"employment in manufacturing (as reflected in the total number of hours worked) did not recover as it usually does following a recession."

Yves Smith is deeply worried about this issue. From the CBO Director's Blog:

"Decline in U.S. Manufacturing Employment

CBO released an economic and budget issue brief today that discusses the factors underlying the decline in manufacturing employment over the past several years. The manufacturing sector of the U.S. economy has experienced substantial job losses since 2000. During the recession of 2001 and its immediate aftermath, employment in the manufacturing sector fell by about 2.9 million jobs, or 17 percent. Even after overall employment began to improve in 2004, the decline in manufacturing employment persisted. By the end of 2007, with the slowing of economic growth, employment in the sector had edged down further, by half a million jobs. And, as of November 2008, employment in manufacturing had fallen yet again, by slightly more than 600,000 jobs. A significant number of additional losses is likely given the current weakness in the economy. ( IT'S A BIG HIT FOR THIS JOB SECTOR )

Although the decline in manufacturing employment in recent years is not a departure from long-standing trends—the sector’s share of total employment has been falling steadily for more than half a century—the recession of 2001 hit manufacturing particularly hard. And, in sharp contrast to the pattern observed during previous expansions, employment in manufacturing (as reflected in the total number of hours worked) did not recover as it usually does following a recession.

The decline in manufacturing employment between 2000 and 2007 stemmed as much from an absence of new hiring as it did from layoffs of individual workers and downsizing. Rates of both job losses and job gains have been lower since the 2001 recession than they were in the 1990s. Workers who lost jobs, however, have typically experienced longer stretches of unemployment than did workers who lost jobs in the previous decade.

The steep decline in manufacturing employment since 2000 is associated with two interrelated developments:( 1 ) rapid gains in productivity (output per hour) in U.S. manufacturing and ( 2 )increased competition from foreign producers. Productivity in manufacturing has risen by about one-third since 2000( THAT'S AMAZING ), and growth in that productivity has consistently exceeded that of the overall nonfarm business sector.

Competition from overseas helped spur U.S. firms to boost productivity, but that competition has also dampened demand for goods produced in the United States, despite domestic manufacturers’ efforts to reduce costs through productivity enhancements. Those same developments have also had some beneficial effects for many U.S. residents, including the ability to buy manufactured goods at relatively low prices( TRUE. IT'S A TRADE OFF ).

This decline in manufacturing employment represents a reallocation of jobs among industries rather than a decline in total employment in the United States. Until recently, other sectors of the economy have more than compensated in terms of overall employment, as evidenced by the relatively low 4.7 percent unemployment rate that existed during early 2007 and the roughly 7.5 million net new jobs created in the U.S. between early 2004 and the end of 2007.

This brief was prepared by David Brauer with the assistance of Eric Miller, both of CBO’s Macroeconomic Analysis Division."

Yves Smith's solution seems to be Managed Trade to enable our economy to keep some of the high end manufacturing jobs. I'm of two minds about this, because, while I believe in free trade, we don't have it, any more than we have a free market. Both are hybrids in which government is heavily and essentially involved.

So, my answer is that I would have to see the proposal about managed trade, in order to assess its efficacy and reciprocity.

"For many, the New Capitalism may well seem fairer and less alienating than the model of the past 30 years"

Robert Peston of BBC considers what changes in Capitalism will follow from the current crisis:

"There's next year, and then there's the next decade.
Economic conditions in 2009 will be treacherous. There'll be a formal recession in
most developed economies, and the economic contraction is highly likely to be more
severe in the UK than almost anywhere else.

Companies and consumers will continue to tighten their belts. There'll be a sharp rise
in unemployment. The extraordinary volatility we've experienced in the price of
sterling, commodities, energy, shares and capital - which makes it so hard for
businesses and investors to plan - is unlikely to dissipate.

Many businesses, especially big ones, will become unviable - and will present the
Government with an appalling dilemma of which ones to put on life support.
So it’s understandable that most of us, including ministers, central bankers and
regulators, are planning for the next few months. We're building the economic
equivalent of bomb shelters and mobile hospitals.

But this is no downturn like any we've seen since the Second World War, for two
reasons: it's global; and its primary cause is the pricking of a massive debt bubble.
We borrowed too much, especially in the US and the UK. And the process of paying
the money back is not only leading to a fall in living standards but is also precipitating
very significant changes in how the global financial economy operates."

So, this financial crisis is different than others in the last 60 years because:
1) It's global ( True )
2) It involves huge debts ( True )

The results will be:
1) A lower standard of living ( Short term, but not necessarily long term )
2) A change in the global economy ( True )

"Capitalism is changing in fundamental ways. For many years to come, what's
happening will affect the relationship between business and government, between
taxpayers and the private sector, between employers and employees, between
investors and companies.

