefits and compared them to the very real costs. As far as I know, they have not. It's my understanding that they have only looked at the isolated impact of these activities on markets -- not their overall impact on our society.

This system, with the highest rewards going to those who create nothing, is antithetical to a capitalist economy. We have turned the underlying premise behind our entire economic system on its head. Now, those who create little, if any, societal wealth receive the most wealth in return.

Moreover, the wealth now inappropriately channeled to Wall Street is harming our society in a myriad of ways: First, money inevitably leads to political power through donations, lobbying, access, and more. Inevitably, trading-related money is now further distorting our capitalist economy by influencing legislation for its own anti-capitalist benefits.

Second, in a society where success is often defined by income (for better or worse) the talent the nation desperately needs to create real wealth is instead sucked up by the financial system and dedicated to arbitrage and other zero-sum activities.

Third, the speculative investments of hedge funds and other trading entities can have a dangerous destabilizing impact on markets and the prices of essential commodities (such as food and energy), and create systematic risk for the economy as a whole. In February of this year, Bloomberg highlighted a federal government report that found that "[h]edge funds and insurers might threaten U.S. economic stability in a time of crisis."

Fourth, it's likely that billions of dollars of our nation's limited resources are spent each year on infrastructure with no real societal value, all of which could instead be spent for productive uses.

Fifth, pay scales throughout the society are thrown out of whack as other elites start to question whether they should be earning similar amounts.

Finally, the notion that all profits are good -- whether they create real societal wealth or not -- is consistently reinforced through the highly publicized example of Wall Street earnings and applied with the same harmful effects in other industries throughout the nation.

Ayn Rand would, I believe, argue that this absolute failure to enforce capitalist principles is exactly what she most feared: The emergence of a powerful group that produces nothing, yet manages to takes a large share of the societal wealth created by others. In her view, this inevitably leads a society to implode and self-destruct.

Yes, Rand did not believe in altruism or any type of social safety net, and I am not addressing this aspect of her "Objectivist" philosophy here. But it is worth noting that she opposed these programs for the same reason I am certain she would be horrified by the current channeling of wealth to financial firms: She believed that they were allocating the benefits of production away from the rightful beneficiaries. Whether we agree or not with these assertions, they are irrelevant to this discussion.

I do, however, feel comfortable asserting that if she returned today, Rand would consider eliminating the transfer of un-earned wealth to the financial sector to be a far greater and far more urgent priority than addressing her beliefs related to the social safety net.

Unless we address the destructive effects caused by making speculators and traders the highest earning class in our capitalist society, the economy will remain dysfunctional.  In effect, the nightmare that Rand's philosophy anticipated for our economy is increasingly real, but because of the financial industry, not the social safety net or taxes.

Here's a final thought: In Rand's Atlas Shrugged, the industrialists who create the real wealth of the society start to disappear as they go into hiding. The trains that make the society work, both literally and metaphorically, stop.

So I have developed what we can call the Ayn Rand test of value: If securities traders and quants at investment firms and hedge funds started to disappear in large numbers tomorrow, would the trains that comprise our economy and society run better or worse?

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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It's Wages, Stupid

Nov 17, 2011Jeff Madrick

By focusing on supply, economists and policymakers have lost sight of the fact that driving down wages destroys demand.

For a few decades now, American economic policy has focused on keeping inflation low, assuming that the natural rate of unemployment is fairly high. In general, that has led to stagnating wages. Family income today is at 1990s levels. Adjusted for inflation, hourly wages are at levels they last reached in the 1960s. The wage share has been falling.

By focusing on supply, economists and policymakers have lost sight of the fact that driving down wages destroys demand.

For a few decades now, American economic policy has focused on keeping inflation low, assuming that the natural rate of unemployment is fairly high. In general, that has led to stagnating wages. Family income today is at 1990s levels. Adjusted for inflation, hourly wages are at levels they last reached in the 1960s. The wage share has been falling.

Some economists claim inequality is the bigger issue due to runaway income at the top. My own view is that a better way to understand America's dilemma to focus on stagnation for the broad middle and bottom. As I note in my latest piece for the New York Review of Books, the incomes at the top, which account for most of the inequality, are made in finance -- much of which is a game Wall Street plays with itself. For this brief piece, I will put that issue aside.

