Saturday, March 22, 2008

Howard S. Katz's Portfolio Returns 20% in Two Weeks

I have been subscribing to Howard S. Katz's newsletter The One Handed Economist for about 3 years. Howard tracks what a "conservative" portfolio. He bases his analysis on Austrian economics as well as technical analysis. The portfolio tracks from 1999. During this period the major stock indexes have gone up and down but now are not much higher than in 1999. In contrast, by the first week of March 2008 Howard's conservative portfolio was up about 115% over the nine-year period. Howard's latest edition came out a few minutes ago. In the past two weeks his portfolio went up better than 20%. It was about 215 in early March when he called a top in precious metals. He moved into several construction stocks which brought the portfolio up to 260. Wow! This was the kind of thing that until now I had read about but not directly experienced. Yay Howard!

Read this doc on Scribd: katz conservative

Firms' Goals and Pricing

Walter Nicholson. Intermediate Microeconomics and Its Application Third Edition. Dryden Press, 1983.

I have decided to treat myself to review some basic economics this evening. It's been 20 years since I looked at my last economics textbook. What better way to brush up than my 1983 copy of Walter Nicholson's Intermediate Microeconomics and Its Application textbook? In this blog I will briefly review his thoughts on costs.

Costs (chapter 9)

Economists view historical costs as sunk costs. The implicit cost of a machine is what someone else would pay for it, i.e., its "rental rate". To minimize production costs firms choose inputs such that the rate of technical substitution is equal to the ratio of input costs. Thus if wages are w and machinery rental rates are v then:

Rate of Technical Substitution = wage rate/rental rate = w / v

That is, the rate of technical substitution is the rate at which one input may be traded off against another in the production process while holding output constant and that rate is the same rate at which they are traded in the open market.

In other words, the rate of technical substitution of labor for capital is the ratio of the

marginal product (labor)/ marginal product (capital)

so that each input should provide the same additional output per dollar spent and if they don't, firms will trade some of the less productive input for the more productive.

Short versus Long Run

In the short run production capacity is fixed. In the long run production can be curtailed. Fixed costs are fixed in the short run.

Short run average total costs = (total costs) / (total output)


Short run marginal costs = (change in total costs) / (change in output)

In the very short run price purely rations demand. This is because supply cannot be increased. But generally in the longer run there is a supply response to changing demand. In the short run (longer than very short run) the number of firms is fixed but firms can adjust the amount they are producing.

Theoretically, marginal and average costs ought to increase in response to increases in output but most studies fail to show increasing average or marginal costs but rather find that marginal and average costs are constant over large ranges of output.

Long Run

In the long run all productive inputs are variable. Nicholson makes the point that some factors may be difficult to alter even in the long run. The rate of technical substitution must equal the ratio of the input prices.

The long run total cost curve is found by considering all short run total cost curves and choosing the lowest one for each possible output level. "The locus of all these cost minimizing choices is called the long-run total cost curve..."

Under the assumption of constant returns to scale, the long term total cost curve is a straight line and average and marginal costs are constant and equal (equal because of the assumption of constant returns to scale which means that the marginal cost equals the average cost).

If there is a fixed input, average costs fall as variable inputs are added, but then rise again as the fixed input causes diminishing marginal productivity.

At the minimum piont of the Long Run Average Total Cost Curve the Long Run Marginal Cost Curve = Long Run Average Total Cost Curve = Short Run Average Total Cost Curve = Short Run Marginal Cost Curve

In reality, many empirical studies find declining long run average costs for smaller size with a flattening minimum average cost beyond a threshhold.

Changes in input prices will tilt the total cost lines. Changing input prices will change the isoquants on which the total cost curves are based and change the ratios of inputs.