Arguably the global economic crisis will turn out to be more significant for us and
other developed economies than the collapse of communism."

I don't agree, unless he's just talking about very recent history.

"A New Capitalism is likely to emerge from the rubble. And although it’s impossible
to be precise about how the reconstructed economy will operate, parts of its outline
are taking shape. What lies ahead can be determined from an understanding of what’s
gone wrong with the existing model.

This, in itself, is no reason for gloom or despair. For many, the New Capitalism may
well seem fairer and less alienating than the model of the past 30 years, in that the
system's salvation may require it to be kinder, gentler, less divisive, less of a casino in
which the winner takes all."

I agree that we could have a much better Capitalist system, and that includes one that has enough of a social safety net and wealthy enough lower and middle classes to be viable, i.e., accepted.

"Here are some of the numbers that tell us what’s gone wrong. For the UK, if you
aggregate together consumer, corporate and public-sector debt, the ratio of our
borrowings to our annual economic output is a bit over 300%, or over £4000bn.
That’s a similar ratio of debt to GDP as that of the US, and it’s a record. Over the past
decade, we borrowed and we borrowed and we borrowed: we assumed that the day when we had to pay it back would never arrive, that there would always be an
opportunity to roll over the debt."

I think that's correct. There was a lot of wishful thinking involved. But I feel that it was more of a belief that government could easily bail us out if things went sideways. The other government actors around the world would also go along with bailing us out. However, I believe that the main assumptions about government coming to the rescue in the event of a financial crisis have proven to be correct.

"Households borrowed too much, £1200bn on mortgages alone. Big companies
borrowed too much, especially those taken off the stock market in private equity deals.
Note however that for all the political fuss about the need for banks to maintain lines
of credit to small companies, they're the unsung heroes of our tale of monumental
financial folly: even today, the aggregated savings of small companies exceed their
debt."

It was the big boys that were paying the insurance premiums called lobbying.

"One of the best ways of understanding how all our debts were accumulated is to look
at the gross foreign current liabilities of our banks. These rose from £1,100bn in 1997
to £4,400bn this year (again, about three times the size of our annual economic
output).
This trend tells two stories. It shows the massive and unsustainable growth in the City
of London and our financial services industry - which is now shrinking with a
vengeance, at the cost of massive job losses and evaporating tax revenues (perhaps
£30bn to £40bn of income for the Exchequer gone forever)."

Our financial services sector is shrinking as well.

"But it also shows that our debts are, to a large extent, the recycled savings of other
countries, notably the massive savings and surpluses of China, other Asian economies
and the Middle East (one note of caution here: a sizeable proportion of these foreign
currency liabilities, but by no means all, were used to buy foreign currency assets).
To put it in crude terms, for much of the past decade, millions of Chinese slaved away
on near subsistence wages and still managed to save, both as a nation (China swanks
£1,400bn in foreign exchange reserves) and as individuals. And to a large extent they
were working to improve our living standards, because they made more and more of
the stuff we wanted at cheaper and cheaper prices - and clever bankers took their
savings and lent the cash to us, so that we could buy the houses we cherished, the cars
we desired, the flat-screen TVs.
This imbalance - between the savings of China, India, Japan and Saudi and our
indebtedness, between their massive trade surpluses and our deficits - was never
sustainable. At some point, the Chinese were bound to say, “we’d like some of the
cake now please, which means you’ll have to have a bit less”.
Tragically, they toiled for our prosperity – or we lived high on the hog while they
fattened the pigs for us – for too long. Which is partly why the return to equilibrium,
to a more balanced global economy, is happening in a horribly painful way that's
impoverishing millions of people."

This was a two way street. It had benefits for both sides, but a restructuring of the situation might prove beneficial. It will certainly be painful unless governments help their citizens out with some of those savings.

"For me, therefore, the most important event of the past week was the chastising of the
US Treasury Secretary, Hank Paulson, by Zhou Xiaochuan, governor of the Chinese
central bank. Zhou said that "over-consumption and a high reliance on credit is the
cause of the US financial crisis" and "as the largest and most important economy in
the world, the US should take the initiative to adjust its policies, raise its savings ratio
appropriately and reduce its trade and fiscal deficits."

This seemed a pretty unambiguous statement by the Chinese that they're no longer
prepared to finance the spendthrift ways of the US and UK: they don't want to lend
more and they want to be confident that what they have lent won't disappear in a puff
of bad debts and inflation."

