Capitalism and European Soccer League

The problems created by the concentration of economic power, a trend that's now universal across business segments and geographies, has been a recurrent theme of this blog. Corporate interests invariably seek to change rules of the game and raise entry barriers, thereby lowering competition and blunting capitalism's productive forces. 

A recent reassuring example that not all is lost in the fight against such anti-competitive form of capitalism came from European football league. 

On April 18th a dozen of Europe’s top football clubs announced plans to disrupt the game with a breakaway “Super League”... The plan was for 20 clubs to compete in a Europe-wide league, kicking off in August. Fifteen “founding” clubs would be guaranteed a spot every year, with the remaining five places awarded competitively... Investors cheered. But fans revolted, broadcasters turned up their noses and governments vowed to block the plan. Within 48 hours half of its founding members dropped out. It was soon declared dead... The 12 clubs that broke cover comprised England’s “Big Six” (Arsenal, Chelsea, Liverpool, Manchester City, Manchester United and Tottenham), plus three from Spain (Barcelona, Atlético Madrid and Real Madrid) and three from Italy (ac Milan, Inter Milan and Juventus... JPMorgan Chase was to stump up €3.3bn ($4bn) of financing to get the league off the ground.

This interesting snippet explains the motivations,  

The venture’s stated aim was to give the world’s best clubs more chances to play each other than Europe’s main existing club competition, the Champions League. Barcelona and Bayern Munich have faced each other fewer than a dozen times in their history. Big clashes would bring in more viewers and more money: the Super League’s organisers had hoped that broadcasting rights might generate €4bn a year, nearly double the €2.4bn brought in by the Champions League in the 2018-19 season... 

Automatic qualification looked even more appealing. Unlike American teams, European sides play in open leagues, where poor performers get demoted to a lower tier, with stingier broadcasting and sponsorship deals. Club owners thus gamble on making it to the top, investing generously at the expense of profits. In closed contests like America’s National Football League (no relation to what Americans insist on calling soccer), clubs face no risk of relegation and so co-operate more. “Draft” systems allocate talent more equally and wages are often capped—something that the Super League hinted it might do, via an agreed “spending framework”. Clubs in closed leagues must worry only about economic competition from rival leagues, which require more upfront investment to start than an individual club. The combination of less risk and less competition for talent produces higher profits for owners. Forty-three of the world’s 50 most valuable sports teams are American, according to a ranking last year by Forbes magazine. By contrast, European sport is a dicey business: between 1992 and 2014 there were 45 insolvencies in the top three tiers of English football, 40 in France and 30 in Germany. “Football is essentially insolvent,” notes Stefan Szymanski, a sports economist at the University of Michigan. Without their deep-pocketed owners, most clubs would not be going concerns.

The backlash among fans was so much that JP Morgan apologised for backing the breakaway league. The FT has this long read about the episode.  

Some observations

1. The theory of Econ 101 inform us that competitive markets create fair and efficient outcomes. It is argued that business competition spurs dynamism and innovation, which in turn enhances quality and lowers prices. It's also argued that this competition keeps everyone honest and thereby prevent market abuse. 

However, in the real world, markets across sectors, when allowed to operate untrammelled, increasingly end up concentrating market share among a few companies. The dynamics of market evolution - aided by trends in technology, consumer tastes, marketing, and regulatory capture - leads to the emergence of dominant firms. The death-blow to competition comes from the emergence of entry barriers, often implicit or innate to the service or product. This results from the dynamics of the prevailing elite-captured political economy. 

Karl Marx was profound in claiming that there is an inexorable trend with the internal dynamics of capitalism which leads to exploitation and market abuse. The "competitive" world of European soccer league has resulted in this deeply anti-competitive denouement, one which US reached several decades back.

2. On a related note, despite its enduring image as the land of competitive capitalism, there is a case that American capitalism was always characterised by corporate power. It's success may have been because despite the dominant trend, there were always spaces available within the system which allowed for innovation and disruption. Anyways, in the world of multiple equilibriums, the US economy, for whatever reasons, had settled on to its own unique equilibrium which fortunately turned out to be productive and innovative. 

The US soccer league is a great example of such closed-club capitalism. The cabal which run NFL have effectively captured the market with its captive consumers, and nobody even realises it. The entry barriers are insurmountable. 