It is time to talk about the importance of high wages to sustainable growth in America and Europe -- indeed, in most countries around the world. The precarious circumstances in the eurozone today are widely understood, as was the U.S. financial crisis, as a problem of fiscal and financial discipline. In fact, I'd argue they were mostly a product of economic models based on low wages that were not sustainable.

Both Germany and China had models that depended on low wages. I'd also argue that the U.S. had a low wage policy to fight inflation, which had become public enemy number one in the minds of even the most sophisticated economists since the 1970s. These economists persistently over-estimated the so-called natural rate of unemployment, which gave the Federal Reserve justification to keep rates up to suppress inflation. In practical fact, the Fed under Alan Greenspan was mostly appeasing bond markets, which Greenspan watched very closely as the signal of inflationary expectations.

We can now focus our attention on wage deficiency. You might be surprised to think Europe or even American financial distress is a wage problem, not a financial discipline problem. But it is time to think this through clearly. We are told too often that disciplined Germany must bail out undisciplined Greece, that America is angry at China's currency manipulation and China at America's profligate government deficits. We might almost believe this is the heart of the matter.

But at the center of the issue are low wage shares and inequality. And one reason the world's policymakers, technocrats, and economists don't think about it clearly enough is that they focus too much on "supply" as the principal source of economic growth -- of machinery, ideas, technology, resources, and human capital quality labor. They focus far too little on "demand" as a source of economic growth.

So here is the brief version of this case. To simplify, aggregate demand must be strong enough to utilize the full productive capacity of a nation in order to optimize growth and keep unemployment down. Demand is largely consumption, which in turn is mostly a product of salaries and wages. In other words, wages must be high enough to support demand for goods and services.

Already we start with an over-simplification. Higher demand, for example, can itself increase productive capacity by promoting investment. On the other hand, higher wages can undermine profits and dampen growth. New School professor Lance Taylor tells us America's economy is profit-led rather than demand-led. I am a little skeptical of this argument, but Taylor readily admits conditions may change. Servaas Storm, the Dutch economist, who has models similar to Taylor's, believes that is exactly what is happening.

If wages are too low, then, there won't be enough demand to support growth. Similarly, if inequality is too high, demand will be insufficient because high-end consumers usually save far more than the rest -- there will be a dearth of consumption. The International Labor Organization is now arguing along these lines.

There are basically two ways to increase demand, and they are at the center of the current financial crises. One is to export much more than one imports. Germany and China are the classic examples of this. Wages are relatively low in Germany and very low on a world basis in China, however hard China is trying to raise them. Low wages and low currency values keep their exports competitive. The other model is to borrow to pay for consumption. The U.S., where wages are also low as we noted earlier, is the classic example of this.

The main point is that neither of these economic models of growth is sustainable.  There is no longer any doubt about the American debt-led model. It collapsed dramatically in 2008 with damaging implications for the U.S. and the rest of the world.

But many seem to believe that the export model can last forever. Indeed, Germany is cited as a model of rectitude for its moderate wages and discipline. It is now called on to bail out the profligate Greeks, and maybe the Italians, the Spaniards, and the Portuguese. There is a moralistic and sometimes I think ethnically prejudiced subtext for this simple diagnosis -- a diagnosis the media repeats carelessly.

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The export model, however, is not sustainable because Germany and China are increasingly dependent on borrowing nations (or relatively high-wage but less export-competitive nations) to buy all those goods. If Germany suddenly left the eurozone, for example, a new deutsch mark would likely rise sharply in value and put its exports at a disadvantage. Then what? One wonders how carefully some of the anti-bailout German economists have thought this through.

In fact, Germany and China are as dependent on those who buy their goods as those who now over-borrowed may be dependent on Germany and China to bail them out. As suppliers of careless debt, their institutions also bear heavy responsibility for their debtors. Thus, both Germany and China have moral obligations to support a bailout.