From Progressivism to Conservatism

Having just read a few books on mugwumps, the evolution of political thinking from mugwumpery to progressivism, the legal reconstruction of American capitalism and the philosophy of progressivism, I have admittedly just begun to scratch the surface of the source of the generic failure of American politics to produce responsive and flexible solutions. Today, on the right, the promise of limited government has been betrayed and given the Republican Party's progressive history, which followed through Rockefeller Republicanism to President Bush's mangling of conservatism, the Republicans had traditionally had a big government impulse and so they are unreliable representatives of the small government view. However, the question needs to be traced through Warren G. Harding and Calvin Coolidge. Coolidge was a teenager when the Mugwumps bolted to vote for Grover Cleveland in 1884, so he was not a Mugwump, but he was very much in the Mugwump tradition. On first glance it seems there is more EL Godkin than Herbert Croly in Coolidge, but I need to learn how that played out in Coolidge's thinking--did he outright reject Progressivism and return to the late 19th century view (and if so why did he not repeal at least some of the Progressive legislation). In general there is a question as to why the Mugwump tradition in American politics has been able to reassert itself vocally but not practically. Reagan adopted free market rhetoric but behaved like a Progressive. Did Calvin Coolidge establish the pattern of twentieth century Mugwump timidity? Or is the timidity simply a reflection of the American public's commitment to the Progressive model? Perhaps special interest theories such as Mancur Olson's can explain the clash between Republican rhetoric and action as simply a reflection of economic self interest on politicians' part. They believe in free markets but know that if they betray special interests they will lose elections. The special interests believe in free markets for everyone else, but inevitably see themselves as an exception. Thus, American politics has become a tragedy of the town commons, where everyone believes in freedom but aims to repeal it for a special favor for themselves.

Hometown Pictures III March 6-8, 2008

Our Cabin
Emerson Hotel
Our Cabin (Freda Navigating Slippery Ice)
Freda at Emerson Hotel
American General Store is closed but not forgotten.

Hometown Pictures II March 6-8, 2008

Ashokan Reservoir I
Ashokan Reservoir II
Ashokan Reservoir III
View From Davis Park, West Shokan
View From Davis Park, West Shokan II

Hometown Pictures March 6-8 2008

Bushkill Creek, West Shokan, Our backyard I
Bushkill Creek, West Shokan, Our backyard II
Bushkill Creek, West Shokan, Our backyard III
Bushkill Creek, West Shokan, Our backyard IV
The "Mayor" of West Shokan

Thursday, March 20, 2008

HBO's "John Adams"

I just watched the first and second episodes of HBO's John Adams and have renewed faith in the liberal media. HBO has produced something very good about American history with a relatively small amount (for HBO) of political correctness and a lot of respect for the nation's heroic founders.

The miniseries makes clear the Continental Congress's great courage. The acting is beautiful, the historical narrative familiar but with enough that is new to the non-historian to make it interesting; and the sets, to include the flags, are superb, in the tradition of HBO's Deadwood series.

Laura Linney plays a fine and inspiring Abigail Adams. David Morse plays a dignified Washington but is more modest than I would have envisioned. Tom Wilkinson is convincing as Benjamin Franklin. But I seem to recall from college that Franklin and Adams spent a couple of days editing the Declaration, not just a few minutes. I'll have to refer to that old Becker book that I read in college on the writing of the Declaration (I still remember after 33 years!).

This has got to be Paul Giamatti's breakthrough to superstardom. According to IMDB he's been in alot of first rate TV shows and movies in character roles (Donnie Brasco, Saving Private Ryan) but in recent years has had several major award nominations. Giamatti is a rare talent. His performance as Harvey Pekar in American Splendor and as Miles in Sideways were both remarkable. His is the kind of talent you get only once in a while, kind of like Lionel Barrymore or William H. Macy. Despite the criticisms of the pretentious-mashed-potatoes-a-la-mode critic set, Giametti is wonderful as John Adams and HBO has done us a service.

For an example of a pretentious-mashed-potatoes-a-la-mode critic, Slate's Troy Patterson writes:

"Sometimes the show feels like an eighth-grade field trip to Independence Hall or maybe a citizenship test..."

Likewise Robert Bianco in USA Today writes:

"sadly, in this elaborately produced, incredibly well-intentioned seven-part HBO miniseries adaptation of the book, Adams recedes once again, outshone not just by his more famous peers but also by just about every minor character. And the blame for that rests on Paul Giamatti, an odd and seemingly uncomfortable casting choice."

I disagree. Giametti is a brilliant casting choice and he does an excellent job. I wonder if critics concentrated on entertainment value and quality rather than on self-important quests for trendy conformity, Hollywood would be in better shape. As well, is it possible that critics like Bianco and Patterson are simply irritated at a positive depiction of the founding fathers that doesn't resort to the liberal media's air-headed ideology?

Martin J. Sklar's Corporate Reconstruction of American Capitalism 1890-1916

Martin J. Sklar. The Corporate Reconstruction of American Capitalism: 1890-1916: The Market, the Law and Politics. Cambridge: Cambridge University Press. 1988. 484 pages.

