47 thoughts on “An agenda for social democracy

  1. ProfQ,

    Below is the first part of my response to the article:

    We must start by asking your definition of “risk” and “uncertainty”. If we take the definition provided by Frank Knight that risk is “quantifiable” while uncertainty is “unquantifiable” I believe that this will help provide a more detailed analysis/critique of your work.

    You start by discussing the Government’s role in reducing individual risk by the state sharing the risk. The other side of this equation is the “reward” that must come. Traditionally the argument has been the greater the risk the greater the reward. However you make a broad and sweeping generalisation:
    “The set of policies traditionally associated with social democracy may be regarded as responses to a range of risks facing individuals, from health risks to uncertain life chances”
    Are these risks from birth or uncertainty from living one’s life? Having medicare does not guarantee that the risks from birth are gone but rather the uncertainty that walking across the street will result in getting hit by a bus.
    Further, risks to health are taken up by insurance companies. One pays a premium for the insurance company to respond by paying the hospital cost in the event that one is hit by a bus. Using actuarial models and vast reams of statistics they put together a risk profile and the premium is commensurate to that.
    Not everyone can pay and this is where the government comes in. It is not the failure of the free market but rather the uncertainty that someone cannot pay or that someone’s employer cannot pay. It is the risk of life that no one can completely mitigate. The Government can plug the gaps but it is the height of arrogance to assume that policies can suddenly mitigate every risk and uncertainty especially since uncertainty is by definition unquantifiable and humanity is not equal.

    You stated that:
    “Risk and inequality are closely linked. On the one hand, the greater the risks faced by individuals in the course of their life, including the risk associated with differences in initial opportunities, the more unequal society is likely to be.”
    You assume that risk only equates with the negative – that it explodes a person is left to pick up the pieces rather than acknowledge that it can take someone from the gutter to the heights. This is the reward aspect of risk taking that without risks comes no reward. Without taking the risk of placing a small amount of capital in a business no revenue or income will come from that to expand to enjoy a higher lifestyle.
    Further, while there is statistical evidence linking where one is born to the outcomes in life it is wrong to assume that opportunities alone account for everything. Differences in ability, luck, uncertainty, natural curiosity and natural risk-taking, natural aversion, social aversion, cultural characteristics all come into play. Assuming that everyone is equal does not work and is impractical.

    Professor Quiggin, you stated somewhat incorrectly that:
    “radical inequality in outcomes, such as that associated with massive rewards to financial traders, encourages a search for opportunities to capture the benefits of risky actions while shifting the costs of such actions onto others, or onto society as a whole.”
    It is right that if you take the risk then the person must be prepared to accept the punishment but it is incorrect to be so presumptive that what can be applied to a few (bailed out banks/traders) can therefore be applied to the entire business sector as a whole. The search for increase in risk is a quantifiable game – in trading it can come from client request for 10% return instead of 9% or that a small business believes that it can service a niche market. It leads to inequality because that is the nature of life – one who risks gets the return but it is the great social democratic Fannie Mae and Freddie Mac where socialised losses and privatised returns helped lead to the underwriting of 40% of the subprime market in the United States. If you are advocating that those who want the risks should accept the punishment then fine. But if you want the benefits of risk to be socialised then there is no incentive to take risk.

    “If individuals are to have security of employment, income and wealth, governments must establish the necessary legal and economic framework and enforce its rules.”
    Whose rules? Societies? The Governments? The Constitution? How about private property? Do you realise that society changes so the acceptable rules 10 years ago is no longer the same today as it would be different 10 years hence? When you put together rules are you suggesting that security of employment should be a “right” which therefore creates an “obligation” on the provider of employment! Who takes the risk when that does not play out? Are you prepared to say that due to Government policies securing employment that when a business is punished by a bad employee the government will compensate the business?
    This is the problem with taking the risk/uncertainty principle and applying to society or the government (social democrats see no difference): you want to mitigate the risk forgetting that someone always carries the risk and where there is no return then the risk will never have initially been borne.

    You make the typical mistake of assuming that Government and society is interchangeable and that society and communities and the government are indeed homogenous:
    “The interpretation of social democracy as a collective social response to risk and uncertainty may be illustrated by considering some of the core functions of the welfare state, such as health care and education.”
    What is “collective”? 51% of the population who votes for one party or the ten people who sit in a room devising a policy or the three academics writing a dissertation? So often people such as yourself call for collective action as if the needs of one person are exactly the same needs of another. As if one community and another believe the exact same things. Humanity is not homogenous. That is why collective action tends to be underwhelming.