I'd like to say that we should not ascribe blame. But some shifting of blame back to Germany and China is necessary if only to balance responsibility for corrective action now. The euro is priced too low for Germany, giving it a great advantage, and China manipulates its currency downward.

The world requires rebalancing. The answer is to raise wages and wage share and reduce inequality. America would then need to borrow less, and China and Germany would need to export less. Current account balances -- big surpluses for Germany and China and big deficits for the U.S. and much of the rest of the eurozone -- would move closer to balance.

One way to start would be immediate coordinated fiscal stimulus. If all provide stimulus, the leak from deficit nations due to the high propensity to import would be mitigated. Similarly, looser monetary policies in the rich nations are required, even as America addresses its so-called zero bound problem. Germany should lead a stimulative fiscal charge in Europe.

Nations, however, are generally doing just the opposite. Germany is mildly stimulative, but austerity economics is tragically in vogue in countries like France. Those within the eurozone, because they cannot cut the value of their currencies, see lower wages as the only recourse to make their exports competitive and generate growth. On the contrary, it will of course bring on slow growth or recession. This has become a vicious circle.

While I don't advocate ending the euro, the single currency makes it difficult for those within the eurozone to adjust currencies. But ideally, China's currency should rise, which has of course been widely discussed in the U.S. and Congress. (Keep in mind, this may provide more advantage to China's even lower-wage rivals, like India, Bangladesh, and Indonesia, than the U.S. and some economists currently consider.) There should be continuing pressure to make this happen.

China needs a strong domestic market to make growth sustainable, but it is not clear that Germany fully understands that it does as well. The European Central Bank has also been especially destructive. Its obsession with low inflation has damaged Europe for a couple of decades. Now, its narrow view that it should not be a lender of last resort could do the euro in.  One wonders whether these technocrats are any better than first year doctorate students who believe all the rudimentary theory they are taught.

Aggressive short-term, medium-term, and long-term strategies are also needed to raise wages in the U.S. On an after-tax basis, policies are a little easier to coordinate. In the U.S., where the top one percent of earners make almost 20 percent of the income, higher taxes should be levied on the wealthy and then distributed as transfers to the rest -- or used to reduce deficits to keep the deficit hawks quiet.

But the more significant task for the U.S., and the more difficult one, would be to fix the broken jobs machine in America and generally raise wages before taxes. Job growth was very slow before the Great Recession, as was wage growth. Such policies could include direct hiring by the federal government, persistent large infrastructure and energy investment programs, a living wage policy, and a higher minimum wage.

In sum, there seems to be a deep and potentially tragic misunderstanding of the sources of today's problems. Internationally, as I note, we should stress how important it is that wages rise in China. Germany must also learn as a nation that its low-wage, export oriented policies are beggar-thy-neighbor policies that cannot last forever, and that it played a part in the financial distress in peripheral eurozone nations.

And the U.S. should get over its own obsession with low inflation, born with the general acceptance of a natural rate of unemployment in the 1970s that no one could forecast but many pretended they could. Keeping wage growth suppressed was a direct outcome of this inflation focus. Compounding the problem is cultural acceptance of low wages and the powerful and widespread influence of Wall Street, which rewards CEOs with stock options that are only valuable with high short-term profits, encouraging them to lay off workers and keep labor costs down.

I plan to write a longer and more nuanced take on this argument, but in light of widespread misinterpretations and possibly calamitous developments in Europe, I thought it important to make this point clear: "It's wages, stupid."

Roosevelt Institute Senior Fellow Jeff Madrick is the author of Age of Greed.

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Employers and Banks Bilk Workers with Payroll Cards

Nov 16, 2011Bryce Covert

A new trend has emerged in which low-wage employers pay their workers with unregulated, high-fee prepaid debit cards.

A new trend has emerged in which low-wage employers pay their workers with unregulated, high-fee prepaid debit cards.

While Bank of America backed down in the face of public outrage against charging customers $5 for using a debit card, there's been a focus lately on the fact that big banks still charge customers for using cards -- it's just that the cards are prepaid debit cards, and the money loaded onto them is from government benefits. Janelle Ross at the Huffington Post had two hard-hitting exposes on how banks are profiting from the distribution of unemployment benefits. I followed up to point out that they also make a killing off of distributing food stamps, even more so because they make money off of both fees from customers and payments from governments for taking the work off of their hands.