3. As the example of JP Morgan's support shows, Big Finance is never far away when Big Corporates make their moves. Thanks to financialisation, Big Finance and Big Corporates are all part of one Big Capital universe. With the scale of economic inequality, Big Capital has managed to seize control of the decision-making processes in the political system.  

4. The example of the European soccer league highlights the power of organised consumers, in this case fans. When consumers can overcome collective action problems and come to collectively exercise their preferences, that's a powerful check against Big Capital. It helps that European clubs are strongly tethered to their cities and communities of origin. 

Unfortunately, unlike club football and fans, collective action failures are the norm elsewhere. Machiavelli famously alluded to the "uncertain support of the powerless many (customers and community) compared to the strong enemity of the powerful few (the oligopolists)". New entrants face the same forces in modern capitalism.

Update 1 (30.04.2021)

FT reports that PE fund Silver Lake has taken a 12.5% stake (at USD 281 m) in the commercial rights of the entity that runs the New Zealand's All Blacks rugby team, despite opposition from players' association. 

The deal, if approved by the association, would initiate a battle for influence in one of the world’s most popular sports between Silver Lake and rival CVC Capital Partners at a time when the Covid-19 pandemic has smashed the rugby revenue stream. Luxembourg-based CVC already owns minority stakes in the English Premiership, Pro14 club competitions and the Six Nations. It has also held talks with South Africa, the reigning world champions, about buying a 15-20 per cent stake in the sport’s commercial arm in the country... New Zealand Rugby made a loss of NZ$34.6m in 2020 on a NZ$55m revenue fall caused by the coronavirus pandemic, which has disrupted fixtures.

Inequality debates and Piketty 2.0

Reviews of Thomas Piketty's latest book, Capital and Ideology.

Idrees Khaloon in the New Yorker writes,

In his retelling, the so-called Trente Glorieuses, the thirty years of relative equality between 1950 and 1980, were the result not of two world wars—which played “only a minor part in this collapse,” he has determined—but, rather, of political decisions made “to reduce the social influence of private property.” And the policies we adopt certainly do influence inequality. Steeply progressive income taxes and estate taxes shaped income distributions during those Trente Glorieuses... He argues that the “Brahmin left”—the most educated citizens and the greatest beneficiaries of the knowledge economy and the supposed meritocracy—has captured the left-wing parties in Western democracies, distracting those parties from their mission of improving the lives of working people. Conservative parties, meanwhile, are under the sway of the “merchant right.” Such polarization makes debate over redistribution impossible, and so the lower classes debate immigration and borders instead.

The review itself is representative of the views of the "brahmin left". Two points in particular. One, the big problem is not inequality per se, but the excessive levels of inequality and the extreme concentration of wealth in the hands of a few plutocrats. Two, the bigger problem with the prevailing levels of inequality is that of elite capture of rule making. The latter makes such levels of inequality bad in itself.

Raghuram Rajan in the FT writes,

Inequality is a real problem today, but it is the inequality of opportunity, of access to capabilities, of place, not just of incomes and wealth. Higher spending and thus taxes may be necessary, not to punish the rich but to help the left-behind find new opportunity.

I think this is somewhat digressive and platitudinous. The inequalities of opportunity etc are only second order manifestations of economic inequality. The real problem is with inequality of income and wealth. And here too, inequality by itself is not the problem, but excessive inequality is the problem.

Excessive inequality with income and wealth, as is the case now, inevitably leads to rigging the rules of the political system and its processes which affect the entire society in favour of a handful and against the overwhelming majority. If a few people become so rich compared to the rest, political capture is inevitable. This is just a fact of life.

Political choices then get made by and for the elites, often to the exclusion and detriment of the vast majority. It becomes a threat to the democratic system itself. So preventing such excessive accumulation of wealth, even if it means punishing the rich by way of taxation, cannot be avoided.

As to "scholarship without solutions", I am inclined to believe that widening inequality and its consequences, as the reviews indicate, are widely under-appreciated. So in some ways, the gravity of the problem itself is inadequately recognised. In the circumstances, articulation of the problem with evidence and historical comparisons is itself worthwhile. As Rajan himself writes,

So Piketty’s focus on documenting the true state of economic inequality, following which informed voters will push for change.

Unfortunately, this alone is very unlikely to do much in realising change, though it is essential to create the conditions.

Rajan is right with the challenges associated with redistribution. And also with the perils of excessive activism by governments. But irrespective of what is driving the widening of inequality, its corrosive effects and the need for corrective action cannot be denied. As to what those corrective actions should be, one can rightfully disagree with Piketty' suggestions.