Here I simply disagree. Zhou was putting on a show. He loves our relationship, but he has interests that we keep bothering him about, and he's using this opportunity to let us know that this lecturing and bothering is now a two way street.

"So the big question is how much debt will we have to repay until our economy is
returned to some kind of stability.
This is tricky to calculate."

Try impossible. We're going to use trial and error.

"One important number, which gives us a clue, is the difference between what our
banks have lent and what they've borrowed from British households, businesses and
institutions that are too small to be players in global financial markets. It's what the
Bank of England calls the customer funding gap. And it matters because it's a guide to
the dependence of British banks on funds from overseas that are diminishing and
could well, over time, drop to zero.
This customer funding gap was nil in 2001. But by the end of June this year,
according to the Bank of England, the gap had soared to £740bn. To be more specific,
a typical British bank has been raising the funds for 40% of all the loans it makes to
you and me from big financial institutions, money managers, giant companies and
other so-called wholesale sources.

The problem for British banks (and for those in many other countries) is that this
source of funds dried up in August 2007 and it’s not at all clear that the tap will ever
be turned on again in the way that it was. The trigger of the closing down of
wholesale markets was the horrifying realisation by financial institutions in every
country that hundreds of billions of dollars lent to US homeowners in the form of low
quality subprime loans – and repackaged into putatively high quality investments as
collateralised debt obligations – were going bad. This undermined trust within the
financial system, in that none of the players could be confident which of them had
been poisoned beyond rehabilitation by subprime. And this trust disappeared
altogether in September of this year, when the US Treasury chose not to rescue one of
the world’s biggest investment banks, Lehman Brothers."

It was the trust in government intervention that got a jolt. There was no way for Lehman to unwind these deals without the money and time bought through government intervention. There was no Plan B.

"This malfunctioning of money markets has also been the trigger for the end of the
recycling of the surpluses from China, or others parts of Asia or the Middle East, into
loans to us. Over the longer term, it would be a very good thing if these great
exporting nations were to consume more of the wealth they generate. That would, for
example, create great opportunities for our trading companies. But in the transitional
period it’s something of disaster for our financial system, because there’s a
progressive and painful withdrawal of funds from our banks (although this withdrawal
of overseas funding from our banks happens in an indirect way, via assorted financial
institutions, since China – for example – rarely lends directly to them).

Our banks have been forced to reduce their dependence on these diminishing sources
of wholesale funds, which is why they’ve been lending less to us. And it’s also why
they’ve had to turn to taxpayers for financial succour on an unprecedented scale.
Since the summer, as an ever increasing number of money managers, huge companies
and financial institutions demanded their money back from our banks, the entire banking system came perilously close to collapse. Our banks didn't and don't have the
readies, for the obvious reason that the cash had all been lent out in the form of
mortgages and loans to companies and consumers.

So you and I, as taxpayers, came to the rescue and filled the gap. Over just the past
few months, British taxpayers have provided loans, commitments, guarantees and
capital to our banks in excess of £600bn (in the US, the equivalent figure for taxpayer
support is around £5,500bn). Which is probably just the beginning."

That's the system.

"In the UK, taxpayer funding for our banks is very likely to rise, probably to more than
£1000bn, perhaps more still. And the reason is that many of our banks are still some
way from equilibrium between the borrowing needs of British companies and
households and the deposits and loans they receive from British companies and
households."

There's more to it than that, but that is a serious problem. The banks won't lend.

"Here it’s necessary to take a detour into the way that credit was created in the boom
years and is in the process of being destroyed.

The recycling of Asian and Middle Eastern surpluses to the UK, Europe and the US in
the form of loans wasn't a simple conversion of a pot of savings into an identical pot
of debt. When loans were used to buy houses, or to support property developments, or
to finance hedge funds that trade in every imaginable security and commodity, or to
fund the buyouts of companies by private equity firms, these loans pushed up the
value of assets. This rise in the value of assets sparked yet more lending, often at
higher ratios of the loan to the value of the asset, to do more deals – which in turn
pushed up asset prices further.

As we entered 2007, whether you were borrowing several billion pounds to buy a
company or £250,000 to buy a house, lenders were prepared to lend you almost 100%
of the purchase price with few strings attached.

There's a subtle but important point here. There were twin connected bubbles in assets
and credit. Both of those bubbles have burst. Falling asset prices are leading to losses
for those who borrowed to buy those assets (hedge funds, private equity firms,
billionaire corporate raiders, banks, homeowners). And as they struggle to pay their
debts, they sell other assets, driving down the price of those assets and causing losses
for other borrowers. And when they can’t repay banks, the resources of banks are
depleted, which means there's less credit available – and no 100% mortgages or other
loans – which drives down asset prices further, which leads to a further contraction of
lending, and so on in vicious cycle of decline."

