In my previous discussions about the need for financial regulatory reform, I made an allusion to the economic proposals of Robert M. “Fighting Bob” LaFollete. Today, I’m going to talk about how the Progressive ideas of LaFollete’s 1924 presidential campaign can be adapted to solve one of our most difficult long-term problems – the financialization of the economy.
America’s recent economic recession is actually a quite odd phenomenon – the financially-driven recession. There wasn’t a massive supply shock, as was the case in the 1970s when the oil crisis suddenly yanked up the cost of making things and transporting them and there wasn’t a cyclical drop in demand or a sudden restriction monetary policy change. But rather than being a new phenomenon, the financially-driven recession is actually a very old phenomenon – it’s what we used to call a “panic” back in the 19th century, and was the cause of such major recessions as the Panic of 1907 (caused by the failure of the Knickerbocker Trust Company after an attempted cornering of the copper market), 1893 (caused by the bankruptcy of the over-extended Philadelphia and Reading Railroad Company), and 1873 (caused by the failure of Jay Cooke’s bank, which had over-invested in railroad stocks). The so-called “Great Moderation” was supposed to put an end to all this.
So why are we traveling back in time? Well, as Paul Krugman notes, the financial sector is much, much bigger than it used to be. In the post-war era through the 1960s, the financial sector made up about 4% of GDP – banking was highly regulated, modestly profitable, and rather dull. The real action in the economy was over in manufacturing, where industrial giants like G.M were so rich that they had made themselves independent of the financial sector for capital. After twenty years of financial deregulation, flash forward to the late 2000s, and financial services make up 20-21% of GDP and are the largest single sector in the American economy; manufacturing’s down to 12% and publicly perceived as circling the drain. Because of the sheer size of the financial sector, it began to develop an enormous influence over other sectors, through the securitzation of mortgages, the creation of new derivatives and credit-swaps, and the aggressive selling of debt as investment vehicles.
All of which, as Krugman points out, has really no actual value. The new financial wizardry created a huge amount of paper money, some $43 trillion in public and private debt, but it didn’t really create much that people can use. The railroad bubble of the 19th century was a huge over-extension of capital, but after the bubble you still had the railroads; the internet bubble of the late 1990s also sent vast sums of money down the drain, but the fiberoptic cables and wireless networks remained.
The financial crash, by contrast, has left us with toxic assets, and toxicity is a good example for how too large of a financial sector starts to destabilize the economy and the larger political order. To give merely two examples: the student loan industry shouldn’t exist; the loans are guaranteed by the government, and they wouldn’t be profitable without government guarantee. Yet while the logical solution would be to have the government directly loan the money and cut out the middle man, the economic rent generated by the private lending system is considerable ($53 billion in risk-free loans adds up to a lot of profit), and the only reason it exists is that the banking lobby uses political influence to essentially graft money from the public trough. To give another, the oil futures industry is completely out of control to the point where regulators are actually talking about limiting the number of times a contract can be traded, after a speculative bubble in the summer of 2008 saw oil hit nearly $150 a barrel at a time when supply was up not down; some oil futures contracts were flipped twenty or more times between the ultimate seller and buyer. So here you have a situation in which financial speculation caused a massive artificial supply shock, contributing to an ongoing recession. The financial industry is making our economy sick.
Bob LaFollete’s Approach:
In 1924, Robert “Fighting Bob” LaFollete had been Governor (2 terms) and U.S Senator (3 terms) of Wisconsin, and had already run for president in 1912 on the Progressive Party ticket, although he had bowed out in favor of Theodore Roosevelt (Roosevelt had won 27% of the vote in 1912, the highest showing for a third party ticket in American history). Both the Republican Party, who nominated Calvin Coolidge (perhaps the most economically right-wing president in American history), and the Democratic Party, who nominated John W. Davis, had moved in a conservative direction, leaving the left open.