As to solutions, the idea of "steeply progressive taxes on income, wealth..., and bequests" may sound fanciful today. But history tells us that once far-fetched thoughts can quickly get adopted as the norm, though one can never tell with certainty about the tipping point.

Ananth has a post on Rajan's review. 

Paul Krugman in Times perhaps gets it right by making the distinction between the presentation and substance of the material. He is disappointed at the breadth and scope of the narrative and feels that it detracts from the central point about what is driving recent inequality that Piketty is making. He calls it an "endless series of digressions rather than the cumulative construction of an argument" and feels that the arguments are scattered throughout the book and "gets lost in the dubiously related material". His summary,

To be fair, the book does advance at least the outline of a grand theory of inequality, which might be described as Marx on his head. In Marxian dogma, a society’s class structure is determined by underlying, impersonal forces, technology and the modes of production that technology dictates. Piketty, however, sees inequality as a social phenomenon, driven by human institutions. Institutional change, in turn, reflects the ideology that dominates society: “Inequality is neither economic nor technological; it is ideological and political.”... 

For Piketty, rising inequality is at root a political phenomenon. The social-democratic framework that made Western societies relatively equal for a couple of generations after World War II, he argues, was dismantled, not out of necessity, but because of the rise of a “neo-proprietarian” ideology. Indeed, this is a view shared by many, though not all, economists. These days, attributing inequality mainly to the ineluctable forces of technology and globalization is out of fashion, and there is much more emphasis on factors like the decline of unions, which has a lot to do with political decisions.

But why did policy take a hard-right turn? Piketty places much of the blame on center-left parties, which, as he notes, increasingly represent highly educated voters. These more and more elitist parties, he argues, lost interest in policies that helped the disadvantaged, and hence forfeited their support. And his clear implication is that social democracy can be revived by refocusing on populist economic policies, and winning back the working class. Piketty could be right about this, but as far as I can tell, most political scientists would disagree. In the United States, at least, they stress the importance of race and social issues in driving the white working class away from Democrats, and doubt that a renewed focus on equality would bring those voters back. After all, during the Obama years the Affordable Care Act extended health insurance to many disadvantaged voters, while tax rates on top incomes went up substantially. Yet the white working class went heavily for Trump, and stayed Republican in 2018.

Could it not be that the shifts in choices of centre-left parties and liberals (perhaps their co-option as ideologues) has had the effect of exacerbating the racial and social cleavages which for years had been alleviated through progressive policies?

Weekend reading links

1. As global supply chains show stirrings of calibrating in response to the US tariffs on China, it is a reasonable proposition that India stand to gain. But not by much if we examine China's competitors in some of the largest affected sectors.

2. Another FT report points to how China has swiftly moved up the value chain to dominate the medium-level technology areas.

The country today has a 32% share of the global medium high-tech industries. Its share of the global capital goods market has risen from 5% to 20% in the 2007-16 period.

3. Another article draws attention to the pensions crisis staring at developed economies in this age of low interest rates. The graphic below show the grossly inadequate savings of working age population and those close to retirement.

4. Nice article on the growing trend of "pass-the-parcel" deal making (or secondary deals) in private equity space, where one PE firm sells stake to another. Last year the industry did a record 576 such deals. The trend has been associated with successive owners paying themselves large dividends, leveraging up, skimping on investments and maintenance, piling up unpaid pension obligations, and passing on to the next firm when they have squeezed out all the juice they can. In industry lingo, the existing owners "sweat" the asset as much as they can before passing it on. And the game goes on.

This story of Simmons Bedding in the US is emblematic,

In the US, mattress maker Simmons Bedding, which was bought and sold by private equity owners seven times in 20 years, filed for Chapter 11 bankruptcy protection in 2009 and more than 25 per cent of the workforce was laid off. Still, its former owners, which included Thomas H Lee Partners, made a profit of $750m through special dividends, according to a New York Times investigation.

Given the vast volumes of dry powder accumulated by PE firms in recent times, $1.7 trillion and growing, industry watchers expect secondary transactions to rise in the immediate future.

