The Case Against Tax Breaks for Private Equity

May 23, 2012Jeff Madrick

Private equity disproportionately rewards privatization companies while others are burdened with the risks. 

Private equity disproportionately rewards privatization companies while others are burdened with the risks. 

I wanted to wait a few days before commenting on Newark Mayor Cory Booker’s spontaneous criticism of Barack Obama for picking on Mitt Romney's experience at Bain Capital. Booker doesn’t know much of anything about private equity, but many financial services donors have his ear. He took in nearly half a million dollars in campaign donations from the industry over the last nine months, and he frankly sounded like its mouthpiece.

Booker backtracked, but it would be nice if he knew something about the private equity business before he spoke publicly about it. This expectation of knowledge should also apply to widely read columnists like David Brooks, who, as usual, reflexively defended the Wall Street practice without presenting evidence. He issued a piece of public relations diatribe that no doubt soothed the right but contributed nothing to our understanding. The contention is that these buyouts turned fat American companies into lean and productive ones since the 1970s. Other pundits less well known for their conservative reflex responses have also given partial defense of private equity.

So let’s begin with one point: there is a place for private equity. In a privatization or leveraged buyout, a company is bought by an investment partnership with moneys borrowed against the company itself. The new money can be used productively even when levels of debt against the company’s assets and profits soar. A smaller company that cannot raise adequate equity can raise money by being bought by a private equity partnership. A company that is doing poorly can benefit from added capital and new management. Sometimes trimming labor costs in the process makes sense, of course. 

But the record of leveraged buyouts and private equity reflects its excesses, and most importantly, the lopsided nature of the financial incentives for doing the deals in the first place. Companies like Romney’s Bain or Steve Schwartz’s Blackstone or Kohlberg Kravis Roberts, the early industry leader when privatizations were called leverage buyouts (LBO), take advantage of a major government-provided benefit. The interest on debt is tax-deductible, and high levels of debt are the source of profits in these transactions. It is just like buying a house with a small down payment; if you can sell as the value goes up, the return on the down payment is high and the interest was deductible all along. In the meantime, the house is collateral for the loan. Similarly, partners are rarely if ever on the line for the debt; the company being privatized is. The one difference is that if the collateral value of the house falls, as it has recently, the homeowner is on the line. This is usually not so with privatizers.  

Great deal? You bet. The owners of the privatizing firm put up very little capital; it is their limited partners who put up more.  Then they borrow like mad from banks, pension funds, hedge funds and so on. If the new company can be sold or brought to market again at a higher price, they make a bundle compared to their equity down payment. The CEOs of the company, or the new executives brought in, are given huge amounts of stock. They too make a bundle. Are these incentives conducive to good business decisions?

Most likely, the investment decision is based not on how much the company can be improved, but how much can be borrowed against its assets. The second concern is the interest rate on the debt. There is no evidence that privatizers mostly buy struggling companies to resuscitate them.

Moreover, companies with high levels of debt are subject to great risk of bankruptcy. Macy’s did one of the first leveraged buyouts of its size, the CEO made out wonderfully, and soon Macy’s was in bankruptcy. It reorganized and reemerged successfully due to its retailing skills, but these were not enhanced by the LBO partners.  

Data shows the newly bought firms create fewer new jobs—or result in more lost jobs—than firms that are not subject to private takeover. But what about the much-lauded productivity gains? On balance, these target firms mostly increase productivity by selling or closing low-productivity units. Arguably, they also make their employees work harder. The fear of lay-offs can enhance productivity. There is no evidence that these firms improve productivity mostly by investing in new technologies, new managerial methods, and so on, which is often their claim.

And of course what productivity gains they have had (overall they are small) did not reinvigorate the American economy. The two main sources of productivity gains in the U.S. were high-tech companies and the retailing behemoths led by WalMart. Many retailing targets of privatizations eventually went bankrupt.

The best recent paper on private equity was written by Eileen Appelbaum of the Center for Economic and Policy Research and Rosemary Batt of Cornell University. The David Brookses of the world will cry that these researchers are of a liberal bent. But read the paper to see how carefully it is done. The exegeses of much of the right in defense of private equity are essentially outright propaganda.   

However, the basic point comes back to government and regulation. A major tax advantage gives rise to these buyouts. The privatization partnerships are lightly regulated. After-fee returns to the limited partners seem to be below average. But as for their benefits to society, privatization rewards investors by cutting short-term costs. For a long time, the stock market pushed up the stock prices of companies that kept short-term earnings growing. The influence of such corporate governance has been to keep downward pressure on wages and stoke fear in employees for three decades.

Let’s be clear; some private equity investments were healthy and some of these partnerships do a good job. But all in all, it is clear most are simply exploitations of tax law, market fashions, and their power to borrow money. There is no reason America should reward these investors with a tax break on their huge loans.   

Privatizers didn’t rebuild America. They were rarely the people who planted the garden, watered it, or designed it.  They were by and large the ones who weeded it, sometimes recklessly, throwing out the gorgeous roses in the process. Gardens do need to be weeded, but should those who do the weeding, often heedlessly, make so much more money than those who do the planting? And with the added help of government tax breaks?

In the end, Romney’s Bain made money even though its takeover target, American Pad & Paper, went out of business. Consult Appelbaum and Batt on how some of these strategies work, involving mortgaging real estate holdings and transfer pricing to reduce taxes. Privatization was mostly, if not entirely, about working the system, not building capitalism.  On balance, evidence suggests it hurt more than helped. Any way you read the evidence, it is clear the rewards for private equity firms clearly exceeded the risks. That’s not good for free markets.  

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

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Can Private Equity Firms Like Bain Do Whatever They Want With the Companies They Buy?

May 22, 2012Mike Konczal

Three critiques of the notion that private equity's actions are above public concern.

The question of Romney's tenure at private equity firm Bain Capital will stay in the headlines as the Obama team releases ads on the subject and Romney continues to run on that record. But what can we take away from this debate?

Three critiques of the notion that private equity's actions are above public concern.

The question of Romney's tenure at private equity firm Bain Capital will stay in the headlines as the Obama team releases ads on the subject and Romney continues to run on that record. But what can we take away from this debate?

Ezra Klein argues that running a leveraged buyout company ought to give one some sense of solidarity with those left behind. As LBO/private equity creates winners and losers, winners should be in favor of an expanded social safety net that helps those who lose in the layoffs get back on their feet with minimial disruptions. Since LBO overall creates more wealth, part of that wealth should be taxed for the benefit of those who need help adjusting to their new economic reality afterwards - such as providing continuous health care coverage, job training, etc.