When he ran for president in 1924, LaFollete’s campaign was perhaps the most left-wing non-socialist campaign in American history. The Progressive Party Platform of 1924 proclaimed that “the great issue before the American people today is the control of government and industry by private monopoly,” and called for (among other things):
- the institution of a Congressional override on Supreme Court decisions
- public ownership and control of water and other natural resources
- “public ownership of railroads…as the only final solution of the transportation problem”
- the right to organize and collective bargaining
- the direct election of the president and a Federal initiative and referendum (including on all declarations of war not involving an invasion of the U.S)
But the heart of LaFollette’s campaign was a commitment: any corporation that controlled more than 19% of market share, and would thus be able to act if not as a monopoly than an oligopoly, would either be split up or nationalized. Even within the context of Progressive thought, this was quite radical – Wilson famously argued that trusts could be prevented by enhancing and enforcing the Smith Anti-Trust Act; even Theodore Roosevelt, in 1912, believed that the government would legalize and regulate most monopolies, and should only break up or nationalize monopolies that “behaved badly.” In his call for the public ownership of natural resources and common carriers, LaFollette was hearkening back to the Populist movement that had swept across his native farm state a generation prior. Moreover, in finally biting the bullet and forthrightly asserting that corporations would have to either be broken up or nationalized, LaFollette was calling essentially for the “de-corporatization” of the towering heights of industry.
The result of such a bold campaign, in the extremely conservative election year, was a quite surprising 17% of the vote, one of the highest ever recorded for a third party race – in addition to carrying his home state, LaFollete won 30% of the vote or more in California, Washington, Idaho, Montana, Wyoming, Nevada, North and South Dakota, and Minnesota. Yet in the end, LaFollete had come 12 years too late.
Given the manifest failure of anti-trust efforts in the last century, to attempt to restore competition within each industry by reducing the size of corporations is probably impossible without serious changes to U.S incorporation and property law. Even if such changes were possible, it’s likely that the process of trying to continually block merges and break up companies that acquire market share would make for a more frustrating task than King Canute ordering the tide to stop.
However, it might still be possible to restore economic balance between sectors, by using a LaFollette-like trigger whereby any industry with more than a certain percentage of GDP would targeted for shrinking or socialization. And here there are a number of tools that could be used:
- Differential Corporate and Capital Gains Taxes – the easiest way to divert capital away from an industry is to make it a more expensive to invest in that sector and to reduce the profitability of said investments. Hence, if a decision is made that the financial industry is simply too big, one way to move capital out of the financial industry is simply to tax shares in financial services companies at (gradually increasing) higher rates than other investments, which will push investors towards other investment vehicles. Alternatively, you can achieve the same kind of incentive by differentially taxing the corporate income (or even the excess profits) of financial services corporations, thereby reducing the profitability of said industries, which in turn would push those industries to lower their risk profile (lower reward, lower risk), and also steer investors towards other investment vehicles.
- Automatic Regulations – if that seems too confiscatory for your tastes, there is also the option of simply making the industry “staid, even boring” as was done to the financial sector during the New Deal. Glass-Steagall did many things, but one of its effects was to reduce the size of the financial sector to about 4% GDP, which was able to meet the needs of the U.S economy quite smoothly for the next forty or fifty years. Simply by separating investment banks from commercial (lending and depositing) banks, prohibiting the payment of interest on checking accounts and capping the interest rate on savings accounts, banning banks from owning stocks, and establishing FDIC, the industry was made more stable, but also less profitable – and yet the industry did not collapse. Similarly, a new set of regulations that for example, required the establishment of cash reserves for hedge funds and other financial services companies would make those entities function in a less risky and less profitable fashion; similarly, a requirement on the percentage of revenues spent on health care would make the health insurance industry less profitable and more stable – the same principle could be extended to utilities, and so on.
- Public Yardsticks – finally, one way to potentially shrink the size of an industry is to establish a public competitor. If you look at the history of public utilities, they do have the effect of reducing the prices of the goods they sell, which tends to reduce the profitability and thus the size of their private competitors (it’s one of the reasons why insurers hate the public interest, for example). If you take the health care sector, for example – single-payer hasn’t eliminated for-profit insurers in the U.K or France or other countries. Rather, private insurance becomes a niche industry, providing supplemental services to wealthier clients (a similar thing exists with Medicare in the U.S). Similarly, Social Security didn’t destroy the private pension or old-age/life insurance industries – it simply shrunk them into supplemental products.
It is a truth widely admitted but rarely discussed that the current sectoral makeup of the U.S economy isn’t healthy – too much of U.S GDP goes towards health care, even in comparison to other advanced countries. But just as that fact means that we will need some form of regulation and a public competitor for health care, it’s also true for the so-called FIRE sector. Ultimately, finance, insurance, and real estate will need both regulation and a public competitor.