Tag Archives: Financial crisis

Updates from McKinsey

How smart choices on taxation can help close the growing fiscal gap
The growing fiscal gap has policy makers in a difficult position. Swift action in a few areas can help them improve the operational efficiency of fiscal systems.
By Aurélie Barnay, Jonathan Davis, Jonathan Dimson, and Marco Dondi – Governments around the world have implemented a range of fiscal and debt measures to fund policy initiatives over recent decades. As a result, tax revenues as a proportion of GDP have risen four percentage points across Organization for Economic Cooperation and Development (OECD) countries since 1980. However, many governments remain inadequately funded. Despite higher tax revenues, spending is rising faster than income, leading to widening budget deficits and higher levels of debt.

Four distinct trends are playing out: increasing automation in the workplace, leading to pressure on employment; the evolution of global trade through the proliferation of e-commerce and digital business, raising questions over cross-border taxation; rising self-employment; and an aging population. Each of these could further widen the fiscal deficit in the years ahead. Moreover, we see all four accelerating, placing policy makers in an ever-tightening fiscal bind.

Basic economics provides two options for balancing the books: either increase revenues or decrease spending.

The bottom line for governments is that there are no easy answers. Whether they seek to increase taxation or boost efficiency, they are likely to face headwinds. Still, decisive and rapid action is essential to optimize tax collections and keep pace with an inevitable rise in demand for services.

Tax revenues in OECD countries have risen slightly over the past 35 years. However, spending has risen more, leading to widening deficits that governments have bridged with debt. OECD tax revenues were 34 percent of GDP in 2017. Because of tax deficits and the effects of the 2008 financial crisis, the average ratio of gross debt to GDP rose from 66 percent of GDP in 1995 to 88 percent in 2017.

Sources of tax revenue have remained stable over time. Over three decades, personal income and consumption together accounted for 82 to 89 percent of revenues. The biggest single contributor was payroll and income tax, accounting for 50 to 55 percent of revenues (even though the contribution of personal income tax declined by nearly 7 percentage points). Consumption and excise duties remain little changed at 32 to 34 percent of revenues.

More people are working for themselves, either as a contractor to several companies or a single company. This emerging gig economy accounts for an estimated 28 percent of EU and US employment. The proportion would rise to 46 percent if everyone had their preferred working arrangement, according to MGI research.

However, the gig economy creates challenges for tax authorities. First, independent workers are generally less compliant than their employed peers, and in some countries are required to pay less taxes. Evidence from the US suggests that workers subject to limited information reporting, such as the self-employed, have an around 50 percentage point lower rate of tax compliance than traditional workers. There are also ongoing legal debates in some jurisdictions over whether gig economy workers are employees for the purposes of worker classification and social security contributions.

Governments can close the widening gap between revenues and expenditures in a variety of ways through tax revenues, nontax revenues, and spending optimization. In addition, some governments are either implementing or considering approaches based on monetary finance.

The gap between government revenues and spending has widened and is likely to continue to do so. The onus, then, is on tax authorities to act now. more>

New Microeconomics: How Evolution Explains Resource Distribution

By Blair Fix – Through years of schooling, mainstream economists are trained to ignore the obvious facts about human nature. The theories that economists learn make it impossible for them to understand human sociality.

Economists are trained that humans are asocial ‘globules of desire’. This is Thorstein Veblen’s satirical term for ‘homo economicus’, the economic model of man.

As Veblen makes clear, economists’ model of human behavior is bizarre. Indeed, the assumptions are so far-fetched that one wonders how this ‘theory’ ever gained acceptance. I’ve spent years trying to make sense of homo economicus as a scientific theory. I’ve concluded that this is a waste of time. Economists’ selfish model of humanity is best treated not as science, but as ideology.

Unlike scientific theories, ideologies are not about the search for ‘truth’. Instead, they are about rationalizing a certain worldview — usually the worldview of the powerful. Economists’ selfish model of humanity is a textbook example.

The discipline of economics emerged during the transition from feudalism to capitalism. During this period of social upheaval, business owners battled to wrench power from the landed aristocracy. To supplant the aristocracy, business owners needed to frame their power as legitimate (and the power of aristocrats as illegitimate). Their solution was devilishly clever. The new business class appealed to autonomy — the mirror opposite of the ideals of feudalism.