5. Renewable energy facts for the week,

Last year, China added 50 gigawatts of solar power capacity, according to the International Energy Agency — more than it added for coal, gas and nuclear power capacity put together, and equivalent to the combined solar capacity of France and Germany. India, the world’s fastest-growing major economy, added around 9.5GW of solar. The country is on course to hit 28GW by the end of 2018 — six times what it had installed three years ago. Wind is growing less quickly, but from a higher base. Last year, China added 15.6GW of wind capacity — an increase of 10 per cent.

By the end of 2017, the price of solar panels have fallen by more than 80% since 2009, and wind turbines by half. However, recent decision by China to cut incentives for solar power have had the effect of weakening domestic demand for panels forcing manufacturers to dump panels at lower prices abroad, in turn eliciting anti-dumping duties in US, EU, and India.

6. Funny how signatures of Marxian analysis making a comeback is everywhere. The latest is Leonid Bershidsky declaring the gig-economy workers as the modern proletariat. He examines a recent ILO report which surveyed 3500 workers in 75 countries employed on web-based gig-economy jobs found in digital labour platforms,

the average worker on five such platforms earned $4.43 per hour—or just $3.31 an hour if one takes into account all the unpaid time, about 20 minutes per hour, spent looking for orders, researching clients, taking qualification tests and writing reviews. Even that is relatively generous: Another study published last year estimated that “Turkers,” as workers on the Amazon platform are known, made a median hourly wage of $2. Almost two-thirds of US “Turkers,” according to the ILO study, made less than the federal minimum wage of $7.25 an hour, and only 7% of Germans on the Clickworker platform made the statutory minimum wage of 8.84 euros ($10.40) an hour. This would perhaps be marginally tolerable if “crowdworkers” only logged on to supplement income from other jobs. But 32% of those surveyed by the ILO earned their primary income from the platforms. These mostly educated people spend many hours filling out questionnaires for academic researchers, transcribing audio, even moderating content for social networks, which means watching violent videos or reading hate-filled posts all day. This is not the nicest work, and some of it can even have a lasting psychological impact, yet the “crowdworkers” live in a world without the basic worker protections guaranteed even to holders of most menial real-world jobs. Not only do they earn less than the minimum wage, they are not protected against non-payment. No one owes them an explanation when their work is rejected or when they fail a test or receive an unfavourable rating.

7. As IL&FS totters at the precipice and strains show up at others like Dewan Housing Finance, it should serve as a wake up call for financial market regulation. It has rattled the financial markets, and spooked the fixed income securities market and shadow financial sector. The 11,400 odd Non Banking Financial Companies (NBFCs) market with a combined loan book of INR 22.1 trillion ($304 bn) is expected to undergo a major churn with several smaller companies winding down. Several debt and hybrid mutual funds have significant exposure to IL&FS's debt securities and a liquidity crisis threatens the market if funds redemption pressures mount. 

There should be greater scrutiny of at least two market participants. One, rating agencies, a culprit in every major financial market crisis in recent times across the world, did not fail to show up this time too. Sample this

On credit quality, IL&FS group’s debt securities looked good till a month and a half ago. The rating rationale for IL&FS Financial Services Ltd was reaffirmed A1+ (top most rating—highest probability of repayment). However, as on 17 September, IL&FS Financial Services was downgraded to D... One must question why the A1+ rating was reaffirmed in August 2018.

The failings of credit rating agencies cannot condone the mindless acceptance of such ratings by fund managers despite the several signatures of concern associated with IL&FS and its business model. 

The second one is state-owned Life Insurance Corporation (LIC). It owns a quarter of the failing entity and runs the risk of of being forced to pour money in order to prevent a contagion and systemic collapse. The worrying thing is that LIC, in view of its role as the state-directed buyer of last resort of capital market instruments, may actually be sitting on more such potential duds. 

There should also be a deeper scrutiny of the transactions undertaken by IL&FS over the years and their adherence to corporate governance standards. Andy Mukherjee has an excellent starting point here. Ravi Parthasarathy's $3.65 m (INR 25 Cr) take home salary last year is only the latest example of sordid ethics in corporate India.

8. The US enjoys its "exorbitant privilege" in being able to run up deficits in perpetuity and fund it at lower cost than others. While that situation is likely to continue well into the future, some recent trends should a matter of some concern.

Dollar's share of global foreign exchange reserves slid from 66% to 62% since 2014, and that too at a time when the dollar has strengthened by 4.52%.

9. Finally, Bhanuj Kappal has an excellent story in Mint about the problems facing the 30,000 resettled illegal slum residents of Mumbai's Mahul Prakalpgrast Samiti (MMRDA Colony). The colony situated in the outskirts amidst polluting chemical and other industrial factories has become a toxic "human dumping ground".