True, but it also involves the fear and aversion to risk and flight to safety. In other words, part of the problem is what the assumptions being acted upon are that are causing this "vicious cycle of decline". One big problem is the fact that government intervention doesn't seem to be well thought out or effective.

"So it is unrealistic to expect our banks to cease the insidious process of contracting the
volume of credit they'll provide - whatever the coaxing and bullying of politicians -
unless and until the price of property, shares, commodities and other assets stops
falling. Or to put it another way, asset prices have to find a floor – and they haven’t
found the floor yet – before the financial economy can rebuild itself and the real
economy can receive the necessary finance that will allow the recovery to begin."

Then Keynes is correct and the government needs to step in. Otherwise, the floor will turn into quicksand. I'm sorry to have to tell the Cato people this, but businessmen don't buy and won't act on a totally free market plan. They don't believe in it, and wouldn't know how to act in it even if they did. It's a bit like Wittgenstein said: "If a lion could talk, we could not understand him. "

"As for alleviating the burden of all that debt, history would suggest that’ll necessitate
the printing of money on a colossal scale, a revival of inflation, to reduce the real value of the debt. But as a deliberate strategy, that would be fraught with risks for the
Government, since the influential babyboomer generation is now old enough to
consist mainly of savers rather than borrowers – who would be the victims of
spiralling prices rather than the beneficiaries."

It's our best shot. Sorry.

"A couple of questions follow. Who's to blame? And where will all this taxpayer
support for banks - and probably, before long, for real companies and the real
economy too - lead us?
It takes a whole book to assign culpability. But the short answer is that we’re all at
fault to varying degrees."

To what degree are you assigning me?

"The authorities in the US and the UK were aware of the dangers of allowing the
financial and trade deficits with China and other exporting nations to persist. They
could have corrected these deficits by using tax and interest rate policies to reduce our
rampant consumption. But they chose not to do so, because it all looked too difficult.
Our own Government turned a blind eye to all the evidence that a rampant lending
binge was taking place, because the Exchequer was receiving all those lovely tax
revenues from the housing and City bubbles – and because there was kudos to be had
from the world renown of our financial services industry.

In 2006 and 2007, I had long conversations with ministers, officials and regulators
about how the hedge-fund and private-equity booms – the mind-bogglingly huge
rewards available to the stars of these industries - were symptomatic of a
malfunctioning in markets. I saw the frenetic activity of these young financial firms as
a manifestation that too much debt was available on ludicrously cheap terms that
didn’t remotely reflect the risks – and this seemed to me to be worrying. The standard
response from those who now know better was that it would all come out in the wash
in a painless way, that these new firms were a great asset to the UK, and I was fussing
about nothing."

They were right about it all coming out in the wash, but had apparently never been in a washer and dryer. It's hard to see how it could be painless. I agree in theory with what he's saying, but the politics of slowing down a booming economy need to be dealt with as you go along. Not at the very end, or all at one time. You need the correct procedures in place, and the ability to expect danger when times are good. Then people will accept a slowdown in the economy. It's all in the preparation and execution.

"A corollary of precisely this complacency was that central banks, such as the Bank of
England, were hopelessly wrong in believing that the explosive growth of credit and
the surge in the price of assets such as houses was somehow hermetically sealed from
the rest of the economy, such that it wouldn’t damage everything when the bubble
was finally popped. That said, most would say that Alan Greenspan, the former
chairman of the Federal Reserve, the US central bank, was the most benighted of all
about how the global economy had become safer and sounder."

He didn't get it. No.

"Also regulators were negligent in allowing the creation of what’s become known as a
shadow banking system, in which trillions of pounds of long term loans in the western
economies were financed with credit that could be withdrawn far too quickly.

As for the media, we certainly could have shouted louder about the risks of all that
debt being accumulated – but perhaps the volume control was set a little too low
because of all the splendid advertising revenue that was generated by the property
boom.

And, to repeat, most of us were prone to forget that if you borrow £100, or indeed
£4000bn, you have to pay it back one day."

I'm sorry, but leave me out of this. Also, I don't like this blaming everyone if it means that criminals will go free because we all made mistakes.

"But it’s quite hard to hard to mount a convincing argument against the notion that
most at fault were the banks and bankers – because they systematically failed to do
what they were handsomely remunerated to do, which was to properly assess the risks
of all that lending."

They're my bottom line as well.