One thing I'm noticing in these debates is an almost tautological idea that since shareholders own the firm, anything shareholders do with their firm is legitimate and outside the boundaries of public concern or critique. It was in the background of what Karl Smith was discussing on Sunday's "Up With Chris Hayes," and Josh Barro made it more explicit this morning on twitter.

A Stick

Let's imagine that I buy a stick. Under a idea of general, everyday libertarianism, since I own the stick I can do anything I want with it. I can break it in half, burn it in a fireplace, carve it into something else, turn it into woodchips, attach a kite to it, exclude people from using it, etc. I can't hit people with it, or use it to set their stuff on fire, or attach duct tape to it in order to steal their stuff - but that's a function of general prohibitions against force and fraud. Short of that, it would be weird to say that I shouldn't do whatever I want to my stick of wood - that something I do with it could be illegitimate - as long as I enjoy it.

But does a private equity firm own its portfolio businesses in the same exact way that I own my stick? Is it weird to even think, outside general prohibitions against force and fraud (which I'll treat as unproblematic as it relates to the question at hand), that their actions could be illegitimate? There are many references to increasing profits, or making firms more dynamic, or "creative destruction," but those are side effects of shareholders doing whatever they want with its portfolio. The core issue is that there could be nothing illegitimate in terms of how a private equity firm runs those businesses in the sense there's nothing illegitimate I could do with a stick I own.

Three Critiques

Starting from this baseline, the critiques as far as I read them (which will draw on two previous posts) break down along three lines:

1. Tax/regulatory loopholes. I did an interview with Josh Kosman, author of The Buyout of America, where he argued that the whole point of the enterprise is to game tax law loopholes. Private equity "saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same."

A recent paper from the University of Chicago looking at private equity found that “a reasonable estimate of the value of lower taxes due to increased leverage for the 1980s might be 10 to 20 percent of firm value,” which is value that comes from taxpayers to private equity as a result of the tax code.

That's one thing in an industry with large and predictable cash flows. But after those low-hanging fruits were picked, as Kosman explained, "firms are taken over in very volatile industries. And they are taking on debts where they have to pay 15 times their cash flow over seven years — they are way over-levered."

This critique has power as far as it goes. But let's combine it with another issue.

2. Risk-shifting among parts of the firm. Traditional "creative destruction" is about putting rivals out of business with better products and techniques. Leveraged buyouts and private equity are about something different, something that exists within a single firm. This is often described as putting new techniques into place, firing people and divisions that are not performing, and generally making the firm more efficient.

The critique here is that, instead of making the firm more efficient, it often simply shifts the risks into different places. As Peter Róna, head of the IBJ Schroder Bank & Trust in New York, described it in 1989:

The very foundation of the LBO is the current actual distribution of hypothetical future cash flows. If the hypothesis (including the author’s net present value discounted at the relevant cost of capital) tums out to be wrong, the shareholders have the cash and everyone else is left with a carcass. “Creating shareholder value” and “unlocking billions” consists of shifting the risk of future uncertainty to others, namely, the corporation and its current creditors, customers, and employees…
 
The notion that underleveraging a corporation can cause problems is neither new nor unfounded. What is new is the assertion that shareholders shouid set the proper leverage because, motivated by maximizing the return on their investment, they will ensure efficiency of all factors of production. This hypothesis requires much more rigorous proof than Jensen’s episodic arguments… although Jensen denies it, the maximization of shareholder returns must take place, at least in part, at someone else’s expense.
Shareholders gain, but at the expense of other stakeholders in the firm. This isn't the normal winner/loser dynamic, where some suffer in the short-term to do what's best for the long-term. Here the long-term suffers to create short-term winners. Once again, this issue becomes problematic when combined with another critique.
 
3. Dividend looting. The theory behind private equity, as Róna caught above, is that it requires shareholders to be the proper and most efficient group to set the leverage ratio. But what if, instead of setting leverage for the long term to make the firm more efficient, shareholders simply use additional debt to pay themselves, regardless of the health of the firm? As Josh Kosman put it:
If you look at the dividends stuff that private equity firms do, and Bain is one of the worst offenders, if you increase the short-term earnings of a company you then use those new earnings to borrow more money. That money goes right back to the private equity firm in dividends, making it quite a quick profit. More importantly, most companies can’t handle that debt load twice. Just as they are in a position to reduce debt, they are getting hit with maximum leverage again. It’s very hard for companies to take that hit twice...
 
The initial private equity model was that you would make money by reselling your company or taking it public, not by levering it a second time...Right after this goes on for a few years, you’ve starved your firm of human and operating capital. Five years later, when the private equity leaves, the company will collapse — you can’t starve a company for that long. This is what the history of private equity shows.

This runup in dividend payouts is feature of the post 1980 financial markets more broadly, one that LBO had a hand in creating:

The blue line is profits, the solid red line is payouts. As Josh Mason noted (my bold), "In the pre-neoliberal era, up until 1980 or so, nonfinancial businesses paid out about 40 percent of their profits to shareholders. But in most of the years since 1980, they’ve paid out more than all of them...It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country’s productive enterprises."

Versions of these three arguments form the core of the private equity critique. Instead of simply carving a figurine or starting a BBQ, private equity uses its stick to game tax law while cashing out short-term value, leaving others in the firm worse off and the firm itself more prone to collapse and less able to produce long-term value. Do you find this critique convincing? What else is missing?

Mike Konczal is a Fellow at the Roosevelt Institute.

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Demand, Deficit, and Denial: A Simplified Case Against Austerity

May 17, 2012Robert Leighninger

President Roosevelt's legacy of public works programs offers insight into the importance of increased government spending to create jobs and restore the economy.

President Roosevelt's legacy of public works programs offers insight into the importance of increased government spending to create jobs and restore the economy.

It’s good to hear more economists talking about the foolishness of austerity in Europe and the United States. Some, including Joe Stiglitz and Paul Krugman, have been saying it for a long time, but the chorus has gotten louder recently. Still, I have yet to hear anyone put the argument in terms simple enough for the average citizen (including the average Republican not too tied in ideological knots) to understand. I’d therefore like to take a shot.