  2. Sean, these all seem to be arguments from first principles, which are unlikely to be resolved. Typically, arguments of this kind, without consideration of the empirical evidence, lead to extreme and unsustainable political conclusions (Marxism and laissez-faire economics being obvious examples).

    If you want a debate, you’ll have to make the case against my claim that, based on the experience of developed countries, including the current crisis, we would be better off if government took a more active role.

  3. I think I will debate that – I am still writing out a critique but after another few pages am still on risk-reward in society. If I keep this up my entire day will be devoted to writing a rebuttal that it longer than the article itself and wholly critical rather than being constructive.

  4. Write at whatever length you think you need. I’ll be happy to put it up as a PDF link.

  5. John

    Are you being a troll here:

    “Typically, arguments of this kind, without consideration of the empirical evidence, lead to extreme and unsustainable political conclusions (Marxism and laissez-faire economics being obvious examples).”

    Marxists could label you and many other ALPers with extreme labels as well. Although this is a bad habit.

    I doubt whether you know sufficient Marxist theory to make such a statement.

    Usually this kind of comments arise from a misunderstanding of Marxism (sometimes deliberately so).

    I think it best if you delete the word “extreme” from your vocabulary.

  6. As others have said, an interesting piece of speculation. JQ is probably fairly correct about the political reaction to the GFC: more regulation, bigger government, higher taxes.
    Following that, I expect slow growth -caused by regulation and increased government participation in the economy – productivity improvements are very small in government provided services. Also higher inflation as a result of the hangover from the current loose monetary and fiscal policies. Governments almost never get the timing right and the political resistance to pulling back on spending and increasing interest rates will be very great.
    So, probably we will have something resembling the stagnant 70s when we had a period of mediocre to very poor government.
    Then, along will come something resembling the Hawke-Keating government to realize how the policies are holding back the country’s potential and we will enter once again a period of high growth and low inflation.

  7. I’m not convinced that the GFC was caused entirely by “economic liberalism”.

    Surely the sheer number of sub-prime US mortgages owes something to the likes of the Community Reinvestment Act. This was used to coerce banks into lending to people who would not qualify under a normal credit assessment.

    The worthy aim was to enable poorer people, mainly blacks, to enter the housing market. That sounds like a “social democracy” option rather than “unrestrained capitalism”.

    Fanny and Freddy were left holding these toxic assets because their losses were backed by taxpayer guarantees. Once again, hardly unrestrained market forces.

    The fact that unethical rentseekers in the financial industry made huge money repackaging and onselling these loans is not the cause of the crisis but a symptom of it.

  8. John,

    At the very end of your essay you say that “the growth in trade in goods and services has been overwhelmingly beneficial … a new international settlement must encourage trade …”

    Can you please comment on the fact that trade/transport is a major contributor to the greenhouse gas problem. How do you deal with the contradiction of promoting trade while having no solution to this very serious problem?

    And also, isn’t there a contradiction in criticising the free market ideology while advocating more free trade? Isn’t free trade supposed to be based on free markets? If, say, the US can massively subsidise its agricultural exports thereby destroying its competition, that’s not much of a basis for ‘free trade’. If you want free trade shouldn’t you be in favor of free domestic markets (no doubt impossible, but economists love abstractions) ??

  9. Paul Williams
    #32
    Fannie and Freddie is being made the scapegoat by the conservatively inclined (and the liberally inclined)and this is quite untrue. Neither Fannie nor Freddie sold the subprimes that caused the collapse. In fact they held mostly prime mortgages. They were forced to pick up some of the fallout from other lenders post 2007. In addition these were private institutions but the only thing that saved them from being up to their necks in subprimes (or CDs)or toxic assets like AIG and other exposed private financial institutions (private sector excess) is because they were run to a congressional charter (that is, as strange as this may sound to you.. Fannie and Freddie had higher standards written into their charter).

    The biggest mistake ever made was in privatising theem under the Johnson admin. Thats where the trouble started for Fannie and Freddie but they were not the cause of the subprime meltdown. That can in all likelihood be blamed on the irresponsible removal of important regulations like the Glass- Steagall Act under the non watchful eye of the Bush administration.

    Prior to that they were a very successful government models (and business model) for some decades. Anyway this conversation has all been played out before in other links.

    What you suggest about Fannie and Freddie is quite untrue.