Feudalism was based on ideals of servitude and obligation. Serfs were obligated to perform free work for feudal lords. And these lords, in return, were obligated to protect serfs from outside attackers. This web of obligation was rationalized by religion — it was a natural order ordained by God.

To upend this order, business owners championed the ideals of autonomy and freedom. Business owners claimed to want nothing but to be left alone — to pursue profit unfettered by government or aristocratic power. From this world view, the autonomous model of man was born. It had nothing to do with how humans actually behaved. It was about rationalizing the goals of business owners. They wanted power, but they framed it as the pursuit of freedom and autonomy. “Power in the name of freedom” is how Jonathan Nitzan puts it. more>

How to save capitalism from itself

Meet the CEOs, workers, activists, thinkers, policy wonks, and class traitors leading the way toward a more equitable, humane, and democratic economic system that works for the many and not the few.
By Darren Walker – Capitalism is in crisis.

The United States—and our democratic values, discourse, and institutions—is suffering from unprecedented levels of inequality. Today, the three richest Americans collectively own about as much wealth as the bottom half of the population combined. Worse, extreme levels of economic inequity are only one of the many forms of inequality that plague our nation: We also face rampant discrimination based on race, gender, sexual orientation, ethnicity, religion, and ability. Looming over all of this is the threat of a global environmental catastrophe, which will make every one of these disparities more extreme through droughts, food shortages, and refugee crises.

Today, a growing number of leaders in the business and social sectors are finding ways to make our capitalist system fairer. They recognize that if we create the context and conditions for an inclusive and just economy, the more we can use capitalism’s undeniable productive power to unlock better ideas and outcomes for humankind.

The idea is simple: Everyone affected by the policies and practices of a firm should have a voice in shaping them.

Moving to stakeholder capitalism is not only a matter of doing the right thing, economists such as Harvard University’s Oliver Hart and the University of Chicago’s Luigi Zingales argue. In many cases, it’s also economically more efficient—which will in turn help everyone’s bottom line.

It’s less expensive to not pollute the environment than it is to clean up pollution. It’s less costly to not sell addictive opioids than it is to provide mental and physical care for those who become addicted.

By considering the perspectives of all the stakeholders involved, we can avoid cases like these where everyone involved ends up suffering. more>

How to Survive a Recession: 12 Steps You Should Take Now to Protect Your Money

By Diane Harris – “The global economy is facing increasingly serious headwinds,” said OECD chief economist Laurence Boone. “An urgent response is required.”

It shouldn’t exactly come as a surprise then that the latest Gallup poll found about half of Americans now believe that a recession in the next year is likely—a more pessimistic reading than the survey found 12 years ago, just two months prior to the start of the Great Recession.

Even more affluent households are often cash-strapped. Among those making $85,000 or more—the top 25 percent of the income range—the typical family only has enough in liquid savings to replace 40 days of income.

If a recession hits, what would your biggest financial problem be? Taking steps to address that pain point now will make your life a lot easier if trouble comes.

“Your emotions are your best clue,” says Stephanie McCullough. “What stresses you out the most—credit card debt, the feeling that you’re spending beyond your means? Whatever the little nagging voice in your head is telling you is what you should tackle first.”

These moves address the most common contenders for many families.

  1. Pay down the plastic
  2. Earmark spending cuts
  3. Get a check-up

more>

The dirty secret of capitalism

By Nick Hanauer – I am a capitalist, and after a 30-year career in capitalism spanning three dozen companies, generating tens of billions of dollars in market value, I’m not just in the top one percent, I’m in the top .01 percent of all earners. Today, I have come to share the secrets of our success, because rich capitalists like me have never been richer. So the question is, how do we do it? How do we manage to grab an ever-increasing share of the economic pie every year? Is it that rich people are smarter than we were 30 years ago? Is it that we’re working harder than we once did? Are we taller, better looking?

Sadly, no. It all comes down to just one thing: economics. Because, here’s the dirty secret. There was a time in which the economics profession worked in the public interest, but in the neoliberal era, today, they work only for big corporations and billionaires, and that is creating a little bit of a problem.