To reignite the economy, we need more people to buy things. For that to happen, we need to keep people in their present jobs, re-employ people who have lost jobs, and employ those just entering the job market. Once people are buying things, those who make the goods and services being bought will have reason to invest, hiring new workers and buying new machines that make things. They have no reason to invest now; there is no likely return on their investment.

Republicans have things backwards. They assume that investors will invest if we give them more money. But they already have lots of money. Why assume that giving them more will change their behavior? They’re not stupid (at least most of them aren’t). What they need is a prospect of profit.

Tax breaks aren’t any incentive. What good are lower taxes on income that you don’t have? What’s the point of hiring another worker if he or she will have nothing to do? Fewer regulations are equally irrelevant. This is why “uncertainty” and “confidence” (the claim that investors won't invest because they are uncertain what their taxes might be in the future or what new regulations they may face) are smokescreens.

What do you suppose investors would do if there were customers pouring through their doors? If goods and services were in demand and inventory was disappearing? They would not say, “No, I don’t think I’ll take advantage of this. I’ll forgo making a profit now because I don’t know what my taxes and regulations will be next year.”  More likely, the response would be, “Wow, we can sell more widgets now; let’s crank up production!”  

In the language of economists, this is a demand-side problem, not a supply-side problem. Republicans have been looking at the world through supply-side lenses for over 30 years and can’t see the total economy. They are blind to common sense.

So how do we get people to buy things? We can save good middle class jobs by aiding states so they can stop laying off teachers, police officers, firefighters, and other public workers. We can create new jobs with large infrastructure projects. There are so many things on the landscape in need of repair or replacement that it shouldn’t be hard to employ or re-employ millions of people. In 1933, the Civil Works Administration (CWA) put 4 million people to work in two months. 

But good heavens, this will cost money! Yes, it will drive the deficit to new heights, and deficits are worth worrying about. But a stagnant economy will not reduce deficits. Putting people out of work through an austerity campaign only decreases revenues and cripples our ability to deal with deficits. A robust economy will handle the problem much more quickly. Restarting the economy will be expensive, but we need to spend the money. If your house is on fire, you don’t tell the fire department, “Don’t use too much water, I want enough for my morning shower.”

If Obama’s $800 billion stimulus package hadn’t been weighed down with so many useless tax cuts, we might not be having this conversation. The experience of the New Deal is relevant here. At its beginning, 25 percent of workers were out of work; when World War II started, it was down to 10 or 12 percent. That is significant progress. And there would have been even greater progress had President Roosevelt not twice stalled the recovery he had created. In March of 1934, after it was only four and a half months old and employing 4 million people, he pulled the plug on the CWA in spite of the fact that even the Wall Street Journal noticed its effect on the economy. He just didn’t want to believe that it was going to cost so much money to end the Depression. 

Once he had replaced the CWA with the Works Progress Administration (WPA), and after his other giant public works programs—the Public Works Administration and the Civilian Conservation Corps—were fueling the recovery, Roosevelt again cut back. Despite the crisis, he still believed in a balanced budget. This return to orthodoxy produced a recession that by early 1938 was looking like 1929. His advisors finally persuaded him to restore the works programs, and thus he ended the recession. Had it not been for these two crises of confidence, the employment rate at the start of the war may have been lower than 10 percent, and we wouldn’t be hearing these claims that it was the war that ended the Depression.

Once demand is stimulated through public jobs, private investment will return and private jobs will increase. A healthy economy can then deal with deficits. It will be costly to regain that economy, but if we don’t, we will have both stagnation and deficits. 

Robert Leighninger is faculty associate in the School of Social Work at Arizona State University, and author of Long Range Public Investment: The Forgotten Legacy of the New Deal.

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JP Morgan Proves That Size Does Matter

May 15, 2012Mike Konczal

Breaking up the big banks might not be the whole solution, but it could make resolution authority more credible.

Breaking up the big banks might not be the whole solution, but it could make resolution authority more credible.

Before we start talking about the advantages and disadvantages of introducing size caps and restricting business lines through a new Glass-Steagall, it is important to understand how very big the five biggest banks are. If you need a sense of how big JP Morgan is and why it is hard for it to "hedge" without moving the market, the graph below gives you a sense. This is a graph I put together during Dodd-Frank based on data that was floating around at the time:

When bills restricting size of a large financial institution have been introduced they usually put size in the context of deposit liabilities (what we provide a backstop for and what reflects consumer savings, expressed as a percent of all deposits) and non-deposit liabilities (what reflects a blunt measure of size and potential for shadow banking runs, expressed as a percentage of GDP). The SAFE Banking Act, which has been reintroduced, mostly impacts the six firms listed above. The original SAFE Banking Act had a cap of 3 percent of GDP for non-deposit liabilities for financial firms (2 percent for actual banks) -- a space that ignores over 8,000 banks to just focus on the biggest six.

Yesterday Elizabeth Warren sent out an email with PCCC calling for a new Glass-Steagall. Let's back up: what kind of regulation do we have in the financial sector? First, there's the background regulation that structures and forms the financial markets. How are derivatives treated in bankruptcy? How is capital income and debt taxed? How are contracts and corporations set up and enforced? And so on.

The second level of regulation is "prudential" regulation. Prudential regulation of financial institutions is the various ways regulators regulate banks. Capital requirements are one example. So is prompt corrective action, restricting dividends for troubled firms, etc. One reason to do this for regular banks is to act as a coordinator for dispersed depositors who are unable or unwilling to perform these functions. Another is that financial firms have serious macroeconomic effects on the economy. And another is to intervene in issues of asymmetric information. The everyday libertarian case against regulating a restaurant is "who would want to poison their customers?" As we saw in the last 20 years, Wall Street is comfortable not only selling their customers poison at a high margin, but taking out life insurance on them through the credit swaps market.

The third level is blunter, and that's strict prohibitions, either on businesses or on size. What are the advantages and disadvantages of adding prohibitions? One factor is simplicity compared to other forms of prudential regulations, but what else is there?

Resolution

Adding prohibitions can help ensure the end of Too Big To Fail. In this sense it works to amplify, rather than replace, Dodd-Frank's resolution authority.

A common response is that the problem with Too Big To Fail isn't that the firms are too big or too complex, but too interconnected. Matt Yglesias notes that in the context of resolution, prohibitions aren't that important: "we can't put investment banks through the bankruptcy process because it's too systemically chaotic. In that case, Glass-Steagall is irrelevant and what we really need is a new legislative mechanism for the resolution of investment banking enterprises. That's what Dodd-Frank is supposed to do. This all just backs in to the point that even though the phrase 'too big to fail' has caught the public imagination, it's never been clear that size is relevant."