One of the joys of being an academic is that I can read great books, and Martin J. Sklar's Corporate Reconstruction is one of them. Sklar targets academics as his primary audience. The book is brilliant, thorough, deep and penetrating. I would argue that all business Ph.D. students should be required to read this book. It explains the American business system in a way that is much more accurate, convincing, and forthright than almost any other.

Sklar begins by reviewing the intellectual foundations of Progressivism, then moves into a detailed analysis of anti-trust law and the two key Supreme Court interpretations of the Sherman Anti-trust Act that led to the Standard Oil and American Tobacco Decisions in 1911. Sklar shows how the courts' interpretation of the Sherman Act as applying to all combinations rather than just unreasonable ones led to increasing demand for a Progressive political transformation. The Standard Oil and American Tobacco decisions led to a Progressive consensus. In President Taft's interpretation, aggressive enforcement of the Sherman Act was sufficient to eliminate unreasonable or unfair restraints of trade. In Wilson's interpretation, a degree of regulation as reflected in the Clayton and Federal Trade Commission Acts were integrated with judicial enforcement. Sklar goes into various political and regulatory reform movements that were associated with Progressivism and that led to passage in 1914 of the Clayton and Federal Trade Commission Acts. He finishes this carefully written, detailed book with a discussion of the leading politicians of the era, Roosevelt, Taft and Wilson.

Sklar argues (p. 20) that the Progressive era resulted from a conflict between the proprietary-competitive stage and the corporate-administered stage of market capitalism. A key part of Sklar's argument is that (p. 22) corporate capitalism could integrate interests of small business, the working class and professions. Perhaps he overstates the importance of corporate capitalism, for the professionalization of medicine, for example, was proceeding in tandem with other aspects of Progressivism and it may not have been affected either way by corporate capitalism. Nancy Cohen argues that the Mugwumps were already establishing professional interests in the late 19th century and this likely was independent of corporate capitalism.

Sklar argues (p.22):

"In its very centralizing and standardizing characteristics, corporate capitalism was inclusive of social diversity in a way that proprietary capitalism-competitive capitalism could not be. Its partisans, accordingly, called corporate capitalism progressive."

Thus, in Sklar's view, (p. 30) capitalists had made a transition from debtor to investor and there was a "consensus" in favor of a regulated market and central banking.

The antitrust debates and the antitrust law (p. 33) were critical to the debate about progressivism because many argued that all corporations ought to be illegal under the Sherman Anti-trust Act. Corporations did not assume their final modern form until circa 1890, and the debate about Progressivism was intimately connected to the 25-year-long debate (1889-1914) about the degree to which corporations should be permitted to exist and the degree to which they should be regulated. Sklar argues that the debate was ultimately decided in favor of the idea that society should have "supremacy over the state", but this question was up in the air. There were serious quesions (p. 34) whether anything besides small producer capitalism was compatible with American society and whether big business ought to be permitted. Corporate capitalism favored administered markets and regulation but rejected socialism. I would add that I have yet to find any evidence in the historical literature that a laissez faire corporate capitalism could not have succeeded. There is certainly plenty of evidence that contemporary businessmen disliked laissez faire which leads me to question how the advocates of statism managed to depict laissez faire as a business ideology. It was in fact a profoundly anti-business ideology but one which left more savings in the hands of the average American.

It is certain that big business executives and their friends in the Republican Party disliked the idea of laissez faire because it meant lower profits and fewer advantages and supports to big business. Sklar (p. 35) argues that corporate capitalism was a "cross class" ideology. This may be true in terms of the public debate, which like any deliberation is based on imperfect information. However, the results of corporate capitalism as opposed to laissez faire was in the interest of corporate managers. Sklar argues that because labor unions supported corporate capitalism, corporate capitalism must have served the interests of labor (as opposed to union leadership) as well. Professor Sklar does note (in a footnote on p. 44) that savings rates were much higher in the 1880s and 1890s, the era of supposed unemployment, overproduction and vicious competition, then they were in the "Progressive" era.

The three major schools of thought concerning corporate capitalism reflected the ideas of the three Progressive presidents, Roosevelt, Taft and Wilson. Roosevelt's was the most statist; Wilson's was a "center left" approach and Taft's was a "minimalist-regulatory corporate liberalism on the center right" that sounds most like today's Republicans. Sklar doesn't trace the relationship between Taft and later conservative movements in America, but it seems to me that Barry Goldwater's laissez faire ideology had to represent a minority current in the Republican Party for the 58 years between 1908 and 1964.