  10. Commission-based lending sure doesn’t help either. A third-party seller gets paid on number of loans and/or volume – hardly difficult to see the ticking bomb there, in a low inflation environment. And why didn’t these sellers get rapped across the knuckles for limbo-dancing style loan assessment criteria? Because once made, the loan becomes backing for the mortgage-backed security market; well, at least after some statistical multiplexing with a better class of bank loan, to bring down the variance. No doubt some kind of mortgage insurance got written (by AIG? 🙂 ) as well?

    Placing all of the blame upon FM is to ignore the chain and each of its links.

  11. #35 #36

    Quite clearly I’m not placing the blame on Fanny and Freddie for the original mortgages.

    As I understand it, the loans were made by local banks under threat of penalty under the CRA. They were forced to write the loans to people who would not normally qualify. The aim was to help poor people get into home ownership.

    That sounds more like social democracy than economic liberalism to me.

    Once the loans proved beyond the capacity of the mortgagees to repay, then wouldn’t economic liberalism allow that property to be repossessed?

    And wouldn’t social democracy deem it to be a greater good that those people stayed in their homes and the mortgage be picked up by taxpayers?

    Which of those two options has been predominantly followed?

    The shonky financial dealings that apparently allowed bankers to make buckets of money and offload the bad loans onto others maybe wouldn’t have happened if normal rules of creditworthiness had been followed originally?

  12. Paul,
    The subprime loans were made to people who had no job no income (ninja loans) and liar loans (you tell us what you earn…and we wont do any credit checks).
    That is no social democracy initiative. That is fraud. It was knowingly making bad loans because you could bundle them as collateralised debt instruments and on flog them to someone else across the US and the world. No bank was forced to do that under threat from the CRA – that is nonsense. The financial institutions that pushed the sale of these loans were tied to the large financial institutions (or were the large financial institutions)and used commission agents in many cases. It was pure fraud (because house prices were rising and while ever they rose …and the more bad loans they granted the more house prices rose and rose and rose…but not of it was sustainable and when they fell they took sound borrowers down with them because their house prices fell too and they then defaulted).

    It was grossly negligent supervision and removal of regulation and a hands off approach of the US financial sector by US regulators. The US was not so long ago critical of the bad loans that China had on its banks accounts. Yet China and other Asian banks didnt pile into risky housing loan based toxic investments and quietly built up foreign reserves and their financial system is more tightly regulated throughout. Now the debt on US banks accounts is monstrous.

    It was too much liberalism. In fact it was fraud and it was laissez faire which is perhaps the same thing.

  13. Professor Quiggin, in his paper, proposes a long term response to the global financial crisis which shifts the risks from individuals and families and places the hand of government firmly on the economic tiller.

    It appears to me that the laws requiring Fannie and Freddie to devote a large proportion of their activity to meeting affordable housing goals is not consistent with the proposition that the risk has been falling on individuals.

    Those laws seem more consistent with the government hand being on the tiller already.

    No doubt Professor Quiggin will be able to point out where I have misinterpreted the situation :), But I cannot see that unchecked economic liberalism is the only cause of the GFC.

  14. Paul

    Personally I doubt whether the CRA had much to do with the sub prime mess. The CRA has been around since the late 1970s and sub prime loans only exploded during the last few years. They were made, securitised, rated and transferred around the world by private institutions who simply got it wrong when assessing their real worth.

  15. TB,

    There were changes made to the CRA, especially in 1995, such as making approval of new branches conditional upon a satisfactory CRA rating, and using input from lobby groups for part of the banks rating.

    These changes were followed by the said explosion in subprime loans.

    While I’m not disputing the need for sensible banking regulations, I don’t see that the GFC has been caused entirely by economic liberalism.

    Without the social democratic underpinning of pressure to write dodgy loans, plus taxpayer assumption of the risk via Fanny and Freddy, would the subprime situation have grown to such significance?

  16. Fannie, the Federal National Mortgage Association, and Freddie, the Federal Home Loan Mortgage Corp., don’t lend money, to minorities or anyone else, however. They purchase loans from the private lenders who actually underwrite the loans.

    It’s the process called securitization, and by passing on the loans, banks have more capital on hand so they can lend even more.

    The private banks that provided much of the subprime lending would not have taken on riskier subprime loans without the implicit support of Fannie and Freddie securitisation services effectively removing the risky supprime loans off the books of the private banks.

    This is clearly a moral hazrd instigated by Fannie and Freddies GSE image status and its capacity to securitise as a result of government regulation.