But here's Martin J. Gruenberg, Acting Chairman of the FDIC, in a big speech last Thursday:

While there are numerous differences between a typical bank resolution and what the FDIC would face in resolving a SIFI, I want to focus on a few key differences...

In addition, the resolution of a large U.S. financial firm involves a more complex corporate structure than the resolution of a single insured bank. Large financial companies conduct business through multiple subsidiary legal entities with many interconnections owned by a parent holding company. A resolution of the individual subsidiaries of the financial company would increase the likelihood of disruption and loss of franchise value by disrupting the interrelationships among the subsidiary companies. A much more promising approach from the FDIC's point of view is to place into receivership only the parent holding company while maintaining the subsidiary interconnections.
 
Another difference arises from sheer size alone. In the typical bank failure, there are a number of banks capable of quickly handling the financial, managerial, and operational requirements of an acquisition. This is unlikely to be the case when a large financial firm fails. Even if it were the case, it may not be desirable to pursue a resolution that would result in an even larger, more complex institution. This suggests both the need to create a bridge financial institution and the means of returning control and ownership to private hands.
Resolution authority is an untested solution for a financial firm, particularly one as large and complex as JP Morgan. Size and complexity make a difference. If financial firms were smaller and more siloed, there is an argument that resolution authority, which is one of the core mechanisms of Dodd-Frank, would work more smoothly and be more credible.
 
Market Power and Competition
 
As Barry Ritholtz noted on the JP Morgan loss, "Simply stated, once you are the market, you are no longer a hedge." Size makes a difference in these markets, and by breaking up the largest firms you'd see reduced market power. In terms of size, Andrew Haldane argues that economics of scale in banking top out at around $100 billion, or signficantly less than a 3 percent GDP liabilities cap. Beyond market power, the largest banks represent a large amount of political power as well.
 
And in terms of business lines, Kevin J. Stiroh and Adrienne Rumble, in "The dark side of diversification," look at financial holding companies as they absorb different business lines in the late 1990s and 2000s. "The key finding that diversification gains are more than offset by the costs of increased exposure to volatile activities represents the dark side of the search for diversification benefits and has implications for supervisors, managers, investors, and borrowers." New business lines introduce new profits but also introduce new volatility. The more volatile a firm is, the harder it is for it to fail without bringing down the financial system.
 
Mike Konczal is a Fellow at the Roosevelt Institute.
 
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The Dimon Fiasco: A Stark Lesson on Why Finance Needs Government Regulation

May 11, 2012Jeff Madrick

J.P. Morgan Chase's trading losses are a perfect example of why we need increased government regulation of banks.

Many people see the $2 billion in trading losses announced by J.P. Morgan Chase as the quintessential example of why strong regulation is needed. There is a lot of irony in this story. It is a true story about the importance of government.

J.P. Morgan Chase's trading losses are a perfect example of why we need increased government regulation of banks.

Many people see the $2 billion in trading losses announced by J.P. Morgan Chase as the quintessential example of why strong regulation is needed. There is a lot of irony in this story. It is a true story about the importance of government.

When Sandy Weill, the rough and tough entrepreneur, ultimately built a financial conglomerate from many pieces—including Salomon, Smith Barney, and Travelers Insurance—into Citigroup, Jamie Dimon, someday to be the outspoken CEO of J.P. Morgan Chase, had always been at his side. A bright and dutiful young man, Dimon stayed with him when Weill was consigned to a number two role at American Express after selling his firm, Shearson Loeb Rhoades, to the credit card giant in the early 1980s. He was with him in San Francisco, when Weill was charged with slimming down American Express’s subsidiary, Fireman’s Fund. Weill’s expertise was making companies lean and mean, which often entailed ruthless lay-offs. Dimon ran the numbers for Weill and participated in the implementation of the lean and mean philosophy.

When Weill finally left American Express, Dimon again went with him. Finally, they found the consumer finance company Commercial Credit Corp, which made high interest loans to low-income consumers, including early subprime mortgages, much like the old Money Store. According to biographers, Dimon liked the industry because it was unregulated. He and Weill took over the company, fired lots of people, issued a stock offering quickly, and used it to rebuild the Weill dynasty, which would soon include Smith Barney, Shearson again, and, the giant Travelers Insurance in 1993.

But Weill still had no serious investment banking presence, so he turned his attention to Salomon Brothers, king of risky bond and currency trading, the birthplace of what later became Long-Term Capital Management, and maker of much money and several major trading losses. How risky was this trading firm?

Dimon was skeptical. But here is the irony. Weill sent Dimon to study how Salomon made its money, and the originally hesitant Dimon said he now believed the risks could be controlled. Immediately after the acquisition in 1997, however, Weill was clobbered by Salomon losses due to the East Asian financial crisis and many more to come. Weill quickly limited trading exposure at Salomon. Dimon must have learned that losses are inherent in such businesses.

Dimon was finally at Weill’s side when Travelers merged with Citicorp to form Citigroup, becoming a massive financial giant. He left soon after in a personal dispute as Citigroup took on more and more risk, more and more debt, and adopted unethical practices that were later unearthed by Eliot Spitzer, which resulted in more fines than for any other company.

Dimon wound up running J.P. Morgan Chase, where he emerged as a hero after limiting mortgage market risks before the crisis that felled so many. He became the most respected of Wall Street’s leaders, and he was arguably the best of them. But Wall Street trading profits are too tempting, and individual Wall Street traders too hard to control. Even with tight oversight, they often go their own way. And they often lose hundreds of millions and sometimes billions of dollars in the process.

Dimon may have known precisely what his London trader, the “Whale,” was doing. I doubt it. But it’s likely the so-called “London Whale” had been making big bucks for the firm for a long while. Giving him more line would only be natural.  

Herb Allison, former president of Merrill Lynch, is a strong skeptic of commercial and investment banks’ trading operations. He even thinks over time they may all lose money. What happens is that they make plenty along the way, then lose it in a big bust.  As author Michael Lewis divulged, a Morgan Stanley trader, Howie Hubler, lost $9 billion in 2007 and 2008. Nevertheless, Hubler left Morgan with millions of dollars, and later returned to work on the Street.