"Their survival as institutions now wholly depends on the goodwill of governments
and taxpayers around the world. From Australia, to South Korea, to Germany, France,
the UK and the US – inter alia – taxpayers financial support for the banking system is
now equivalent to more than one quarter of global GDP, or more than £9,000bn.

There are reasons to believe that credit from taxpayers can’t and won’t be repaid for
many years, in that this credit is financing the correction of huge financial and trading
imbalances between the western and eastern economies. So if we’ve witnessed a
semi-permanent nationalisation of the banking system and will soon see significant
taxpayer support for real companies in the real economy, then our banks and privatesector
companies will have to work much harder to sustain the goodwill of those who
are keeping them alive: millions and millions of taxpayers."

That's the Reich problem, only framed differently, and I concur.

"That means, I think, that those running our biggest commercial businesses will have
to be more visible. They’ll have to manifest a genuine understanding not only of the
anxieties of their employees but of all taxpayers. Those chief executives who succeed
will be those who imbue in their businesses very simple, commonsense standards of
decency. And they’ll almost certainly be paid less for doing more, because the
pricking of the debt bubble has undermined the institutions – the private-equity firms,
hedge funds and investment banks – that were ratcheting up the pay of all business
leaders."

It will all have to be completely and clearly explained. Period. How to pay these people won't be a problem if we chuck them.

"But the biggest lesson of all is that we are a million miles from having created the
political and regulatory institutions to help us contain the risks of globalisation. We
and most of the world may well have been beneficiaries of the open global economy.
But as millions lose their jobs in Europe and the US in the coming year, the benefits
will be forgotten.

If the unfettered movement of capital, goods and services is going to survive, if
there’s not going to be a retreat into national fortresses that could impoverish all of us
over the longer term, we’ll have to find a far better way of monitoring global risks and
of bringing governments together to deal with these risks.

Some may see this as a threat to national sovereignty, as the thin end of an antidemocratic
wedge that’ll see the world ruled by unaccountable bureaucrats.
Reconciling our political traditions with the imperative of making safe the globalised
world will be a challenge, to put it mildly. But it’s not a challenge we can shirk."

I agree with this as well. We're not talking world government, or, at least, I'm not, but cooperative agreements that are negotiated and willingly entered into. We need to keep on the path of globalization and free trade.

"Globalisation seemingly erodes governments’ ability to redistribute wealth"

Here's an interesting post on Vox by G. Bertola and A. Lo Prete:

"Globalisation seemingly erodes governments’ ability to redistribute wealth. This column presents new evidence of the tradeoff between integration and redistribution, showing that financial development has filled in where government has receded. The current crisis may pose political challenges to both financial development and economic integration."

Before we go on, let me say one thing. I would expect, and I hope, that as countries get wealthier, government spending and welfare spending will go down. That's my libertarian side. How low, time will tell. But I also preface this on the following: that the people on the bottom rung of income and the middle class getting wealthier. In essence, there can only be a cutback in government spending if people are wealthier and capable of weathering life's vicissitudes on their own. That's one reason I'm a Democrat. I'm for a robust, to use the word of the day, social safety net. Truthfully, I believe that would actually help us through this crisis we're in now, as people wouldn't be as terrified as they currently are. As it is, there's clearly not a panic like in the 30s.

So, let's see what they say:

"The current global financial crisis highlights the vexed issues of what role national governments should and do play in an internationally integrated economic system. In Dani Rodrik’s (1998) classic analysis of data from the 1960s to the early 1990s, openness to international trade was found to be associated with a larger share of government in GDP."

More International Trade= More Government as measured by percentage of GDP. That's interesting.

"Government policies meant to shelter citizens from risk may indeed be more important in countries where international market access fosters opportunities to trade but also exposes workers to more frequent and intense shocks."

Creative Destruction increases, so to speak, leaving workers more subject to changing jobs and careers. However, the first statistic just said that government was growing. It didn't divide it up, did it?

"More recent and precise data on social expenditure in 18 OECD countries confirm Rodrik’s observation. In Figure 1, the fraction of GDP spent on such policies is larger in OECD countries that import and export more, perhaps because they are small and near to each other or because they choose to deregulate international trade.

Figure 1. Public social expenditure and trade openness

It would be nice to know which it is. However, this seems to say that there is more social spending in countries with more trade.

"Another mechanism is relevant, however. Redistribution may be more useful in more open economies but national governments are less powerful if economic integration allows private agents to seek more lenient taxes and more generous subsidies across countries’ borders. Competition among systems (Sinn, 2003) may reduce the viability of collectively enforced national policies, making income redistribution negatively associated with international openness. It is not difficult to find such a relationship in the data."