So, what is a society to do? Well, it’s super clear to me what we need to do. We need a new economics. So, economics has been described as the dismal science, and for good reason, because as much as it is taught today, it isn’t a science at all, in spite of all of the dazzling mathematics. In fact, a growing number of academics and practitioners have concluded that neoliberal economic theory is dangerously wrong and that today’s growing crises of rising inequality and growing political instability are the direct result of decades of bad economic theory. What we now know is that the economics that made me so rich isn’t just wrong, it’s backwards, because it turns out it isn’t capital that creates economic growth, it’s people; and it isn’t self-interest that promotes the public good, it’s reciprocity; and it isn’t competition that produces our prosperity, it’s cooperation. What we can now see is that an economics that is neither just nor inclusive can never sustain the high levels of social cooperation necessary to enable a modern society to thrive.

So where did we go wrong? Well, it turns out that it’s become painfully obvious that the fundamental assumptions that undergird neoliberal economic theory are just objectively false, and so today first I want to take you through some of those mistaken assumptions and then after describe where the science suggests prosperity actually comes from. more>

What’s Elizabeth Warren’s wealth tax worth?

By Isabel V. Sawhill and Christopher Pulliam – On both sides of the Atlantic, economic inequality has rocketed up the political agenda and inspired a new wave of populism. Wealth inequality is high and rising in the UK and staggeringly so in the US. The top 1% of American households now have more wealth than the bottom 90%. In the UK, the top 10% holds over half the wealth. The richest 400 individuals in the US average a net worth of $7.2 billion.

How did we get to this point? As Thomas Piketty, in his book Capital, famously argued, a capitalist economy left to its own devices will tend to produce not just inequality but ever-rising inequality of wealth – and the income derived from wealth. The main reason is because the returns earned on assets such as stocks and bonds normally exceed the growth of wages.

Imagine an economy with one capitalist and one wage earner. If the annual rate of return to financial assets is, say, 3%, but wages are only growing by 2%, more and more income ends up in the hands of the capitalist. Wealth then begets more wealth as the capitalist, not needing to spend all of his added income, adds to his existing wealth and reaps ever-growing income from that wealth. Unless a war or other shock destroys his wealth (think depression or the devastation in Europe after the Second World War), or government decides to tax it away, we end up with the rise in wealth inequality that we are now seeing in many rich countries – the US in particular.

There is something deeply disturbing about Piketty’s work. If one takes his thesis seriously, it means that the inequality of wealth and its corollary, income inequality, along with their continued growth, is the new normal. They are baked into a capitalist economy.

Of course, some financial capital gets invested in productive assets that help the economy grow. But productive investment and growth have slowed in recent decades, making it hard to argue that the rise in wealth at the top has benefited everyone. In the meantime, the accumulation of wealth in high-income households is one reason that income inequality is rising so sharply at the very top. While the richest 20% of US households, which benefit from a lot of human capital but not a lot of wealth, saw their market incomes rise by 96% between 1979 and 2016, the top 1% – which receives far more of their income from wealth – saw their incomes rise by a staggering 219%.

In short, growing wealth inequality spawns growing income inequality, so if we care about the latter, we cannot focus only on redistributing income. We need to tackle the accumulation of wealth as well.

What to do? Senator Elizabeth Warren, a serious contender for the US presidency, has proposed a wealth tax. more>

Updates from Chicago Booth

Why the big banks aren’t safe yet
By Haresh Sapra – The next financial crisis will not come from the traditional banking sector. So goes conventional thinking among financial policy makers. The world’s biggest banks are now safer, according to the narrative, thanks to stricter capital requirements and frequent stress tests that have curbed the appetite for extreme risk and tightened up lax regulatory standards.

I wish I were completely reassured. But as an accountant, I know that the headline capital numbers result from a subjective calculation. Banking regulators typically spend too little time digging into how those figures are calculated. I also know that when the US financial system is healthy, as it is now, we should strive to do better at accounting for potential losses, because that might cushion the blow when the inevitable downturn arrives.

To be sure, the big banks have all passed the Federal Reserve’s stress tests with flying colors. And this reflects substantial increases in capital buffers: the 35 banks that underwent 2018’s stress test have added about $800 billion in the highest quality type of capital over the past decade, according to the Fed. The central bank has deemed that the banks would therefore be strong enough to continue lending if the economy were to plunge into another severe downturn.