    This is not economic liberalism. This is a moral hazard brought about by government regulations. The government was clealry trying to be popular not a economic liberal. The government clearly aided and abetted in this fraud. In fact It was the instigator of the fraud. Why so ? without the capacity of Freddie and Fannie to securitise these second rate mortgages it would have been the private banks who would have to have worn the risk and I expect they wouldn’t have done so.

  17. John, really excellent paper. Thanks for posting it. Just a few points:

    Page 5, para 13: “In the long term, markets cannot manage the risk associated with the fact that some people will have chronically worse health than others.” Health insurance markets unencumbered with restrictions on risk rating (eg community rating requirements) can price health coverage for those chronically ill, and manage the risk through differential pricing. The result is that only the rich can afford to pay the premium. This leads to the injustice of the chronically ill being left without coverage, clearly a failure of social policy for those who believe in market solutions to health insurance. But the failure is not in the ability of markets to price the insurance and manage risk. It’s the failure of such solutions to provide universal coverage for all who are ill. That goal can best be achieved through government health insurance schemes.

    Page 6, para 13. “From the 1980s onwards, businesses routinely dismissed employers in large numbers, not as a last resort, but as a preferred method of making already substantial profits even larger.” If we accept that the role of private companies is to maximise profit then this behaviour seems both rational and reasonable (within a marketplace of competitive firms). Alternatively we could expect businesses to be sub-optimal profit maximisers in order to deliver higher social ideals but that would confuse the roles between the public and private sectors. And if such cost cutting delivered lower prices for goods and services (again assuming a competitive market) then that is overall a good result for consumers.

    Page 7, para 3: “Fiscal policy (taxing and spending) is the central business of government.” The use of the word “the” implies that fiscal policy is the most important business of government at present. I would argue that it is one of the areas of focus but should not be seen as the only area for government attention. There are still many areas of social policy that require thoughtful and detailed responses from government. Access to due legal process for the poor, protection of children from abuse, public housing, reduction in inequalities between indigenous and non-indigenous Australians are just some areas where taxing or spending by itself is not going to deliver the changes needed. The challenge for social democracy is to solve (or at least make improvements) in these areas with creative and innovative policies, and with as much vigour as the tackling of the GFC. I know that your focus in the paper was on the policy responses to the financial crisis, but I fear that other social policy issues will be downplayed as being less important while governments grapple with sorting out the problems in the financial markets.

    Page 9, para 11: “It seems likely that additional public debt of 20 to 30 per cent of national income will be incurred”. Would appreciate a link or reference to how this was calculated.

    Page 12, para 2: “Most Australians say they would prefer improved services to tax cuts, but governments of both parties have offered tax cuts anyway.” One of the early lessons learned by those that study marketing is that just because a focus group of consumers say they will buy your product does not mean they will actually do so when they walk down the supermarket aisle. It would be a brave political party that goes to an election promising increased taxes to pay for increased services, when their competitor promises reduced taxes. It not clear that the political consumer (the elector) will buy that deal. We could argue that the tax cut stuff with the major political parties is just knee-jerk “me tooism”. Or it could be the rational behaviour of parties that understand what electors are really willing to say yes to.

    Page 12, para 3: “Expanding provision of these services [human services sector] will make a major contribution to the restoration of full employment.” Provided such expansion is focused on addressing social policy outcomes, and not just an end in itself to get the employment numbers up. Public expenditure should be efficient. The problems of the past that you allude to in page 13, para 5 would include expansion of public sector programs and employment without any clear social objective or sense of measurable result that government was seeking to achieve. This provided some ammunition to the economic liberals to pull back government expenditure and shrink the size of government. They should not be given such a leg up in the future.

  18. Paul and Ubiquity

    It is a completely false premise to apportion the blame for the GFC on Freddie and Fannie and the CRA. The GFC was very much more related to a lack of or a laxity in administration of sound regulation that any existing regulation. The only regulation changes that contributed actively to the GFC was the removal of the Glass Steagall Act and the refusal to monitor particular hybrid debt instruments (undertaken under the Bush administration). If you are suggesting that the removal of regulation (risky financial deregulation) was a regulatory oversight then in that sense you may have a point.

  19. What is the equivalent of Freddie and Fannie in the UK? In Spain? Both of these countries screwed up royally with their own housing failures, and I am not aware of any FM/FM?

  20. This is just silly. Government caused the problem by allowing and encouraging fractional reserve, and via fiat money, and now John says government is the solution.

    John. Try learning some economics. It helps to understand the material.

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