This is so representative of similar slum rehabilitation programs across Indian cities. Relocate residents far away from their livelihoods (after all large vacant tracts are likely to be available only in the suburbs), poor quality of housing construction by government agencies, colonies with any basic community facilities (schools, hospitals etc) and limited transport connectivity. 

Revisiting Marx and Smith

Frank Partnoy and Rupert Younger revisit The Communist Manifesto and draft The Activist Manifesto in the context of today's problems, and finds that they ended up retaining almost three-quarters of the former's prose!  They write,

In our redrafting, we have had to go far beyond merely substituting “communism” with “activism”. The “Pope and Tsar, Metternich and Guizot, French Radicals and German police-spies” and others in Marx’s and Engels’ sights have gone. We have introduced their modern counterparts: “the corporate Haves, the elites, the billionaires, the establishment politicians of the Republican and Democratic parties, Conservatives and Labour, the talking heads at Davos, the echo chambers of online media and fake news.” But we have kept much of the rhetoric along with Marx’s and Engels’ relentless focus on economic inequality. Two centuries after Marx’s birth, and however much communism has rightly been discredited, a great deal of the argument is as relevant now as it was then... We substituted “Have-Not” in place of “proletariat”... we substituted “Have” in place of “bourgeois”... the document was, fundamentally, an attack on inequality... The Haves have never in history held so much advantage over the Have-Nots.

And Paul Sagar's revisit of Adam Smith,

According to Smith, the most pressing dangers came not from the state acting alone, but the state when captured by merchant elites... Indeed, Smith’s single most famous idea – that of ‘the invisible hand’ as a metaphor for uncoordinated market allocation – was invoked in precisely the context of his blistering attack on the merchant elites... in the passage of The Wealth of Nations where he invoked the idea of the invisible hand, the immediate context was not simply that of state intervention in general, but of state intervention undertaken at the behest of merchant elites who were furthering their own interests at the expense of the public.

It is an irony of history that Smith’s most famous idea is now usually invoked as a defence of unregulated markets in the face of state interference, so as to protect the interests of private capitalists. For this is roughly the opposite of Smith’s original intention, which was to advocate for restrictions on what groups of merchants could do. When he argued that markets worked remarkably efficiently – because, although each individual ‘intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention’ – this was an appeal to free individuals from the constraints imposed upon them by the monopolies that the merchants had established, and were using state power to uphold. The invisible hand was originally invoked not to draw attention to the problem of state intervention, but of state capture... Smith’s analysis implies that a free society with a healthy economy is going to need to put fetters on economic elites if the invisible hand is to have any chance of doing its paradoxical work. 

Contrary to the conventional wisdom, at least in the context of the issue of widening inequality and political capture, the similarity in the contextualised messages of both is remarkable.

Update 1 (26.08.2018)

Jesse Norman has an excellent interpretation of Smith for modern times in the FT. His nuanced suggestions are spot on,

Markets for Smith are very different to those of economists today. They are not the disembodied mathematical constructs of modern economics and policymaking, and his view of individuals is not that of a desiccated economic atomism. Rather — recalling his insights about language and ethics — markets are living institutions embedded in specific cultures and mediated by social norms and trust. They shape and are shaped by their participants, in a dynamic and evolving way. They often have common features, but they are as different from one another as individual humans are: markets for land and labour and capital, asset markets from product markets and all the innumerable rest of them... what matters is not the largely empty rhetoric of “free markets”, but the reality of effective competition. And effective competition requires mechanisms that force companies to internalise their own costs and not push them on to others, that bear down on crony capitalism, rent extraction, “insider” vs “outsider” asymmetries of information and power, and political lobbying... markets constitute a socially constructed and evolving order that exists and must exist not by divine right but because it serves the public good. It follows from this that the modern doctrine of market failure, which derives from academic models assuming perfect competition, needs to be expanded and supplemented. The truth is that outside academic models there are few if any genuinely free markets, and the imagined benefits of perfect markets disappear once any imperfections are allowed. Instead, policymakers need to start by asking two much simpler questions: What is this specific market for? How is it actually working?... both individual markets and the market order itself rely on the state. While political intervention can destroy market functioning, it can also enable it. But markets are not inviolable, and they derive their reason for being not from any supposed sanctity of capitalism itself, but from their place within modern commercial society. Ultimately, especially within democracies, it falls to the state to underwrite that legitimacy. And if the preservation of the freedoms, trust and order that make up modern commercial society requires the periodic reform of capitalism, then reform it we must.