Dimon, among the most cautious of executives, couldn’t control this trading animal with a life of its own, either. That’s the important conclusion. A Volcker rule to limit speculative trading for banks is necessary. They are using federally insured money to finance much of their banking operations, enabling them to leverage other facets of the company. They are using shareholder money, not their own, to take risks, yet they take enormous bonuses when all goes right. And they are implicitly using taxpayer money, because if they lose too much, they will be bailed out by the federal government. They remain too big to fail.

Serious capital requirements must be implemented against such trading, and banks must also change banker compensation procedures further. For traders, it’s a heads I win, tails you lose proposition. And so it is with the bank CEO as the firm’s overall earnings rise and are socked with a blow only every once in a while. These compensation plans have changed under pressure from the federal government to some degree. But probably not enough. The firms’ partners and employees have to be on the line for losses over time.

All this is a case study in why finance needs more government rules and regulations than most other industries. The omnipresent claim that such rules undermine liquidity in markets is almost laughable. In truth, we have a lot of liquidity when we don’t need it and little when we do—such as after the Lehman Brothers catastrophe in the fall of 2008. As regulations were eliminated and weakened after the 1970s, finance became more unstable, crises more frequent, and trillions of dollars were invested down the rat holes of speculation and fantasy, while Wall Street employees made countless millions. Yes, finance is important to economic growth, but only if government controls it properly. Otherwise it can be and has been damaging.       

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

 

Banner image courtesy of Shutterstock.com.

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Assessing Yet Another Round of the Structural Unemployment Arguments

May 8, 2012Mike Konczal

No matter how much elites insist that our unemployment problem is structural, they don't have the data on their side.

David Brooks has the 2012 version of the structural unemployment argument in his editorial today, "The Structural Revolution." Here's rooting for this one, as the previous arguments haven't held up all that well.

No matter how much elites insist that our unemployment problem is structural, they don't have the data on their side.

David Brooks has the 2012 version of the structural unemployment argument in his editorial today, "The Structural Revolution." Here's rooting for this one, as the previous arguments haven't held up all that well.

The 2010 version of the argument had to do with an increase in JOLTS "job opening" data, data that turned out to be incorrectly estimated by the BLS (as we learned in 2011). The 2011 version focused either on the idea that the unemployed had bifuricated into a normal unemployment market and a long-term, zero-marginal productivity market (it hadn't) or that the "regulatory uncertainty" of the Obama administration was holding back the economy (which, as Larry Mishel found, wasn't backed by the data).

There's been a ton of situations where these structural unemployment arguments came charging down the runway only to hit a cement wall of data. One "oops" moment was Raghuram Rajan citing Erik Hurst in claiming that unemployment would be three points lower if it wasn't for "structural" reasons, and Hurst having to publicly point out his preliminary research said nothing of the sort. Another was Rajan arguing, in June of 2011, against monetary policy. Why? Because "one view is that corporate investment is held back by labor-market rigidities (wages are stubbornly too high)....There is, however, scant evidence that the real problem holding back investment is excessively high wages (many corporations reduced overtime and benefit contributions, and even cut wages during the recession)." Empirically that means that there shouldn't be any bunching of wage changes at the zero mark. Here's what the San Francisco Fed found early this year:

Whoops.

Apparently none of that changed anything for anyone. So what do we have now? I want to address three specific points in Brooks's essay which I think are wrong in a very useful way. First, Brooks argues that "Running up huge deficits without fixing the underlying structure will not restore growth." The argument here is that a larger deficit will not help with short-term growth. I'll outsource this to Josh Bivens, addressing a similar argument from Adam Davidson:

This is the reverse of the truth – there is wide agreement that debt-financed fiscal support in a depressed economy will lower unemployment. Now, it’s true that there are holdouts from this position. And others who think the benefits of lower unemployment are swamped by the downsides of higher public debt (they’re wrong, by the way). But, the agreement is much more widespread – ask literally any economic forecaster, in the public or private sector, that a casual reader of the Financial Times has heard of if, say, the Recovery Act boosted economic growth. They will all tell you “yes.”

You won’t find anywhere near such a consensus on long-run tax or education or health care policy. In fact, public finance economists can’t get unanimous agreement on if, in the long run, income accruing to holders of wealth should be taxed at all (it should, by the way). In short, anybody waiting for the current unpleasantness to pass and for economists to unite in harmony in future policy debates shouldn’t hold their breath...

Lastly, Davidson notes that there is a rump of economists (he calls them, reasonably enough, the Chicago School) that argue that debt-financed fiscal support cannot help economies recover from recessions. But, it’s important to note that there is pretty simple evidence that can be brought to bear on this Keynesian versus Chicago debate. Nobody denies, for example, that the government could borrow money and just hire lots of people – hence creating jobs. What the Chicago school argues is that this borrowing will raise interest rates (new demand for loans will increase their “price,” or interest rates) and this increase in interest rates will dampen private-sector demand. But interest rates have not risen at all since the Recovery Act was passed and private investment has risen, a lot.

Second, Brooks argues that "there are the structural issues surrounding the decline in human capital. The United States, once the world’s educational leader, is falling back in the pack." If this is the case -- that our problems are a lack of education and investment in human capital -- then recent college graduates would have significantly lower unemployment rates than most, or they would be the same, or if they were higher then they'd come down even faster. Also from EPI, Heidi Shierholz, Natalie Sabadish, and Hilary Wething, "The Class of 2012":

Young people with recent college degrees have high unemployment rates. That's not good, either for Brooks's argument or for the huge number of young people being devastated by the weak economy and the weak response of elites.

Third, we have Brooks arguing that there are issues "surrounding globalization and technological change. Hyperefficient globalized companies need fewer workers. As a result, unemployment rises, superstar salaries surge while lower-skilled wages stagnate, the middle gets hollowed out and inequality grows." Some occupations require high skills and have sufficient demand, but some occupations require mid-skills and are disappearing. (Low-skill jobs should be fine on unemployment, but low on wage growth, in most versions of this "job polarization" theory.)

Let's take BLS CPS unemployment data by occupation, March 2007 and March 2012, and see if you can tell me which occupations require these high-end skills from their low 2012 unemployment rates:

I'm having trouble seeing them in the data.