Wait a second, this sounds like the opposite.

"In Figure 2, we plot deviations from countries’ means of social expenditure and openness, which capture reasons for countries to be permanently more or less open, or more or less inclined to social expenditure. The relationship is negative. This suggests that as technological progress and multilateral trade liberalisation have made borders less of a barrier to economic activity, the scope of redistribution policies has become smaller.

Figure 2. Public social expenditure and trade openness, deviation from means

The line seems to be pointing down now. That's the opposite direction, isn't it? The countries are spending more, but the spending is more concentrated?

"As an increasingly globalised economic system increases the risk households face and makes it harder for governments to enforce redistribution policies, something has to pick up the slack. Our CEPR Discussion Paper 7048 finds that, controlling for country and time effects, the negative association between openness and redistribution illustrated in Figure 2 is more pronounced when and where financial markets are better developed. As globalisation progressed, financial development substituted for government policies. In theory, this makes a lot of sense. Financial markets must indeed be more important if international competition makes it difficult to implement social protection schemes while introducing new sources of income risk. In a more risky world, absent heavily redistributive national welfare states, credit and insurance volumes have to increase."

I thought that government expenditure was going up. So, it's going up, but the countries are spending less on the social safety net. Is that the thesis? Then what are they spending more on?

"Globalisation increases aggregate incomes but erodes redistribution, and it could decrease welfare if it were not accompanied by better insurance against new and larger risks. In our empirical work, following Jappelli and Pagano (1994), we proxy the accessibility and efficiency of household financial markets by loan-to-value ratios – the percentage of a house purchase price that may be financed by mortgages. Available indicators are significantly and sensibly related to openness and social policy developments. Over time, loan-to-value ratios increased from about 75% on average in the 1980s to about 90% in the 2000s. They differed sharply across countries in the 1980s, when loan-to-value ratios already exceeded 80% in the UK and the US but were only slightly above 50% in Italy and Greece. By the late 1990s, the loan-to-value ratios in all our OECD countries exceeded 70%, and by the early 2000s they ranged up to 115% in countries such as the Netherlands.

From the perspective of this column, a high loan-to-value ratio is a good thing. Borrowing allows households within countries to buffer the ups and downs of international competition without having to rely on collective redistribution and makes it possible to reap the fruits of globalisation in terms of overall competitiveness. For individual households, it is beneficial to be able to borrow a lot and go bankrupt upon negative income shocks. But there can be too much of a good thing."

So, people are going into debt to keep up their standard of living, because Government money to them has gone down. This sounds like Robert Reich.

"If individual repayment risk is not properly packaged and diversified, financial market development can be a source of aggregate instability. Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity."

So, let's see. If governments have to spend more on their citizens, they will have to trade less. Does that follow?

"Researchers will be looking carefully at signs of such reversals. Not only financial market development, but also trade and social policies will change as a consequence of the current economic turmoil. The character of these developments may foster confidence in the structural character of the empirical relationships we detect in our paper, which could so far be spuriously driven by trending factors other than those we focus on."

I guess we'll have to wait and see.

"And policymakers should also be keenly aware of these mechanisms. The path that led to the Great Depression was paved by protectionism and an increasing role of government. Rescuing financial institutions fosters confidence, but using the rising power of governments in the current financial storm to bail out manufacturers distorts competition and reduces confidence in further economic growth. To steer clear of the Great Depression path in a world where redistribution is no longer very effective and financial markets are key to the sustainability of international integration, we must develop an internationally coordinated financial regulation framework and avoid retracing backwards decades of international integration and financial development."

Now it sounds like they're warning against this inevitability, and arguing that trade be kept going, otherwise we''ll have a depression.

Let's take stock:
1) As countries trade more, governments get bigger
2) But less goes to the social safety net
3) People go into debt because of the loss of income from government
4) If the social safety net needs more spending, then it might be necessary to trade less
5) Trading less is bad, because it can lead to a depression

Why did the social safety net go down?
A. Capitalists got richer, and cut wages and benefits and influenced the government to get out of their way. Is that it?

Well, Martin Wolf is not going to like the no trading idea, and neither do I. I take it that they don't as well. Fortunately, I have Dani Rodrik on my blog. Let's see what he says:

"Economic theory and intuition suggest that as economies become more globalized, the ability of governments to undertake redistributive policies and to engage in social spending erodes. After all, a large part of the tax base--corporations, financial intermediaries, and skilled workers in particular--become internationally mobile and can evade taxes needed to finance those public expenditures. "

I would think that as countries get wealthier, the hope would be that the people would get wealthier, so that there would be less need for a social safety net, although there will always need to be one, and the certainty that it's there if needed. Rodrik's thesis seems to be as well that Capitalists command more of the wealth and workers lag behind due to the growing wealth and power of the Capitalists.