Theodore Roosevelt (p. 38) would view the entire large corporate sector of the economy as monopolistic and would have subjected all of big business to direct, socialistic state control. Today's Republican advocates who speak of "Republican principles" and "traditions" would do well to study the history of their own party. The most socialist president in American history was a Republican, although much of Theodore Roosevelt's socialism came when he ran as the Bull Moose candidate. Wilson was less statist than Roosevelt because he and his followers "distinguished more finely between positive government and statism."

Between the 1880s 1904 (p. 46) "there were roughly 300 industrial combinations with an aggregate capitalization" and about three fourths with a capitalization of about $6 billion occurred in 1898-1904.

Sklar points out that the corporate view of the period "conceived" that (p. 55) "overproduction" was "chronic tendency inherent in modern industrial capitalist development. Concentration...was the inevitable concomitant of modern industrial methods..."

Economic necessity required either alliances, contracts to restrict price, corporate mergers and consolidations. Thus, firms felt impelled to merge, but the Sherman Anti-Trust Act posed a problem.

In the Progressive era, the leading advocates of the overproduction thesis that justified mergers included Arthur Twining Hadley, Jeremiah Whipple Jenks and Charles Arthur Conant. These Progressive writers had a theory of business strategy that emphasized the importance of economies of scale and fixed investment, a situation that the Progressive era assumed would carry forward indefinitely (p. 58):

"Large fixed investment put a premium on economies of scale, and, as Andrew Carnegie explained in what came to be known as 'Carnegie's law of surplus,' every manufacturer preferred to lose one dollar by running full and holding markets through selling at lower prices than to lose two dollars by running less than full or close down and incur the risk of losing markets, defaulting on interest payments and falling into bankruptcy. Four years before Carnegie made this piont in print, Hadley had already noted...that the idea of competition in which prices tended to be proportional to the cost of production approximated reality in Ricardo's time but not in an era of growing fixed investment. 'It very often involves worse loss to stop producing than to produce below cost.'"

Like David Ames Wells, Hadley believed that large fixed investment changed the relationship between marginal costs and marginal revenues for profit maximizing firms. He believed the long term equation of marginal costs and revenues to have been eliminated by fixed investment. From the standpoint of today's microeconomics, this is a peculiar argument, and it suggests a reason for Progressivism's fixation on statism. The equilibration of marginal costs and benefits is a condition for rational behavior. The Progressives thus believed that firms behaved irrationally. The existence of fixed costs does not alter the rationality of the equation of long term costs and benefits. For firms to behave otherwise would suggest an inability to develop coherent business strategy. Firms will continue producing until the present value of expected margainal costs of production equal expected the present value of expected marginal revenues. If fixed cost investment causes irrational, sub-optimizing behavior in some firms, more rational firms would leave the market, leaving it to the sub-optimizing firms. In turn, supply would be reduced. Although such adjustment would take time and be painful to owners, it would certainly occur. Moreover, the Progressive model diametrically opposes basic thinking about business strategy. Progressives like Hadley argued that firms were incapable of strategic thinking and were unable to change direction. The idea that a firm would continue producing ad infinitum because it is cheaper to produce than to close shop, an argument found in David Ames Wells's work as well as Hadley's, ignores valuation based on future earnngs. Firms are valued not only on the basis of cash flow and current earnings but on the present value of future earnings. Publicly traded firms that are willing to take losses ad infinitum will have share prices that reflect infinite losses and will therefore be valued at close to zero. Short term gains due to closing may be less than short closing costs, but short term closing costs cannot be greater than ad inifinitum production losses. Although cash flow might be hurt by closing, the argument that existence of fixed costs repeals the principle that firms will produce to the point where their expected costs of production just equal the expected revenues because is false.