Felix Salmon points out that this trend shouldn't have to be negative. Checks, he says quite vehemently, are outdated. "They're expensive, insecure, anachronistic, and dangerously reliant on the less-than-stellar delivery record of the US Postal Service," he writes. Checks are "a technology which deserves to be killed off with extreme prejudice."

Missing from the discussion of unemployment benefits and food stamps is the fact that low-wage employers are now turning to the same idea. But perhaps it would seem on its surface that employers who are similarly doling out money -- this time, salaries and wages -- without the use of paper would be a win for everyone. Wal-Mart, one of the most gargantuan of low-wage employers, announced last year that its payrolls would be distributed completely paper-free. For employees with traditional bank accounts, that means they can simply get their checks through direct deposit. But for the 17 million unbanked Americans, that won't be possible. The solution for them is the payroll card, which is basically a prepaid debit card with wages loaded onto it. According to a company spokesperson, about half of its 1.4 million employees use direct deposit. That leaves the other half, about 700,000, with no option except payroll cards. Wal-Mart isn't alone in this practice. The FDIC estimates that these cards were used to distribute $15.9 billion in wages in 2007; that number is expected to reach $60 billion by 2014. One group estimates that there will be over 17.5 million cards in use this year alone. Where Wal-Mart goes, the industry will follow.

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And some will win out from this arrangement. Trees stand to benefit from the approximately 200,000 pounds of paper no longer required to process Wal-Mart's paychecks, saving 3,116 of them from being chopped down. Because of this, the company also stands to save substantial money. By eliminating 18 million paper paychecks per year (with the conservative estimate that each check costs the company $2), it will net $36 million in savings from no longer cutting the checks -- which doesn't factor in saved resources from labor and distribution.

But will the employees benefit? True, cards can be more convenient, and Wal-Mart is so generous as to allow them to load paychecks from other jobs onto the cards. But as the Consumers Union and National Consumer Law Center have pointed out, "the employer's benefit could be the employee's burden if the cards have high and numerous fees, offer payday-loan type credit features or are simply too complicated or difficult for employees to use." Just as with regular prepaid debit cards, which are almost completely unregulated and come with a host of fees, workers can face charges for ATM transactions, point-of-sale purchases, not using the card, replacing the card, overdraft transactions, live customer service, reloading the card, or getting funds by check. The Consumers Union and NCLC offer some helpful ways to protect workers, including providing written disclosure of terms and conditions (like these fees) before issuing cards, giving employees the chance to opt out of the cards, and keeping the cards from offering payday-lending type features. But while many states have enacted regulations on payroll cards, they aren't uniform, and some still have no regulations at all.

While employers benefit from the use of these cards to the possible detriment of their workers, the other players that make money from this arrangement are the banks and servicers who facilitate the cards. The banks are set to lose $14 billion this year due to new laws tamping down on how much they can charge merchants for debit swipe fees. But those rules won't apply to transactions with prepaid debit cards, whether they be for unemployment benefits, food stamps, or wages. Ross spoke with an industry analyst, who estimates that banks are aiming to recoup 30 to 50 percent of what they're losing from swipe fees through other fees such as these. But as Ross reports, "Banking experts say the real money lies in the fees the bank collects for a range of services," and it's not hard to see why when they have open season to charge consumers for anything. The potential convenience of a card is endangered by the possibility of wages being whittled away by fees.

Bryce Cover is Editor of New Deal 2.0.

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Arizona Puts Profit Over Prisoners' Progress With New Fee

Nov 10, 2011May Mgbolu

prison-wall-150Families already struggle to visit incarcerated loved ones, but a new charge will make it harder and further isolate inmates.

prison-wall-150Families already struggle to visit incarcerated loved ones, but a new charge will make it harder and further isolate inmates.

Imprisonment has always generated invisible inequalities. But new legislation in Arizona now forces families and friends of inmates to bear an extra burden and will end up creating more barriers to reentry for inmates after they leave the system.