So here's the important thing about the demand-side recessions: If I wanted to come up with a "supply" theory for Brooks, I'd say, looking, at the data above, that we have too many college graduates and too many business and professional workers. I'd also say we have too many non-college graduates and too many service workers. I'd also say we have too many of all ages, all educations, and all occupations. Something is weak at a fundamental level in the economy, which is impacting everything, even before we get to the pressing issues related to job polarization or education. That weakness is demand, and that is where the policy response should be. Don't tackle it, and the longer-term problems are even harder to manage.

As David Beckworth noted, "[t]his evidence in conjunction with that of downward wage rigidity excess money demand, and the Fed handling the housing recession just fine for two years should remove any doubt about there an aggregate demand problem. The real debate is how best to respond to this problem." The evidence he referred to was the SF data noted above along with the tracking he found between sales being reported as the "single most important problem" by small businesses and the unemployment rate:

Mike Konczal is a Fellow at the Roosevelt Institute.

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A Message to World Leaders: Ignore the Financial Markets

May 7, 2012Jeff Madrick

A solution for the eurozone? Listen to the people, not to the markets.

For 40 years, there has been a tug of war between government in democracies and what we may call “the other government.” By the latter I mean, of course, the financial markets. James Carville highlighted his concerns when he announced that in the next life he would want to be a bond trader. Alan Greenspan followed the bond markets religiously for signs of increased or reduced inflationary expectations.

A solution for the eurozone? Listen to the people, not to the markets.

For 40 years, there has been a tug of war between government in democracies and what we may call “the other government.” By the latter I mean, of course, the financial markets. James Carville highlighted his concerns when he announced that in the next life he would want to be a bond trader. Alan Greenspan followed the bond markets religiously for signs of increased or reduced inflationary expectations.

Now Europe faces the threat of a financial market rebellion. Democracy has spoken loudly in this weekend’s elections on the Continent and in England. Voters said, "We have had all the austerity economics we can take."  They threw over Sarkozy in France and many Conservative and Liberal candidates in England. In Greece they ran for the extremes. The moderate liberal Pasok party won the least votes in memory, but it may yet form a coalition to run a new government. Italian election results will be in soon.

And democracy is working! The instinct among those in the financial markets is that democracy usually reflects the weak-willed demands of the public. But the public is generally right this time, and it has been many times before. Austerity economics is self-destructive when economies are so weak.   

Yet of course the financial markets’ initial reaction to the European elections was to sell, as if austerity economics was actually working to make nations' bond payments easier to handle. It was not! But the markets fear that a new strategy will make matters worse.

Political leaders should ignore the financial markets in the short run, pure and simple. This may drive up financing costs for a while, but the eurozone should absorb those and adjust policies. The European Central Bank (ECB) ought to accommodate its needs. The right policies are stimulus from the current account countries and the end of extreme austerity in the periphery. Wages should rise in the eurozone core and stabilize in the periphery; they can even rise from their current lows in places like Greece. The 17-nation Eurozone or the 27-nation EU should issue jointly backed bonds to provide social safety net support to the financially weak nations, to raise demand for them and get their economies going, while reducing the extreme financial pain and sacrifice that now jeopardize social stability. As examples, the Greeks voted for extremist parties, the Le Pen party did well in France, and the Tea Party runs amok in the U.S. Austerity fever even grips Washington, which makes the November election especially important.

What the crisis requires is elected government, not bond trader government. Any idea that the financial markets are rational should have been discarded four years ago. They have been absurdly wrong for decades. In the U.S., they persistently overestimated future inflation by driving interest rates too high compared to the CPI and the GDP deflator. Greenspan treated them as the height of rational forecasting, when indeed they were simply following the latest conventional wisdom. In my informal opinion, he used long-term rates as a guide to policy. Now the ECB remains too tight as well. In the U.S., the “rational” bond traders actually traded what they thought the market would think, rather than what rational foretellers of the future would think. It was Keynes’ beauty contest analogy—choose the woman you think others believe is beautiful. The belief that the markets were right was the fallout of extreme efficient markets theory.

The media too often treated the markets as rational as well. Bond traders implicitly endorsed austerity economics until fairly recently, and the media usually reported them as being right. The supposedly sophisticated financial media (with some noted columnists as exceptions) wondered what could possibly work if not austerity. Now there are signs that the press is waking up to reality and realizing that it, along with the financial markets, is not working.

There are some signs of the ice breaking. The German finance minister announced it was okay for German wages to rise. They have actively restrained wage growth to make their exports more competitive for over ten years. The main sources of their demand were the European periphery, where wages were rising a bit due to a property bubble caused by irrationally low interest rates offered in the financial markets. But there are still signs of backward thinking. Many in Europe think of growth policies as nothing more than making labor markets more competitive through deregulation and reduced wages. As if the more flexible labor markets in the U.S. are leading to rapid recovery.

In sum, what’s needed in Europe is fiscal stimulus, a more accommodative ECB, social transfers from rich states, higher wages in many nations, a change in the silly EU agreement to keep deficits absurdly low, and industrial policy to gear capital investment across the continent, free of prejudice and nationalistic tendencies. The elections may bring some of this about. Then, once policies are working to support growth and reduce financial burdens as tax revenues rise, the financial markets will at last respond constructively. They must be waited out for now.

To put it most simply, what’s needed is the will of the government of the people to ignore the financial markets and stop treating them like a more rational government than democracy itself.   

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

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The EEOC Stands Up for Transgendered Workers While Congress Stalls

Apr 30, 2012Tyler S. Bugg

genderless-icon-144The EEOC's decision to extend protections against discrimination to transgender workers is an important step toward social justice and a stronger economy.

genderless-icon-144The EEOC's decision to extend protections against discrimination to transgender workers is an important step toward social justice and a stronger economy.

Two months ago, I wrote that our country should pass the Employment Non-Discrimination Act (ENDA) and expedite the process of ending discrimination based on sexual orientation and gender identity in the workplace. This month, we’re one step closer. A groundbreaking ruling handed down from the Equal Employment Opportunity Commission (EEOC) on April 20 dictates that protections against gender identity discrimination are covered by Title VII of the 1964 Civil Rights Act and can be called upon in gender and sex discrimination complaints to the bureau and in subsequent lawsuits. This is a major leap forward for transgender Americans and for their job security.

