Over the weekend I read two articles that gave me some new insight into how America got into its current economic fix and which policies might not just help us reverse the decline but also set the conditions for more effective markets in the future.
First, Thomas Geoghegan writes persuasively (Subscription Required) in Harper’s Magazine that the central cause of the current economic crisis is a shift of capital from manufacturing and production to financial markets after the repeal of usury laws made hedge funds and lending much more profitable than making stuff:
“That’s when we found out what happens when an advanced industrial economy tries to function with no cap at all on interest rates. Here’s what happens: the financial sector bloats up. With no law capping interest, the evil is not only that banks prey on the poor (they have always done so) but that capital gushes out of manufacturing and into banking. When banks get 25 percent to 30percent on credit cards, and 500 or more percent on payday loans, capital flees from honest pursuits, like auto manufacturing. Sure, GM is awful. Sure, it doesn’t innovate. But the people who could have saved GM and Ford went off to work at AIG, or Merrill Lynch, or even Goldman Sachs. All of this used to be so obvious as not to merit comment. What is history, really, but a turf war between manufacturing, labor, and the banks? In the United States, we shrank manufacturing. We got rid of labor. Now it’s just the banks.”
This is not a socialist argument about how corporations exploit the poor by charging high rates of interest and constructing loan agreements to give consumers more information and power to make informed choices about whether and how they should borrow money. Geoghegan is making a capitalist case that tax policy and regulatory institutions create incentives to which capital and investors will respond by shifting the components of production between sectors in search of the highest profits. He is pointing out that the invisible hand sometimes slaps us.
In the same issue of Harper’s, Daniel Brook offers an example (Subscription Required) with the story of how Allan Jones invented the payday lending industry. When Mr. Jones sought investment opportunities for his excess cash, he chose not to open a small factory, manufacturing plant, restaraunt or service industry firm (e.g., janitorial services). Instead, he decided to lend it to people at usurious interest rates. Jones might have opened his payday lending storefronts even with interest capped under 500 percent–the large numbers of transactions would deliver a profit even at a smaller margin. And a careful reading of the story suggests that the high interest rates reflect exploitation of circumstances, not pricing of risk.
All of this suggests that the market predictably moved capital to its most profitable–if not its most efficient–use. The problem then is not a structural problem with capitalism, but mismanagement of the capitalist system that delivered–whether or not intentionally–an unsustainable outcome. We need to decide whether to accept market-delivered results like this just for the sake of ideology, or to make an effort to regulate the system sensibly so that we achieve mutually agreed upon goals.
Placing limits on interest rates could bring its own unintended consequences, and it is easy to see that this would likely limit access to needed short-term or consumer loans to those who need it least. But Americans may find that moving capital back into making stuff makes the economy stronger and more resilient–and less dependent on too-big-to-fail banks.