Naked Economics (27 page)

The United Nations has created the Human Development Index (HDI) as a broader indicator of national economic health. The HDI uses GDP as one of its components but also adds measures of life expectancy, literacy, and educational attainment. The United States ranked thirteenth in the 2009 report; Norway was number one, followed by Australia and Iceland. HDI is a good tool for assessing progress in developing countries; it tells us less about overall well-being in rich countries where life expectancy, literacy, and educational attainment are already relatively high.

The most effective knock against GDP may simply be that it is an imperfect measure of how well off we really consider ourselves to be. Economics has an overly tautological view of happiness: The things we do must make us happy; otherwise we would not do them. Similarly, growing richer must make us better off because we can do and have more of the things that we enjoy. Yet survey results tell us something different. Richer may not be happier. Remember that robust growth of the 1990s? It didn’t seem to do much good for our psyches. In fact, the period of rising real incomes from 1970 to 1999 coincided with a decrease in those who described themselves as “very happy” from 36 percent to 29 percent.
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Economists are belatedly beginning to probe this phenomenon, albeit in their own perversely quantitative way. For example, David Blanchflower and Andrew Oswald, economists at Dartmouth College and the University of Warwick, respectively, found that a lasting marriage is worth $100,000 a year, since married people report being as happy, on average, as divorced (and not remarried) individuals who have incomes that are $100,000 higher. So, before you go to bed tonight, be sure to tell your spouse that you would not give him or her up for anything less than $100,000 a year.

Some economists are studying happiness directly, by asking participants to keep daily journals in which they record what they are doing at various times and how it makes them feel. Not surprisingly, “intimate relations” is at the top of the list in terms of positive experiences; the morning commute is at the bottom, lower than cooking, housework, the evening commute, and everything else.
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The findings are not trivial, as they can illuminate ways in which individuals think they are making themselves happy but aren’t really. (Yes, you should see the influence of the behavioral economists here.) For example, that long commute may not be worth what it buys (usually a bigger house and a higher salary). Not only is the commute unpleasant, but it often carries a high opportunity cost: less time spent socializing, exercising, or relaxing—all of which rate as highly pleasurable activities. Meanwhile, we quickly become inured to the benefits of the goods that we previously coveted (kind of like getting used to a hot bath), whereas the happiness generated by experiences (family vacations and their lingering memories) is more durable.
The Economist
summarizes the prescriptions of the research so far: “In general, the economic arbiters of taste recommend ‘experiences’ over commodities, pastimes over knick-knacks, doing over having.”
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If GDP is a flawed measure of economic progress, why can’t we come up with something better?

We can, argues Marc Miringhoff, a professor of social sciences at Fordham University, who believes that the nation should have a “social report card.”
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He proposed a social health index that would combine sixteen social indicators, such as child poverty, infant mortality, crime, access to health care, and affordable housing. Conservative author and commentator William Bennett agrees with half of that analysis. We do need a measure of progress that is broader than GDP, he argues. But ditch all that liberal claptrap. Mr. Bennett’s “index of leading cultural indicators” includes the kinds of things that he considers important: out-of-wedlock births, divorce rates, drug use, participation in church groups, and the level of trust in government.

French President Nicolas Sarkozy instructed the French national statistics agency in 2009 to develop an indicator of the nation’s economic health that incorporates broader measures of quality of life than GDP alone. Two prominent economists and former Nobel Prize winners, Joseph Stiglitz and Amartya Sen, chaired a panel convened by Sarkozy to examine a seeming paradox: Rising GDP seems to come with a perception that life is getting more stressful and difficult, not less. Sarkozy wants a measure that incorporates the joys of art and leisure and the sorrows of environmental destruction and stress.
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Measuring these elements of the human condition is a noble gesture—but a single number? The
Wall Street Journal
commented, “Chapeaus off to Messrs. Stiglitz and Sen if they can put a number on such spiritual matters—but don’t hold your breath.”

So you begin to see the problem. Any measure of economic progress depends on how you define progress. GDP just adds up the numbers. There is something to be said for that. All else equal, it is better for a nation to produce more goods and services than fewer. When GDP turns negative, the damage is real: jobs lost, businesses closed, productive capacity turned idle. But why should we ever have to deal with that anyway? Why should a modern economy switch from forward to reverse? If we can produce and consume $14 trillion worth of stuff, and put most Americans to work doing it, why should we toss a bunch of people out of work and produce 5 percent less the following year?

The best answer is that recessions are like wars: If we could prevent them, we would. Each one is just different enough from the last to make it hard to ward off. (Though presumably policymakers have prevented both wars and recessions on numerous occasions; it’s only when they fail that we notice.) In general, recessions stem from some shock to the economy. That is, something bad happens. It may be the collapse of a stock market or property bubble (the United States in 1929 and 2007, Japan in 1989); a steep rise in the price of oil (the United States in 1973); or even a deliberate attempt by the Federal Reserve to slow down an overheated economy (the United States in 1980 and 1990). In developing countries, the shock may come from a sudden fall in the price of a commodity on which the economy is heavily dependent. Obviously there may be a combination of causes. The American slowdown that began in 2001 had its roots in the “tech wreck”—the overinvestment in technology that ultimately ended with the bursting of the Internet bubble. That trouble was compounded by the terrorist attacks of September 11 and their aftermath.