"This is important because historically countries that are more exposed to international trade have actually had larger public sectors, in part to insulate their citizens from shocks originating from abroad. This fact, along with the lack of an obvious decline in the overall tax take in major advanced economies, has led many observers to think that the hypothesized decline of the welfare state has not in fact taken place."

I don't think that the welfare state has gotten smaller. Does anyone? We've just lived through the largest increase in government spending ever it seemed like.

"Another interesting argument Bertola and Prete make is that private finance seems to have partly filled the whole left by public transfers. The claim is that more developed financial markets are able to supply the insurance and consumption-smoothing provided traditionally by the welfare state in very open economies. They use the share of house prices financed by mortgages as an indicator of financial development."

I think it's more like they thought that people had gone into debt, as Robert Reich does:

"Borrowing allows households within countries to buffer the ups and downs of international competition without having to rely on collective redistribution and makes it possible to reap the fruits of globalisation in terms of overall competitiveness. "

It does certainly seem that this is going to be diminished for a time.

"I am sure this argument made a lot more sense a year ago, when the authors were doing their original research, than it does now. It will take a while until we think of finance, and housing finance in particular, as a source of insurance and stability.

Bertola and Prete are aware of this of course. So they conclude thus:

Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity.

Indeed. Welcome back to the political trilemma of the global economy."

How can we be welcomed back to a trilemma? Does it go away?

"Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an "impossibility theorem" for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full."

Is this logically impossible, or just a fact of life?

These three:
1) Democracy
2) National Sovereignty
3) Global Economic Integration
Can't exist simultaneously. Only two of three.

I don't see how this can be logically impossible, but let' see.

Here is what the theorem looks like in a picture:

It looks like a triangle. In what sense is a theorem?

: an idea accepted or proposed as a demonstrable truth often as a part of a general theory :

Okay. What's the general theory?

"To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs."

So it looks likes it 2 and 3 can't go together, since one is global, and one is national. What about free trade agreements? I suppose that there are always going to be unresolved issues, but 3 seems to be a matter of degree. What does "deep" mean? Complete?

"So what do we do?

One option is to go for global federalism, where we align the scope of (democratic) politics with the scope of global markets. Realistically, though, this is something that cannot be done at a global scale. It is pretty difficult to achieve even among a relatively like-minded and similar countries, as the experience of the EU demonstrates."

Get rid of countries. Forget it.

"Another option is maintain the nation state, but to make it responsive only to the needs of the international economy. This would be a state that would pursue global economic integration at the expense of other domestic objectives. The nineteenth century gold standard provides a historical example of this kind of a state. The collapse of the Argentine convertibility experiment of the 1990s provides a contemporary illustration of its inherent incompatibility with democracy."

Nations do that now. All agreements are trade offs. I don't understand the need for "only". Is this some kind of Kantian Argument?

"Finally, we can downgrade our ambitions with respect to how much international economic integration we can (or should) achieve. So we go for a limited version of globalization, which is what the post-war Bretton Woods regime was about (with its capital controls and limited trade liberalization). It has unfortunately become a victim of its own success. We have forgotten the compromise embedded in that system, and which was the source of its success."

I don't see why we should give it up. By that standard, we should certainly get rid of the UN. It couldn't stop The Congo, Sudan, or Rwanda, or about 30 other smaller wars. It has a terrible success rate. It's violations are beyond any forgetting, and involve abetting.

"So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man's land."

If you can give up some of each and compromise, it's not unsolvable or mutually contradictory in any way. He needs a Venn diagram or some other depiction of his "theorem". It looks more like a simple relationship between three chosen facets of human institutions. One could throw war, famine, ethic conflict into this mix, and really complicate things.

I'm perfectly content with his default position. As near as I can tell, it's what I actually believe. I wouldn't call it a theorem.

As for the Welfare State and Global Trade argument, I don't quite get it. It seems clear that government expenditures have risen. The only point that's worth considering is the basic argument that global trade has shifted power, wealth, and influence to one group of people at the expense of another. But I can think of lots of ways to correct that imbalance which don't involve Socialism, Communism, or any other debunked human arrangement. We have a Welfare State, Corporate Capitalism, and so does Sweden. It's merely a matter of emphasis, some of which is related to culture and trial and error, but all of which is related to Human Agency at bottom.