In his section on the anti-trust law Sklar emphasizes that the British American common law (p. 93)prohibited restraints of trade. Under the case of Horner v. Graves price fixing and contracts to restrain trade were totally legal unless (p. 95) "they directly and unduly or unreasonably restrained competition and were therefore detrimental to the public interest." Contracts "restraining trade completely" were against public policy. Thus, (p. 100) "Invalid restraints of trade at common law were those contracts, agreements or combinations that were unreasonable and therefore void..." Unreasonable restraints of trade attempted to control an entire industry, restrict entry by new businesses. Reasonable restraints of trade were consistent with freedom of contract and property. "The common law, then, was not intended to protect weaker or inefficient competitors from stronger or more efficient competitors nor even to compel competition" (p. 104)

When the Sherman Act was passed, the courts first interpreted it merely as a restatement of the common law that added treble damages and made unreasonable restraints of trade federal crimes (p. 105). Sklar goes into the Sherman Act's legislative history and shows that Sherman's original draft did not satisfy a common law interpretation, although that was Sherman's intent, and more expert Senators such as James Z. George and John T. Morgan redrafted the bill to ensure its common law implication (p. 115). Between 1890 and 1897 the federal courts interpreted the Sherman Act consistent with the reasonable/unreasonable distinction.

In 1897, led by Justice Harlan, the Supreme Court reversed itself (p. 127) in the case United States v. Trans-Missouri Freight Association. In Trans Missouri the Supreme Court held that all combinations, reasonable and unreasonable, hence potentially all corporations, were illegal restraints of trade. The Supreme Court reached a similar decision in United States v. Joint Traffic Association and Addyston Pipe, in which Judge William Howard Taft ruled that reasonable and unreasonable restraints of trade must be declared illegal even though that interpretation disagreed with his analysis of the common law. The aggressive interpretation of the Sherman Anti-trust Act lasted from 1897 to 1911.

In 1911 the Supreme Court returned to the common law interpretation because of judicial and public criticism (p. 146). The Standard Oil and American Tobacco cases involved the break ups of those two firms, but the Supreme Courts did so in such a way to say that the corporate economy was safe, in other words that it was returning to the common law interpretation of the Sherman Act as illegalizing unreasonable but not reasonable restraints of trade. The United States had been unique in the world in prohibiting all restraints of trade (p. 154) so the return to the unreasonable standard was a return to the global norm.

I think this material sheds a lot of light on William Howard Taft's labor law decisions when he became Chief Justice after losing to Wilson. The labor history has tended to overlook the importance of anti-trust law to Taft's career, and his anti-union interpretation of the Sherman Act during his nine years on the Supreme Court, which led to the Norris La Guardia Act in 1932, needs to be viewed in light of his broader anti-trust ideas.

The two interpretations of the Sherman Anti-trust Act respectively reflected the interests of rural, single proprietor firms versus large corporations. It was not realistic to attempt to impede the growth of large corporations in this way.

In his section on the politics of antitrust law Sklar traces the history of the Bureau of Corporations, which Congress created in February 1903. The commission originally advocated publicity about corporate affairs and federal licensing of corporations (p. 185). The supporters of the Bureau of Corporations included George W. Perkins of JP Morgan. Sklar traces considerable detail about legislative proposals of Jeremiah Jenks and Herbert Knox Smith. Herbert Knox Smith didn't agree with Roosevelt's extreme statism. Roosevelt favored federal incorporation or licensing of corporations and Knox worked on this to please Roosevelt, but he disagreed (p. 201). He also traces in considerable detail the reform efforts of the National Civic Federation led by Mugwump and Progressive Seth Low.

The case of Loewe v. Lawlor also known as the Danbury Hatters' case, had important implications. As Theodore Roosevelt was cajoling (p. 230) Seth Low on behalf of the Civic Federation to propose a generalization of the Hepburn Act that would have radically increased federal authority over corporations. (The Hepburn Act applied centralized economic planning principles, rate setting and the like to railroads.) Under a proposed bill that was kicked around, all corporations engaged in interstate commerce could register with the federal government. All combinations and contracts of the corporation would be filed with the federal government. If a corporation chose to file it would not be proscecuted for past Sherman Act violations. The bill provided for favorable treatment of labor unions. This was Roosevelt's bill, but Roosevelt refrained from aggressively supporting it because it was so radical. Sklar notes (p. 245) that had it passed it would have done a few things: (1) it legalized large corporations; (2) it subjected them to federal regulation; and (3) it established administrtive executive supervision rather than judicial review. The Bureau of Corporations would have become a central planning agency and American big business would have been state directed. The bill would have mandated a degree of direct government control (p. 248) over big business that the business executives did not expect. The bill did not catch on and died.