No matter the cause, the most fascinating thing about recessions is how they spread. Let’s start with a simple one, and then work our way to the “Great Recession” of 2007. You probably didn’t notice, but around 2001 the price of coffee beans plunged from $150 to $50 per hundred pounds.
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Although that drop may have made your Starbucks latte habit modestly more affordable, Central America, a major coffeeproducing region, was reeling. The
New York Times
reported:

Whether you live in Central America or Santa Monica, someone else’s economic distress can become your problem very quickly. The recession of 2007 (which erupted into a financial crisis in 2008) has been the scariest in a long time. The economic “shock” in this case originated with sharp drops in both the stock and housing markets, both of which left American households poorer. Christina Romer, chair of President Obama’s Council of Economic Advisers, estimates that U.S. household wealth fell 17 percent between December 2007 and December 2008—five times the size of the decline in 1929 (when fewer families owned stocks or houses).
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When consumers sustain a shock to their income, they spend less, which spreads the economic damage. This is an intriguing paradox: Our natural (and rational) reaction to precarious economic times is to become more cautious with our spending, which makes our collective situation worse. The loss of confidence caused by a shock to the economy may turn out to be worse than the shock itself. My thrift—a decision to curtail my advertising budget or to buy a car next year instead of this year—may cost you your job, which will in turn hurt my business! Indeed, if we all believe the economy is likely to get worse, then it will get worse. And if we all believe it will get better, then it will get better. Our behavior—to spend or not to spend—is conditioned on our expectations, and those expectations can quickly become self-fulfilling. Franklin Delano Roosevelt’s admonition that we have “nothing to fear but fear itself” was both excellent leadership and good economics. Similarly, Rudy Giuliani’s exhortation that New Yorkers should go out and do their holiday shopping in the weeks after the World Trade Center attack was not as wacky as it sounded. Spending can generate confidence that generates spending that causes a recovery.

Unfortunately the Great Recession that began in 2007 had other aspects to it that spread the economic damage in virulent and scary ways. Many American households were “excessively leveraged,” meaning that they had borrowed far more than they could manage. The housing boom had encouraged ever bigger houses with ever bigger mortgages. Meanwhile, the down payments—the amount of their own money buyers had to spend to get a loan—were getting smaller relative to what was being borrowed. Subprime mortgages (a financial innovation, one must admit) made it easier for people to borrow who were otherwise not creditworthy and for other people to borrow in particularly aggressive ways (e.g., with no down payment at all). This all works fine when housing prices are going up; someone who falls behind on their mortgage payments can always sell the house to repay the loan. When the housing bubble burst, however, the numbers became a disaster. Overleveraged American families found that they could not afford their mortgage payments, nor could they sell their homes. Millions of houses and condos were thrown into foreclosure by whatever bank or financial institution owned the mortgage. When these properties were dumped on the market, it drove prices down further and exacerbated all the real estate–induced problems.

But we haven’t even arrived at the scary part yet. America’s mortgage problem spread to the financial sector through two related channels. First, banks were plagued with lots of bad real estate loans, which made them less able and willing to make new loans. Anyone looking to buy a home had trouble doing so, even with good credit and a large down payment. (You guessed it: This compounded the real estate problems yet again.) Meanwhile, Wall Street investment banks and hedge funds had loaded up on real estate derivatives—fancy products like mortgage-backed securities whose value was somehow tied to the plunging real estate market. Like American homeowners, these institutions had borrowed heavily to make such investments, so they too faced creditors. Much of this debt was “insured” with the credit default swaps described in Chapter 7, wreaking havoc on firms with that exposure.

There was a stretch of time in the fall of 2008 when it looked like Wall Street—and therefore the global financial system—would implode. The most serious moment came when the investment bank Lehman Brothers recognized that it could not meet its short-term debt obligations—meaning that without some infusion of outside capital, the firm would have to declare bankruptcy. The U.S. Treasury and the Federal Reserve were unable, or unwilling, to save Lehman. (Earlier in the year they had saved Bear Stearns, another troubled investment bank, by arranging a takeover by JPMorgan Chase.) When Lehman declared bankruptcy, leaving all of its creditors high and dry, the global financial system essentially seized up. A Treasury official described the cascade of panic to
The New Yorker:
“Lehman Brothers begat the Reserve collapse [a money-market fund], which begat the money-market run, so the money-market funds wouldn’t buy commercial paper [short-term loans to corporations like GE]. The commercial-paper market was on the brink of destruction. At this point, the banking system stops functioning.”
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Sensible people started talking about surviving by raising goats in the backyard. (Okay, that was me.) My college roommate, who has gone on to become the CEO of a major company, admitted later that he had hidden $10,000 in a cowboy boot in his closet. (I was left wondering primarily why he owns cowboy boots.) We were not alone. James Stewart has described the Lehman collapse and all its attendant damage in a brilliant piece for
The New Yorker.
Here is one sample:

You don’t have to like investment bankers to care about all of this (and to appreciate why the federal government needed to stop the panic on Wall Street). Once the financial system seizes up, no one gets credit. At that point, healthy companies become less healthy because they don’t have access to loans that allow them to do things that are necessary for business, such as buying inventory. The damage of the financial crisis spread to every corner of American society. In 2009, pre-order sales for Girl Scout cookies plunged 19 percent from the year before.
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Meanwhile, the number of adult films produced in Southern California fell from five or six thousand films a year to three or four thousand.
The Economist
reported on the macroeconomic effects of less porn: “Some firms have shut down, others are consolidating or scraping by. For the 1,200 active performers in the [San Fernando] Valley this means less action and more hardship…For every performer, there are several people in support, from sound-tech to catering and (yes) wardrobe, says Ms. Duke [a spokesperson for the adult film industry], so the overall effect on the Valley economy is large.”
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