As of July 20th, Arizona became the first state to pass a "background check fee" that charges adults a one-time fee of $25 to visit any of the 15 prison complexes that house state prisoners. While the legislation was instituted under the pretext that the profit would be used to support the administration of background checks, Wendy Baldo, chief of staff for the Arizona Senate, has explained that the earnings will fund prison maintenance and repairs. However, prison maintenance and repairs is the least of concerns among prisoners and visitors.

Instead, the legislation imposes unusual punishment on the prisoners' family and friends. This fee directly penalizes the family of inmates for the simple reason that their loved ones are in prison and they want to visit them while incarcerated.

While $25 may not seem like a huge amount for many Americans, there is a vast economic disparity between the families of inmates and an average two-parent household. Although specific figures on household income of incarcerated parents are not available, a single parent home that loses one parent to the prison system is expected to experience an income drop of an average 41 percent in the first year. Although the majority of families affected by incarceration are often already low-income households, there is evidence that the men within these families are the key contributors to household income. For instance, 54 percent of the men incarcerated reported being the primary financial support in their household, with an average of 61 percent of fathers employed full-time and 12 percent of employed part-time.

The magnitude of the destabilization of a family struggling financially before an incarceration only demonstrates the declining probability of a family being able to make ends meet in a single household. Arizona's fee simply adds another cost for the family. It comes on top of acquiring the funds necessary to maintain contact with their loved ones such as having to take time off of work and travel to the desolate areas where prisons are often located. It should come as no surprise, then, that this fee is likely to reduce the frequency of visits and cut off inmates' connection to their loved ones and the outside world.

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While prison maintenance is important to the functions of Arizona's Department of Correction, prisoners, their families, and the law has the potential for long-lasting negative effects on prisoners. Importantly, the new law may put a key goal of our criminal justice system in jeopardy: rehabilitating and integrating formerly incarcerated people back into society.

With this fee forcing families to shoulder greater expenses, the Arizona Department of Correction undermines their mission of "successful community reintegration." It discourages visits from wives, husbands, children, and many loved ones that play a vital part in keeping prisoners on a straight and narrow path. While others programs, such as Florida's Department of Correction, create strategies to decrease recidivism through visitation programs, Arizona's Department of Correction chooses to discount the importance of visitation. The PEW Center and the National Prison Project of the American Civil Liberties Union have stated that prison visitation has a positive impact on inmates socially and psychologically, deterring them from potentially bad influences that could lead to reincarceration. Adding a price tag to an important factor in an inmate's ability to avert reincarceration defeats the purpose of the prison system.

This fee may be the first of many to be seen among state correction departments looking to join the national trend of "prisons for profits" and decrease the state's cost of incarceration. While the politics of prisons for profit are anything but new, such policies continue to be a strong determinant of the future of the impoverished communities victimized by the hardships related to incarceration. We need to reconsider the goals and values of our criminal justice system so they are not just about how they save money and make profits.

Barrett Marson, the spokesman for the state Department of Correction, explained that Arizona receives over 30,000 applications to visit prison inmates each year and expect to generate at least $750,000 a year with this fee. But it will undeniably challenge families' of inmates access to visitation, reduce prisoners' chances of adequate rehabilitation and reintegration, and instead encourage the revolving door of prison's release and reentry in order to generate less then 1% of Arizona's Department of Correction's $1 billion budget. As a nation we need to understand the destructive implications of such policies. Is this income worth the greater price tag?

May Mgbolu is the Senior Fellow for Equal Justice at the Roosevelt Institute | Campus Network and a senior at the University of Arizona.

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Move Your Money. But Be Careful Where It Goes.

Nov 10, 2011Bryce Covert

A word of warning to those fleeing big banks and bringing their money to nonbank lenders.

A word of warning to those fleeing big banks and bringing their money to nonbank lenders.

This past Saturday was "Bank Transfer Day," in which 40,000 frustrated customers joined the 650,000 who had already switched their money out of bank accounts with the Too Big To Fail behemoths to smaller community banks. The preliminary results are encouraging: on that day alone, customers deposited $90 million with credit unions and had moved $4.5 billion in the weeks leading up to it.