Herbert Knox Smith, who was an official of the Bureau of Corporations, although a Roosevelt follower, did not agree with the bill. He was (p. 300) troubled by the "centralizing tendency and implications of a government-directed economy. He was no less concerned, at the same time, with the economically and socially deleterious effects of concentrated market power represented by big corporations." Smith favored a publicity function of the Bureau of Corporations and that this could be accomplished by requiring registration of corporations with the federal government without too much additional regulation (p. 305): "Most important, in Smith's mind, the registration system he favored would avoid the state direction of market transactions implied in (other) proposals." Senator Newlands introduced an interstate trade commission bill in July 1911 (p. 310) which was a "tough license-registration measure." However, the bill stalled because of labor issues and Smith convinced Newlands to moderate the bill. Smith argued that a system of regulation would be smoother than a system of court enforcement.

Sklar traces through the evolution of the Federal Trade Commission and Clayton Acts of 1914, the rather minimal regulatory outcomes of the debates about whether to regulate corporations. Although Progressivism was mostly Republican, it reached its climax with Woodrow Wilson, who pushed for the Federal Reserve, which had been a Mugwump idea. It is important to understand that the Federal Reserve adopted in 1913 was very different from today because there was a gold standard and so the central bank's power to create money was limited. However, it was the first of three steps that led to unlimited money creation power.

In the final sections of the book, Sklar gives a really fine review of the ideas of Roosevelt, Taft and Wilson.

Overall, I found Martin J. Sklar's book to be energizing and informing. It took me a long time to read, but it was worth it.

Groupthink and Rigidity of the Statist-Liberal Consensus

Progressivism led to a consensus that the state is necessary to manage the economy. Republicans like William Howard Taft emphasized the free market to a greater degree than did Democrats like Woodrow Wilson, but both political parties have been committed to a state managed big business system. Unfortunately, the system has not performed well. The subsidies that the state has provided the financial sector have been squandered on excessive salaries and incompetent management. When the financial firms prove to have been ineptly run so that they near bankruptcy, the public bails them out further despite years of mismanagement, poor decision making and excessive salaries. Income transfers from the public to state-supported managers, to include CEOs in the corporate manufacturing and service as well as in the financial sector, have resulted in increasing income inequality even as firms are not managed competitively by global standards. Despite the failures of the Progressive model, few observers question its merits. In particular, the peculiar argument that society should evolve, so that the adoption of the Progressive model was appropriate in 1910 and is also appropriate today begs the question: why is the Progressive model appropriate today if society evolves? And why are academics, politicians and businessmen so defensive about the Progressive model given its repeated failure, its tired history and its antiquated assumptions about the importance of scale, mass production and stability?

Part of the obsessive commitment to the Progressive model results from the liberal groupthink that was necessary to its foundation. Progressivism was first and foremost a mode of transfer of wealth from the general public to corporate interests. It accomplished this by reducing competition and establishing preferred access to credit by large business. Smaller business may have been accomodated to a degree, but the most important source of business innovation, entrepreneurial start-ups, are missing from the Progressive model. The result was a decline in American competitiveness during the twentieth century. The major business innovations after 1940 were Japanese, not American.

Liberal groupthink plays a key role in defending progressivism. Liberalism establishes a hierarchy of media that is imitative, much as in many mid-century industries firms followed a price leader or followed pattern collective bargaining in their industries, in media there is a unitary point of view that reflects the opinions of liberal leadership. Such opinions are costly to believe if you are an investor. They are costly for society to follow. They have destroyed New York City. They have caused the loss of competitiveness in American industry. But the comfort that liberal groupthink provides to its acolytes provides a critical bond, much as religious belief does.

Progessivism's Ossification

The current political, economic and social system in the United States was formed in the Progressive era. There were some additional changes in the Depression era, notably introduction of some pro-labor legislation and the abolition of the gold standard, but Roosevelt, Taft and Wilson established the basic outline of today's political economy. The argument for reforming the 19th century approach to American government, which was not laissez faire because of the spoils system and involvement of local government in the economy, was that economic evolution leads to the need for new approaches to government. In particular, it was believed that the rise of big business changed the relationship between the state and business enterprise because big business was capable of abuses that needed to be regulated. In addition, there were arguments that the federal government needed to provide guidance and expertise to big business. As well, the Progressives believed that credit markets needed to be managed.