But I am not the only observer who remains concerned. In a speech to Americans for Financial Reform in May, Georgetown’s Daniel Tarullo, who was a Fed governor from 2009 to 2017, questioned the robustness of the stress tests. Banks know what regulators are looking for, Tarullo observed, enabling them to “find clever ways to reshape their assets,” thereby reducing their capital levels without reducing their risk exposures. And he also cast doubt on a Fed proposal to create a “stress capital buffer” to stop banks from running down their capital cushions by using dividend payments. Such a buffer, Tarullo argued, could actually prompt banks to take on even more risk. more>

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Updates from Chicago Booth

How machine learning can improve money management<
By Michael Maiello – Two disciplines familiar to econometricians, factor analysis of equities returns and machine learning, have grown up alongside each other. Used in tandem, these fields of study can build effective investment-management tools, according to City University of Hong Kong’s Guanho Feng (a graduate of Chicago Booth’s PhD Program), Booth’s Nicholas Polson, and Booth PhD candidate Jianeng Xu.

The researchers set out to determine whether they could create a deep-learning model to automate the management of a portfolio built on buying stocks that are expected to rise and short selling those that are expected to fall, known as a long-short strategy. They created a machine-learning algorithm that built a long-short equity portfolio from the top and bottom 20 percent of a 3,000-stock universe.

They ranked the equities using the five-factor model of Chicago Booth’s Eugene F. Fama and Dartmouth’s Kenneth R. French. Fama and French break down the components of stock returns over time into five factors: market risk, in which stocks with less risk relative to their benchmark outperform those with more risk; size, in which companies with small market capitalizations outperform larger companies; value, where a low price-to-book ratio outperforms high; profitability, where higher operating profits outperform; and reinvestment, in which companies that reinvest outperform those that don’t. more>

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Optimizing for Human Well-Being


By Douglas Rushkoff – The economy needn’t be a war; it can be a commons. To get there, we must retrieve our innate good will.

The commons is a conscious implementation of reciprocal altruism. Reciprocal altruists, whether human or ape, reward those who cooperate with others and punish those who defect. A commons works the same way. A resource such as a lake or a field, or a monetary system, is understood as a shared asset. The pastures of medieval England were treated as a commons. It wasn’t a free-for-all, but a carefully negotiated and enforced system. People brought their flocks to graze in mutually agreed- upon schedules. Violation of the rules was punished, either with penalties or exclusion.

The commons is not a winner-takes-all economy, but an all-take-the-winnings economy. Shared ownership encourages shared responsibility, which in turn engenders a longer-term perspective on business practices. Nothing can be externalized to some “other” player, because everyone is part of the same trust, drinking from the same well.

If one’s business activities hurt any other market participant, they undermine the integrity of the marketplace itself.

For those entranced by the myth of capitalism, this can be hard to grasp. They’re still stuck thinking of the economy as a two-column ledger, where every credit is someone’s else’s debit. This zero-sum mentality is an artifact of monopoly central currency.

If money has to be borrowed into existence from a single, private treasury and paid back with interest, then this sad, competitive, scarcity model makes sense. I need to pay back more than I borrowed, so I need to get that extra money from someone else. That’s the very premise of zero-sum.

But that’s not how an economy has to work. more>

Consumerism isn’t a sellout – if capitalism works for all

By Richard V. Reeves – The essential thinginess of capitalism has been one of its most-criticized features. Materialism, and specifically consumerism, are almost always used as pejorative terms. Nostalgic conservatives, egalitarian progressives and environmentalists loudly agree on at least one thing: we are just buying too much stuff.

They’re not wrong. The U.S. self-storage market is already worth $38 billion, and growing fast. Almost one in ten households are now renting extra space. One feature of late capitalism is that many of us have more things than we have space for things.

At its best, however, consumerism is a powerful, positive force. It allows for the expression of identity, it can hold sellers to public account, and it drives new thinking and development. But this is only the case when consumers are being served fairly in the market. Today, there is a pressing concern about whether the forces of “bigness” – a trend toward fewer larger companies – combined with a reluctance on the part of governments to intervene in consumer markets, is dampening innovation and narrowing choice.

Before worrying about whether the market is serving consumers, we need to agree that it should. Critiques of consumerism have to be taken seriously before examining whether contemporary capitalism is friendly to consumers. These critiques usually come in four types: moral, aesthetic, financial, or environmental.

The moral critique of consumerism is that the acquisition of things displaces more worthwhile activities or priorities. Instead of shopping, we should be spending time with friends and family, in places of worship, or in nature. more>