I don't feel near as disoriented as others do. The 1930s would have certainly disoriented me much more. So, maybe this comes down to basic assumptions of Human Agency, and the Existential Situation we find ourselves in, which is not near as dire as some must be presuming.

"that globalization was the biggest bubble of them all based on the sharp decline in the Baltic Dry Index. "

A fascinating chart from Bespoke, although this is not a new story:

Globalization: The Biggest Bubble of Them All

At the end of October, we released a B.I.G. Tips report to Bespoke Premium members highlighting that globalization was the biggest bubble of them all based on the sharp decline in the Baltic Dry Index. Click the thumbnail image below to view the report.

At the time of the B.I.G. Tips release, the Baltic Dry Index, which measures changes in the cost to transport raw materials, was down 90.26% from its highs earlier in the year. Well, things have gotten much worse even since our 10/23 report. As shown in the chart below, the Baltic Dry Index is now down 94.2% from its highs, which is 40% lower than where it was on 10/23. On May 20th of this year, the Baltic Dry hit 11,793. It currently stands at 684. Talk about deflation -- maybe even call it leveraged deflation.

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December 03, 2008 at 11:55 AM in Market Analysis | Permalink

At some point, I need to check out Jim Rogers and see what he thinks about commodities. He's a favorite of mine, who I've actually met and talked to a couple of times. He did a very interesting interview on the FT recently, but I have a hard time, basically I can't do it, with videos and YouTube , or whatever it is, and such. It was a terrific interview, but I haven't been able to find a transcript.

"Abdullah Hajeri led a march on the Emir's palace in Kuwait last week"

Speaking of the Gulf. Bloomberg, again:

"The region's rulers are under pressure from citizens to shore up investors, not just banks, as they try to fend off what may be the worst economic crisis since December 1998, when oil at $10.35 a barrel forced them to slash spending. Crude prices have fallen 50 percent from a record $147.27 in July, and stock indexes in Dubai and Saudi Arabia are down by as much this year.

Gulf economies are more susceptible to financial turmoil than in the past because of their greater dependency on international expertise, investment and tourists to diversify away from oil. While Dubai, home to the world's tallest building and the man-made Palm Island, is considered most at risk, no part of the Persian Gulf will go untouched."

Where have we encountered this conundrum before? Citizens who don't like only the banks getting a bailout? Now that's globalization. We're all alike.

"There aren't many international investors left in the region, he added.

Regional competition to attract investors and tourists from around the world led to a surge in record-breaking projects."

Put those on hold, just like everywhere else, there's an economic credit hoovering back home going on.

"The emirate has almost 8 percent of the world's oil reserves and a sovereign wealth fund with assets between $250 billion and $875 billion, according to a range of estimates compiled by the International Monetary Fund. Even with its decline, oil still averages $110 a barrel for the year.

Residents of the region are used to government intervention. All Gulf countries are run by unelected rulers who maintain political power through tribal allegiances and marriages. Generous state welfare programs have traditionally damped demands for more political participation.

How the region's rulers cope with the turmoil may define relations with their people in the future, as they try to wean their subjects off state handouts and encourage them to find jobs and embrace market capitalism.

``There's no question that it sets back the move from socialist, paternalistic societies toward more modern capitalist states,'' said Gabriel Stein, a director at London's Lombard Street Research, which provides economic analysis to investors and companies. ``It is a trend that we have seen all over the world. The immediate reaction is that you told us to do this, so now things are going wrong it's up to you to help us out.''

Ah yes, governments will grow larger for the near term. However, helping citizens through economic downturns needn't be seen as a rush towards socialism. Nor, apparently, massive government interventions in the economy. So don't go all marxist quite yet.

``The U.S. financial crisis has ramifications for all countries, including the Gulf,'' U.S. Deputy Secretary of Treasury Robert Kimmitt said this week during a speech in Dubai, where he met representatives of sovereign wealth funds. ``Our capital markets are more integrated than ever before, allowing opportunities, but also financial difficulties, to spread rapidly across borders.''

We did some good before, look at all your wondrous buildings, so please don't blame us for this financial crisis which we started.

"Of the Gulf states, Dubai may be hardest hit by a global economic slowdown because it has borrowed more to finance its transformation from a Persian Gulf trading post to a financial and tourist hub, and has only 4 billion barrels of oil reserves.

Government-controlled companies owe at least $47 billion, more than Dubai's gross domestic product, and they will continue to accumulate debt faster than the economy grows, Moody's Investors Service estimated in an Oct. 13 report. It concluded that Dubai may need financing help from Abu Dhabi."

Let's change that from 'may' to 'will'.