Without treating the claims that Progressives made, the question is, why do we still have, 90-100 years on, the same economic system that the Progressives developed? Have business processes not changed? Have labor relations not changed? Do the supposed threats that Standard Oil and US Steel posed in 1911 remain the same today? Have economic processes and technology not changed? If so, then why do we have the same system of regulation today that Woodrow Wilson considered to have been evolutionary in 1914?

The model of business regulation has proceeded as follows:

government support for business (19th century) ---> regulation and selective support(Progressive era) ----> attack and hyper-support (New Deal era) ----> ossification and increasing special interest power; inability of corporate/government system to increase net living standards ---->de-modernization, increasing income inequality and social stratification.

The problem is that Progressivism failed to anticipate evolution, despite its claim to be founded on evolutionary economics. The Progressives did not understand that government policies did not necessarily lead to rational decision making, and even if they did were going to become outdated. When they do become outdated, they are far more difficult to change. Thus, the Progressives' mainstream, statist model (and I include all three presidents, Taft, Wilson and Roosevelt) led to inflexibility and inability to evolve. This has led American society to become less imaginative, innovative, progressive and equal than it could have been. Mainstream academics, who see their role as supporting the liberal-big business consensus via Marxist and state liberal ideologies, have appeared increasing retrogressive and out of touch with developments in world business. For instance, no academic of importance advocated quality management before it became a critical competitive issue in the 1970s and no academic of importance has offered a coherent explanation for declining real wages since the 1970s.

This Week's Triumph of Howard S. Katz

Last week Howard S. Katz pulled out of gold and commodities and went long on stocks. The next day his stock picks went up 15%. They fluctuated since but are now significantly up. Many who heard of this move last week were puzzled. Mayer Rothschild once said, leave the last 10% to someone else. Howard seems to have left the last 5%, for although gold went up to $1002, it is now in the $920s, and Howard sold at 950. In place, Howard bought certain specific stocks that have aggressively outperformed the indexes. Howard's "conservative" portfolio is now at an all time high. Yay Howard!

Tuesday, March 18, 2008

Progressivism Contradicts progressivism

Progressivism was the ideology of early twentieth century American government. Its argument was based on the idea that big business had developed to a point where it was too powerful not to be regulated and that in order to counteract big business's power the limited federal government of the 19th century needed to be expanded. Progressivism was mainly concerned with how to best manage big business in the public interest. The Progressives were pro-large business. They did not think, as many business executives did not think, that private ownership of monopolies was necessarily appropriate. In many respects Progressivism was similar to Marxism in that it argued that big business was a natural historical development and that an increase in state power was necessary to manage the big business. The Progressives wanted to make certain that the efficiency potential of big business would be actualized and that efficiencies from big business would be managed in ways that weer conducive to the public interest.

The pro-big business attitude of the Progressives changed during the New Deal. Part of the reason was that the New Deal did not focus on the efficiency goal. This was viewed as having been achieved. As well, the New Deal emphasized the importance of finance as opposed to manufacturng, and its policies primarily reflected the interest of large financial firms. In order to accomplish this, the New Deal had to cloak its positive supports for finance with imagery related to social democracy. The New Deal is thus associated in the minds of historians and the public with Social Security, the Fair Labor Standards Act, the National Labor Relations Act, the Securities and Exchange Act and unemployment insurance. However, the chief and most far reaching reform of the New Deal was the abolition of the gold standard and the granting to the financial community the power to create fiat currency in its own interest unimpeded by the gold standard.

In order to justify this profoundly redistributive policy that served the interests of large corporations, real estate holders and stockholders as well as the commercial banks and Wall Street the New Deal needed to seem anti-business. This was accomplished by insisting on unionization of large manufacturing, which created short term political resistance from Alfred Sloan and other business leaders but in the long run (seven decades) provided little or no benefit to the working class. At first, the division between manufacturers and the Roosevelt administration made Roosevelt seem a traitor to his class. However, this is not the case. The financial arrangements Roosevelt created resulted in the largest gains and the longest gains that have accrued to capitalists in the history of the world. There is no other time in recorded history when the asset markets have risen so consistently and to the degree that they have since the New Deal, and there is no other time in American history when real wages have progressed so little.