The social "trade-offs" are no longer trade-offs?

Greg Mankiw has a nice description of the three trade-offs faced by society and how differing views about them are shaped by our ideological predilections. He writes,

Arthur M. Okun... wrote that the big trade-off faced by society is between equality and efficiency. We can redistribute income to give everyone a more equal slice of the economic pie, but as we do so we blunt work incentives and the economic pie shrinks... From this perspective, the Democrats are the party of more equality, and the Republicans are the party of more efficiency.  

Another view is that the important trade-off is between community and liberty. As members of society, we have goals we want to achieve with others. But as we reach those shared goals, we are asked to sacrifice some personal freedoms. From this perspective, the Democrats are the party that emphasizes communal values, and the Republicans are the party that emphasizes individual liberty.

Finally, there is the issue of how much one trusts centralized governmental power. Democrats tend to want to expand the scope of the federal government to improve the lives of the citizenry, while Republicans are more fearful that centralized power leads to abuse and lack of accountability.

There is nothing wrong with these trade-offs by themselves. What makes it disconcerting is how the interests of the economic and political establishment, cutting across party divisions, converges towards one side of the trade-off, thereby perpetuating the status quo.

Consider this. The economically and politically entrenched, and their supporting intelligentsia, have an obvious interest in favoring efficiency over equality. The debate about any form of increase in taxation is a reflection of this trend. The other two trade-offs relate to a cognitive bias that has become socially internalized about the role of the government.

The traditional free market view has been that government's role should be confined to the issue of currency, national defense, protection of property rights, enforcement of contracts, maintenance of law and order, and provision of certain basic public goods. In the post-war consensus, a welfare state consisting of a basic social safety net has become added to government's responsibilities. The dispute about the role of government has mostly revolved around the extent/boundaries of the provision of public goods and social safety nets.

As the economic and political system has become more self-perpetuating (for example, social mobility has declined), the practical and psychological imperatives for its beneficiaries to support public provision of public goods and social safety net has eroded. They are both able and could afford to access most public goods from private providers or pay for their use. Assured of their entrenched socio-political and economic positions, the normative underpinnings of social safety nets is of limited concern for them. A two-tier system - where one group is privileged to access the best schools and health care, benefit from establishment networks, and enjoy even better quality of public goods - which works against equality of opportunity appears to have emerged.

Therefore, the decision makers in all three trade-offs, are more likely (and this likelihood may be increasing) to be pre-disposed in one direction. These are no longer real-world trade-offs, and are confined to ideological debates. Unfortunately, this trend is not confined to the US alone. Marx, it appears, was atleast partially right.

State of the dismal science

Economist explores the state of economics today in the aftermath of the sub-prime crisis in two articles that question the state of macroeconomics and financial economics - "macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it". It writes,

"Macroeconomists, especially within central banks, were too fixated on taming inflation and too cavalier about asset bubbles. Financial economists, meanwhile, formalised theories of the efficiency of markets, fuelling the notion that markets would regulate themselves and financial innovation was always beneficial. Wall Street’s most esoteric instruments were built on these ideas."

It finds that most standard macroeconomic models and theories paid inadequate or even no attention to the workings of the financial markets, which were seen as a black box whose utility lay only in channelling savings into loans for invesmtents. As the article writes,

"Modern macroeconomists worried about the prices of goods and services, but neglected the prices of assets. This was partly because they had too much faith in financial markets. If asset prices reflect economic fundamentals, why not just model the fundamentals, ignoring the shadow they cast on Wall Street?... In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don’t exist. And whether firms finance themselves with equity or debt is a matter of indifference. The Bank of England’s DSGE model, for example, does not even try to incorporate financial middlemen, such as banks... The mainstream macroeconomics embodied in DSGE models was a poor guide to the origins of the financial crisis, and left its followers unprepared for the symptoms."

About the failure financial economists , it writes,

"Few financial economists thought much about illiquidity or counterparty risk, for instance, because their standard models ignore it; and few worried about the effect on the overall economy of the markets for all asset classes seizing up simultaneously, since few believed that was possible."