The landmark change came as a response to the case of Mia Macy, a transgender woman and former Phoenix police officer who applied for and was tentatively accepted for a ballistics job -- until the employer conducted a background check. After obtaining information about Macy’s transition from a man to a woman, the employer allegedly (and untruthfully) informed Macy the offer was eliminated due to budget cuts and then promptly filled the position with another (not transgender) applicant. EEOC policy has been vague on exactly the types of cases are covered under its statutes, and are therefore under its legal jurisdiction, and detrimentally so. But under the new ruling, Macy’s filing of a complaint of gender discrimination with the EEOC can move forward to the next investigative steps.

The new ruling, however, has ramifications much larger than Macy’s case alone. It clarifies existing national policy and makes stronger what’s often been a too slowly evolving area of employment law. It sets into motion protections for potential employees from workplace discrimination regardless of their gender identification, expression, or status. The policy holds obvious significance for cutting away unnecessary pressures within the workplace environment, pressures that are both bad social policy and bad business policy.

Human Rights Watch’s “Corporate Equality Index” has striking evidence in support of the last point. Not only are employees who usually face discrimination finding more inclusive employment laws beneficial, so are employers. While employees experience higher confidence in their job searches and eventual careers, employers can access improved applicant pools. Benefits like more inclusive health plans and policies, gender-minority support and focus groups, and diversity councils are all additional assets that strengthen the commitment to productive and respectful employer-employee relations, guided by principles of fairness and equity. The economic outlook, in the long run, is the real winner.

The EEOC ruling will also have profound effects in curbing some disturbing trends. Data from the National Center for Transgender Equality (NCTE) shows that mistreatment at work is widespread. A disturbingly high 90 percent of transgender individuals reported feeling harassed or mistreated at work, and 47 percent reported being fired, not hired, or denied a promotion or salary increase as a result of their non-conforming gender status.

On top of this, the lack of protection against discrimination in the workplace has long had alarmingly adverse effects on gender-minority individuals elsewhere. The NCTE further reports that as transgender employees face workplace discrimination, their personal lives suffer as well. As a result of negative workplace environments, transgender individuals are four times more likely to be homeless, 70 percent more likely to abuse drugs and/or alcohol, and 85 percent more likely to be incarcerated.

The EEOC ruling is a vital first step with the potential to be a game changer in the job market. Its potential for setting a precedent for the passage of laws like the ENDA, one of the most stagnant pieces of legislation of the past two decades, is also promising. But it’s not the whole solution. While it's certainly a strong deterrent for employers with histories or ongoing incidents of gender discrimination, it’s only a mechanism as strong as we make it. It shouldn’t only be a reactive method that penalizes discrimination by threatening lawsuits, legal fees, and unwanted government intervention. Rather, it should foster a culture of prevention aimed at normalizing acceptance of all workers.

Tyler S. Bugg is a member of the Roosevelt Institute | Campus Network and an Organizing Fellow with Obama for America studying international affairs and human geography at the University of Georgia.

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A Year of Ben Bernanke Press Conferences

Apr 25, 2012Mike Konczal

A year ago, in April of 2011, Ben Bernanke gave his first press conference.  I wrote it up for the American Prospect here.  Looking back, I had flagged that more of the questions asked Bernanke whether he was doing too much, rather than too little, to stimulate the economy.  I noted:

A year ago, in April of 2011, Ben Bernanke gave his first press conference.  I wrote it up for the American Prospect here.  Looking back, I had flagged that more of the questions asked Bernanke whether he was doing too much, rather than too little, to stimulate the economy.  I noted:

the press conference, roughly nine questions worried about inflation, a weak dollar, the country's S&P rating, oil prices, and whether the government can fashion an appropriate response to the financial crisis or long-term unemployment at all. These all reflect the worry that government is doing too much instead of too little. Meanwhile, there were only two questions asking why the Federal Reserve wasn't doing more to lower unemployment. When Binyamin Appelbaum asked, "Is it in the Fed's power to reduce the rate of unemployment more quickly? How would you do that? Why are you not doing it?" it was almost out of place.

That wasn't the case today.  The questions were much harder and more frequently about why Bernanke wasn't doing more to get the economy going.  They took for granted, as the first questioner pointed out, that "unemployment is still high, the economy is slowing, inflation is subdued" and Bernanke and the FOMC is, to their critics, "still being too cautious."  I count, on a quick scan, five questions related to the idea that the Federal Reserve has the ability to do more and is choosing not to do it, with only two more related to concerns of inflation hawks or a "bond bubble."

There's a lot of reasons for this: the wasted year of 2011 for the economy, the continued low interest rates of the United States even after a ratings downgrade, growing fears of a permanent decrease in the labor force participation rate and hysteresis, and more.  But part of this change is the result of the economics blogosphere pushing the debate about monetary policy at the zero-lower bound into the mainstream of financial and economics journalism.  The econoblogsphere should be proud of itself, and I will try to do more to advance this important conversation to whatever extent I can.

A year ago I held an event for the Roosevelt Institute on the Future of the Federal Reserve.  It was the same day as the Bernanke press conference, and as such we asked each of the participants to ask Bernanke a question, and we put them online.  Matt Yglesias' question was:  "I would ask him about his own paper on self-induced paralysis in Japan and what he has changed his mind about since then."  This change from Ben Bernanke the professor who called for aggressive monetary action to the Ben Bernanke we see now must have been on the minds of all the reporters in the room, as it is the subject of a great Krugman New York Times Magazine article this upcoming weekend.  The question finally got asked by Binyamin Appelbaum, who, as we note above, asked the hardest question about the Fed not doing enough a year ago at the first conference.  Bernanke's full answer:

Binyamin Appelbaum: Unemployment is too high and you said you expect it to remain too high for years to come, inflation is under control and you expect it to remain under control. You said you have additional tools available for you to use, but you're not using them right now. Under these circumstances, it's really hard for a lot of people to understand why you are not using those tools right now. Could you address that? And specifically, could you  address whether your current views are inconsistent with the views on that subject you held as an academic.
 
Ben Bernanke: Yeah, let me tackle that second part first. So there's this, uh, view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time. I made two points at that time. To the Bank of Japan, the first was that I believe a determined central bank could, and should, work to eliminate deflation, that it's falling prices. The second point that I made was that, um, when short-term interest rates hit zero, the tools of a central bank are no longer, are not exhausted there, are still other things that, um, that the central bank can do to create additional accommodation.
 
Now looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010 or at least a moderate risk in late 2010, we used additional balance sheet tools to return inflation close to the 2% target. Likewise, we've been aggressive and creative in using nonfederal funds rate centered tools to achieve additional accommodation for the U.S. economy. So the, the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that, Japan was in deflation and clearly, when you're in deflation and in recession, then both sides of your mandate, so to speak, are demanding additional deflation. 
 