It's easy to understand frustration with these banks. It wasn't too long ago that Bank of America and a handful of others were threatening to charge customers for using debit cards, even though profits from consumers are helping keep some of these banks afloat. Bank fees can add up, particularly for lower income people who may not be able to keep minimum balances, use direct deposit, avoid overdraft fees, and otherwise stay away from banking fees.

But that frustration may be leading some into the arms of even more pernicious institutions: those that serve the unbanked. Before Move Your Money, about a quarter of American families, or 60 million people, were already considered unbanked or underbanked, meaning that they have little to no relationship with traditional banks. But someone has to fill that hole. Those who step in see a real business opportunity, as the ranks of the unbanked are growing.

The traditional stand-ins are payday lenders, check cashers, and prepaid debit card companies. The first problem with these institutions is that they avoid the scrutiny and regulation that is supposed to reign in traditional banks (although the CFPB stands to change all of that). On top of that (and likely because of it), they come with extremely high interest rates and hidden or unexpected fees. For example, payday loans can come with interest rates that exceed 450 percent when annualized. That doesn't include fees, which can include an upfront $45 -- no small price for those with stretched budgets. Check cashers often skim between 2 and 4 percent of each check's value. That could add up to $40,000 over a customer's working life.

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Prepaid debit cards are a burgeoning market in and of themselves. It's expected that Americans will load $37 billion onto prepaid cards this year, and by 2013 that number is expected to reach $672 billion. This could mean killer profits for those offering the cards. But an AARP study found that they "may actually be an expensive alternative to traditional banking sources" due to monthly costs and other fees. Consumers can be hit with fees for using ATMs, calling customer service, activating an account, or simply not using the card.

All of these loosely regulated institutions have been making tidy profits from the gap between traditional banks and mattress stashing. Now new entrants are getting into the game, showing the perceived business potential in offering these products. The New York Times reported this week that Wal-Mart has slowly been building up an offering of financial services. More than 1,000 locations across the country let customers cash checks, pay bills, wire money, or load cash onto prepaid debit cards. As with everything else it sells, it's found a way to offer things on the cheap: it offers cards that normally cost $4.95 to buy and $5.95 a month to maintain for $3 for each fee. It only charges 1 percent to cash checks under $300 and a flat rate of $3 per check for checks from $300 to $1,000. But these fees can still add up.

Beyond being swindled by fees and interest rates, banking with nonbank institutions supports businesses that are likely no better than the large banks. Taking money out of Bank of America and bringing it to Wal-Mart is no way to free yourself of the corporate world. And shady nonbank lenders that escape regulatory scrutiny don't need to be bolstered with our business.

So yes, move your money. Just be careful where you put it.

Bryce Covert is Editor of New Deal 2.0.

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Hoop Dreams: Dorian Warren on the Link Between NBA Players and the 99%

Nov 1, 2011

What do Occupy Wall Street protesters have in common with NBA players who are on strike? At first glance, not much. Few basketball stars are worried about avoiding foreclosure, and the people camped out in Zuccotti Park aren't signing multimillion-dollar endorsement deals with Nike. But as Roosevelt Institute Fellow Dorian Warren tells CNN's American Morning, they're all being exploited by the richest of the 1%.

What do Occupy Wall Street protesters have in common with NBA players who are on strike? At first glance, not much. Few basketball stars are worried about avoiding foreclosure, and the people camped out in Zuccotti Park aren't signing multimillion-dollar endorsement deals with Nike. But as Roosevelt Institute Fellow Dorian Warren tells CNN's American Morning, they're all being exploited by the richest of the 1%.

Dorian explains that the driving force behind the NBA strike is that team owners are raking in bigger profits than ever while claiming there's not enough to go around when it comes time to compensate the players who are doing the actual work. Sound familiar? The difference between basketball players and most American workers is that the athletes still have a strong union that's ready and willing to fight for their interests.

To read more about the strike and why it represents an opportunity for solidarity rather than resentment, check out Dorian's recent Washington Post op-ed, co-written by Princeton's Paul Frymer.

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