Another blindspot in formal macroeconomic training arose from the excessive fixation, to the exclusion of all else, with preservation of price stability (inflation targeting) and, to a lesser extent, economic growth. There was nothing to guide Central Banks about when to shift objectives from preserving price stability to safeguarding financial stability. In other words, there was nothing to help central bankers make the decision of when to take the punch bowl away.

Chris Dillow provides an excellent Marxist (or "neo-Marxist"!) perspective by analyzing the failure of financial institutions to manage risk properly from the principal-agent framework. He claims that agency problems within banks militated against understanding risks like tail risk, correlation risk, liquidity risk and counterparty risk. He draws attention to Marx's allusion to "the hidden abode of production", where he examined the issue of how income was distributed between profits and wages, and which was ignored by all orthodox macroeconomic theories.

Detroit Big Three and UAW come together!

Karl Marx will be turning in his grave if he were witnessing the drama surrounding the crisis that has engulfed the Big Three Detroit automaker - GM, Ford, and Chrysler. The exploiters and exploited, owners of capital and the labor have joined hands in an effort to save themselves. Faced with a battle for their very survival, United Auto Workers (UAW), the premier automobile workers union in the US, and the managements of the three firms are unitedly lobbying the Federal Government against any Chapter 11 bankruptcy and in favor of an additional $25 bn federal loan bailout of the auto industry.

A Chapter 11 bankruptcy will lead to removal of the existing management, cut executive payouts and dividends, abrogate workers’ contracts, and probably lead to sharply reduced wages and benefits for any jobs that remain. Saddled with high wage costs ($27 per hour) and burdensome health care benefits and pension liabilities, the Detroit automakers have been ceding ground to the Japanese automakers in recent years. If they obtained bankruptcy financing, the companies could then continue operating and slim down to a more manageable size, with cuts occurring over a period of months or years. But some of their operations could be taken over by other automakers or they could even be forced to liquidate.

The big Three companies employ about 240,000 workers, and their suppliers an additional 2.3 million, amounting to nearly 2% of the nation’s work force. Even in this year of plunging car sales (it fell 14.6% from 2007), the three automakers and their vast supplier network still accounted for 2.3% of the nation’s economic output, down from 3.1% in 2006 and as much as 5% in the 1990s.

The final decision on the fate of the automakers will be a test case of the American government's resolve to play by the game of free trade it regularly preaches to others. This assumes importance since many industry experts say the big foreign auto makers are established enough to take control of the industry and its vast supplier network more quickly than is widely understood, thereby minimizing the disruptions that are likely to be created if the Detroit Three go under. Like the Big Three, these foreign firms would together dominate manufacturing in the United States, becoming big customers for steel, aluminum, plastics, glass, machine tools, computer chips and rubber.

Update 1
David Leonhardt examines the wage costs of the Big Three.

Marx and the financial crisis

Chris Dillow feels that the ongoing crisis, with its origins in the financial markets, makes Marxian explanations of the crises facing capitalism, which are based on the real economy, less relevant. To Marx, crises in capitalism originated in the real economy. Recessions occur when an over-accumulation of real capital equipment combine with a lack of demand to cause a falling rate of profit and then capital-scrapping, job cuts and slump. This could atleast partialy explain the previous major recessions.

Interestingly, as Dillow argues, Marx showed that capitalism was micro efficient but macro inefficient - individual capitalists, each pursuing profit maximization, could produce an outcome that was bad for capitalists in general (falling profits and crisis). He seems to have taken for granted that individual capitalist enterprises were rationally organized - an assumption clearly belied by the recent happenings in the financial markets.

However, on a broader canvas, as the cataclysmic recent events highlight, Marx was right to show that capitalism was a force for great growth and great instability; right to show that profits arose from exploitation; right to stress that technical progress determines social conditions; right on alienation and primitive accumulation.

But where Marx, and his classical predecessors and even neo-classical successors, failed was in drawing conslusions from these underlying developments. Much before Marx, Malthus had already postulated that the supply of labour would rise to offset increasing demand, keeping real wages down (theory of the "increasing misery" of the working class), and Ricardo (and Smith) had prophesied that the law of diminishing returns would cause the rate of profits to fall thereby leading to a "stationary state" in which economic growth ceased. But they all, including the neo-classical exogenous growth theories, failed to appreciate the importance of technological progress. Explaining how capitalism continues to survive, Dillow writes, "Economic growth is a race between technical progress and diminishing returns. And technical progress has won."