Why don't we do more? I would reiterate, we're doing a great deal of policies extraordinarily accommodative. You know all the things we've done to try to provide support to the economy. I guess the, uh, the question is, um, does it make sense to actively seek a higher inflation rate in order to, uh, achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very, uh, uh, reckless. We have, uh, we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable, in that we've been able to take strong accommodative actions in the last four or five years to support the economy without leading to a, [indiscernible] expectations or destabilization of inflation. To risk that asset, for, what I think would be quite tentative and, uh, perhaps doubtful gains, on the real side would be an unwise thing to do.
Watch the video - Bernanke gets really agitated answering this question.  That's the argument to deal with.  I need to think this through more, but on its face it seems like they think they need to maintain their credability in order to keep rates at or below their target.  There's no tradeoff here - the credibility at best has allowed Bernanke to fight off opportunistic disinflation from becoming a goal (which may, in fact, be a victory).  
 
Meanwhile if the Bernanke wants to maintain credibility the best way to do it isn't by keeping the economy in a permanent quasi-recession but instead annoucing an NGDP target or announcing what he wants and what he is willing to tolerate to get it - say 3% inflation until unemployment is below 7%, like Chicago Fed President Charles Evans has suggested.
 
Important other notes: In response to a question about the dropping labor force participation, Bernanke noted that the rate was dropping because they are "no longer getting increased participation from women... society ages and also, for other reasons, male participation has been declining over time."  However a lot of it "represent cyclical factors, much of it is young people, for example, who presumably are not out of the labor force indefinitely, but given the, uh, weak job market, they are going to school or doing something else, rather than, than working."  As such "the unemployment rate may not fall as quickly going forward," because when the economy picks up "many of these folks are going to come back into the labor force looking for work."
 
Bernanke notes that in the absense of a zero lower bound the interest rate would be negative but that they've done other things to counteract this.  "We, we see monetary policy as being approximately in the right place at this point. Based on the analysis that we've been doing of the economy and the outlook."
 
All in all, the media has gotten a lot better pushing the Federal Reserve to account for its role in the weak economy over the past year.  Let's take victories where we can get them.
 

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Our Brave New Service Economy

Apr 23, 2012Bryce Covert

More low-wage, dead-end jobs might sound good to business owners, but is that what we want for our country?

More low-wage, dead-end jobs might sound good to business owners, but is that what we want for our country?

One of Romney’s big selling points is that he knows the “real economy” (much like some conservatives know “real America,” I guess) because he has experience as a businessman. Conservatives have started substituting business acumen for political acumen, making the mistake of comparing what’s required to run a country to what’s required to run a company. At first blush it almost makes sense: both oversee groups of people, both deal with budgets, both make decisions. But not only does that experience not necessarily translate to the White House, it also belies a deeper problem about the kind of economy we’re trying to recreate in the aftermath of the Great Recession. Viewing the country, and its economy, as a private business isn’t likely to create solid middle-class jobs.

“This American Life” had a recent episode called “What Kind of Country” that explored what kind of country Americans want this to be, but parts of it had more to do with what kind of economy we want. Take the example they give in act three: Colorado Springs. With a stretched city budget, local businessman Steve Bartolin, CEO of the Broadmoor Hotel, decided to look and compare it to running his hotel. After all, he tells the reporter on the story, “We have the same number of employees as the city… I look at us as a service delivery organization,” just like the city, apparently. They are both concerned with “how do you deliver the highest quality of service in the most efficient, cost effective manner.”

His main focus became how much both entities spend on their employees. “They’re running a 70 percent labor cost and we’ll run a 35 percent labor cost,” he says. “Any business person can look at that and say, ‘Jesus, we’re going to be out of business by 2014 at this pace.’” He writes a manifesto to the city council that ends up being circulated all over town: the city should lower starting wages for its employees, require them to pay more for their health insurance, and start contracting out anything it can to private businesses.

A city councilwoman explains that payrolls for the city government are higher than the hotel’s because it doesn’t control its own pension costs, which are mandated by the state. But she also makes a very important point: it has to hire people with more training and experience. City engineers and police officers can’t be hired on the cheap like the service industry workers at the Broadmoor.

And herein lies a big problem. What Bartolin proposed, basically, is to make government employees more like service employees. This is highly problematic, particularly for the black Americans and women who have long relied on public employment because it paid decently, offered good benefits and stability, and enabled them to move up the economic ladder. Public employment has been credited with helping to create the black middle class. If we make these jobs as unstable and low-benefit as service jobs, we’ll be taking away a huge boon from groups who have historically benefitted from it.

But we’re not just dragging public employees down to the level of service workers. In fact, the jobs our economy is best at producing these days are service jobs. As Harper’s recently tweeted, the chances that an employed American works in the service industry are six in seven. Those jobs have been growing very quickly: from 2010 to 2011, occupations like salespersons, cashiers, and food preparation workers grew by 3.2 percent. As Nona Willis Aronowitz recently reported, one in 10 employed Americans works in food service, making up 9.6 million people. And young people are taking a lot of those jobs: a quarter of people ages 16 to 29 who have a job work in hospitality, meaning travel, leisure, and food service. “A study of 4 million Facebook profiles found that, after the military, the top four employers listed by twentysomethings were Walmart, Starbucks, Target, and Best Buy,” she writes.

These are low-wage, low-benefit jobs that rarely pay much more than minimum wage (if even that) and offer schedules that can change on a whim. A report from the Retail Action Project in New York found that over half of retail workers made under $10 an hour – and 12 percent earn the minimum wage. Less than a third get health benefits through their employer. The Restaurant Opportunity Centers United reported that the average yearly income for restaurant workers in 2009 was $15,092, and less than a third make a livable wage. And what about those hotel workers who might be under the employ of Batolin? Non-managers make less than $12 an hour on average.

And unlike government work, these jobs offer little training and room for advancement. The sector relies on employee churn to keep labor costs lower. (Just ask Barbara Ehrenreich.) Service careers aren’t designed to advance much farther than flipping burgers.

Is this what we want our economy to look like? Do we want most jobs to offer wages that don’t cover basic expenses and to deny workers the benefits they need to stay healthy? Businesspeople would call this cost effective. I call this unsustainable.

Bryce Covert is Editor of Next New Deal.

 

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