Book Review: Plunder and Blunder, by Dean Baker

I recently read Dean Baker‘s new book, Plunder and Blunder: The Rise and Fall of the Bubble Economy. Baker both gives a very brief economic history of the United States and more thoroughly recounts the two recent major economic bubbles: the stock market bubble of the late 1990′s and the housing bubble, which he noticed as early as 2002. The book is noteworthy for being extremely comprehensible, while not dumbing down too much for a lay audience. Baker, whose expertise is in economic history, methodically traces both particular and systematic changes in the U.S. economy during the post-war period. He goes over data that is well known to economists, such as the equitable growth in prosperity during the period from roughly 1950 to 1970. He then traces the (again, well-known) financialization and deregulation of the economy (especially during the Reagan and Clinton administrations) leading up to the unique bubble-based prosperity of the late 1990′s. Governmental and institutional leaders did not learn their lessons from the stock market crash of 2001 – so Baker claims – and repeated analogous mistakes in the immediate aftermath: namely, supporting the housing bubble and simultaneously denying its existence.

One useful feature of Baker’s book is its handy glossary of economic terms, which are emboldened throughout the text. Probably the most exquisite virtue of Baker’s book in all of its features and content is its very high information/length ratio. It is a very short and concise text, packed with useful and readily understood information. Much of it is well-known to economically savvy people and academics, but for the layman, and for someone wanting a clear overall picture of the financial crisis, Baker’s work is invaluable and, to my knowledge, incomparable.

Here I will summarize chapter 1 of Baker’s book as I understand it, with comments throughout. Later, I will post on other chapters, or just other parts that interest me.

Baker begins his book with a chapter called “How We Got Here,” which focuses on the financialization of the U.S. economy after WWII. He highlights the fact that during 1947-1973, real income not only grew alongside rapid productivity growth, but the growth was relatively equitable, and so “the benefits of that economic growth were shared widely” (Baker, 5). Baker uses an extrapolation to emphasize the high rate of productivity growth.

To appreciate the magnitude of this growth, consider the following: if we maintained the same rate of productivity growth in the United States experienced in the early postwar era, we would be able to take an additional 24 weeks of vacation each year, or reduce our average workweek to 21 hours, and still have the same income in 2030 as we do today (Baker, 6).

Basic econ tells us that increase in productivity-based income and wealth creates a “virtuous circle,” where higher wages lead to more consumption, encouraging the expanse of business, thereby encouraging the increased productivity that raises wages. Baker notes that the stock market itself only grew modestly during this period, not driving the economy. “[Americans'] savings were mostly held in traditional pension plans or in old-fashioned savings acconts” (Baker, 7).

This period of steadily growing productivity and incomes was marked by a somewhat protectionist environment – imports made up a very small percentage of GDP, only 7.6% by 1970 (a whopping 17%  in 2007!). A similarly stark trend occurs in what made up corporate profit. The financial sector constituted around 10% on average in 1960, but 30% by 2004. Baker posits a few causes for the growth of the financial sector, the most interesting being computers, the relatively cheap use of which “allowed for the proliferation of complex financial instruments that were previously impractical,” such as creating options on many commodities and other financial products, thereby allowing quasi-insurance through financial instruments. The expanding use of leveraged bets is also an important feature, according to Baker.

The financial sector received a great boost in the 1980s and through the 1990s, when deregulation became standard practice. Baker points to the deregulation of savings and loan institutions in the 80s, as well as the repeals of elements of the Glass-Steagall Act in 1999, as particularly significant examples. The former, Baker claims, “led to the failure of over 2,400 U.S. thrift institutions and cost about $560 billion, most of which was ultimately paid for by U.S. taxpayers. … [and] contributed to the large federal budget deficits of the early 1990s” (Baker, 11). The latter eliminated regulation which “mandated separation between investment banks and commercial banks,” the consequences of which are now extremely well-known, denied by only a conspicuous few, e.g. Bill Clinton. The literature supporting the contribution of the Glass-Steagall repeals is vast. Here’s one example I like.

Baker explains that after 1973, productivity growth slowed down significantly. This resulted in the stagnation of wages. But curiously, insofar as there was growth, the wealth increase was no longer equitably shared beginning around 1980. Baker closes the chapter by giving (by my count) five reasons why wealth began to be distributed mostly to the rich, and not among the American workforce as had been the norm from the 1940s-1970s.

1) Policy changes: The Reagan administration weakened labor unions through several mechanisms, including appointing disproportionate numbers of pro-management people to the National Labor Relations Board (NLRB), cutting funding to the NLRB (resulting in a backlog of cases), and making the unprecedented move of firing public sector employees on strike (air traffic controllers). This led to the greatly reduced credibility of workers bargaining with their employees.
2) Minimum Wage: This is in some ways a subset of 1, but it is much more direct. Reagan prevented increases in minimum wage, which is the same as cutting workers’ wages every year, because of inflation. Says Baker: In real term, the minimum wage was 26% lower when Reagan left office in 1989 than when he took office in 1981″ (Baker, 14-15).  This aspect of preventing minimum wage increases is often ignored.
3) Strong dollar: Baker observes that that the strong dollar during the Reagan years hurt American workers.

The large federal budget deficits of the Reagan years, coupled with the high interest rate policy pursued by the Federal Reserve Board, caused the dollar to rise in value against the currencies of our major trading partners. The high dollar made imports from these countries relatively cheap for American consumers, but it also made it harder for American firms to sell their products abroad. This in turn led to the loss of many high-wage jobs in manufacturing, especially in the automobile and steel sectors (Baker, 15).

4) Trade agreements: Agreements like NAFTA in the 1990s, says Baker, caused American workers to be in direct competition with low-paid workers in other countries. This put downward pressure on the earnings of blue-collar workers; no comparable policy was pursued which would have put high-paid professionals (like doctors) in competition with cheap labor.

5) Immigration policy: Baker points out that lax enforcement of immigration laws increases the supply of low-paying jobs, causing downward pressure on the wages of blue-collar workers. Again, this is not a problem for upper-tiered workers.
Baker says that between 1980 and 1995 real wages declined for average American workers by 0.9%. This is a dramatic change from the 2% increases in the post-war period. Worse yet, “Workers at the 10th percentile had a 7.5 percent decline in real wages over this period” (Baker, 16). This is contrasted with the striking fact that CEO income “went from 24 times the pay of a typical worker in 1965 to 300 times the pay of a typical worker in 2ooo” (Baker, 16).

All these facts together paint a picture of why the economy failed to perpetuate the “virtuous circle” of the post-war period. Baker’s conclusion is succinct:

The upward redistribution of income after 1980 meant that the economy couldn’t sustain the same virtuous circle that characterized the postwar period. Wages weren’t rising consistently, so workers couldn’t buy more with their income. Even with more two-paycheck households, many families saved less and borrowed more to support their standard of living. The increased globalization of the economy, especially in the manufacturing sector, meant a weaker connection between increases in domestic demand and increases in investment in new U.S. plants and equipment. American firms could meet increases in demand with production from abroad, and many did. In short, policy changes during this period helped break the virtuous circle of rising productivity, wages, consumption, and investment.

More and more, the U.S. economy depended on something far less virtuous than productivity gains and broad prosperity. In pursuit of short-term growth, key institutions relied on risky bets and unsustainable policies. In short, we got hooked on bubbles (Baker, 17-18).

Well, that’s it for chapter 1. If I feel like it, I will post on later chapters.