The progressives lack the perspective of the Progressives because Progressivism held that economic growth depended on a set of social relations, to include big business, stabilized markets and efficiently run companies, and that social justice would flow if big business was managed appropriately. It recognized that efficiency and productivity necessarily preceded social justice. In contrast, the New Deal did not focus on efficiency and concerns. It saw its goals as primarily redistributive. In rhetoric, business executives were reactionaries who fought its redistributional goals and big business was therefore its enemy. The New Deal assumed that the problem of production had been solved. Its followers were not able to grasp the profoundly redistributive policy that the New Deal established of redistributing from the poor to the rich because they naively assumed that the regulatory sops that were thrown to the poor constituted a major redistributional program. But the New Deal gave $100 to the rich for every $1 it gave to the poor, and in public image broadcast the $1 while cloaking the $100 in arcane Keynesian lingo that served as a cloak to 19th century Populist ideas, namely Greenbackism and free silver.

Academics were only too happy to lend credence to Keynesian rhetoric and to serve the rich. Marxism and Keynesian were two ideologies which ultimately serve to cloak the interests of the financial community and alternatively serve to so cloak the academic community's true intersest in providing succor to the wealthy.

Second, progressive rhetoric depicted big business as the enemy rather than a necessary development. Without claiming to foster business progress, progressivism becomes a form of attack on the nation's source of wealth. Small p progressives do not articulate a theory of economic growth and advocate ideas, to include protectionism, income taxation, regulation and expansion of the state that can easily be shown to harm innovation and economic development. The progressives are not troubled by their assault on progress because of their quaint insistence that the problem of production despite the development of innovative production concepts in Japan that American firms have been unable to replicate and have been protected from replicated by the progressives' inflationist and government support policies for big business.

In fact, the progressives reserve their worst venom for the few innovative businesses, such as Wal-Mart, which have contributed to economic growth. Those that have not, from Wall Street to Detroit, are viewed with favor by the progressive movement.

Progressivism in Decline

The early twentieth century saw the triumph of Progressivism. By the time Theodore Roosevelt assumed the presidency following the assassination of William McKinley in 1901 Progressive doctrines had become dominant in elite circles. As Martin J. Sklar shows in his monumental Corporate Reconstruction of American Capitalism 1890-1916, the key debate in the Progressive era was among three or four schools of thought. Both today's conservatism and today's liberalism are offshoots of those schools of thought. The first school was small business populism which held that all big business was undesirable. In response to this movement, the US Supreme Court held for about 15 years that all business combinations were in violation of the Sherman Anti-Trust Act beginning with the 1897 decision in United States v. Trans-Missouri Freight Association. Progressives were troubled by this decision because they believed that only unreasonable restraints of trade should be illegal under the Sherman Anti-Trust Act, and that was the opinion of the law's authors. In response to this decision, Progressives held that corporations should be permitted to exist but should be regulated. The most aggressive advocate of regulation was Theodore Roosevelt, who evolved into the position that the state should largely control and set policy for corporations (Sklar provides rich detail about Roosevelt's ideological evolution). In contrast, William H. Taft, who succeeded Roosevelt as president in 1908. Taft believed in very minimal regulation of the trusts with aggressive enforcement of the Sherman Anti-trust Act through the courts. This was so following the Supreme Court's Standard Oil decision, which broke up Standard Oil (arguably to satisfy populists and the left) but overturned the Trans-Missouri decision and reinstated the common law interpretation of the Sherman Act that only unreasonably uncompetitive trusts are illegal. Thus Taft's Republican position was that corporations ought to be minimally regulated with aggressive enforcement of the anti-trust law to satisfy small business interests, anti-union small manufacturers and the left. Roosevelt might have agreed with Taft's approach during his presidency, but had veered to a highly statist viewpoint and so ran against Taft as the Bull Moose candidate in 1912. The third view, that of Democrat Woodrow Wilson, was that big business was natural but there needed to be a combination of meaningful regulation (but less than the Republican Roosevelt advocated) but also enforcement through the courts. Taft can be viewed as the progenitor of today's Republicans while Roosevelt can be viewed as the progenitor of today's "progressives". Both were Progressives in the early twentieth sense, so today's politics can be viewed as a battle between forms of Progressivism. By 1900 there was no serious advocate of laissez faire and this was not part of any significant conservative movement. Nor did the advocates of laissez fair in the late nineteenth century grasp the arguments of the twentieth century Austrians, Friedman and Schumpeter. Thus, today's free market economics, while relying on marginalism that John Bates Clark, an advocate of the kind of big business statism that the Progressives adopted, as well as crucial insights of Smith and Ricardo, was a twentieth century develop and appeared after progressive-liberalism, the conservative Progressivism of Taft, the evolutionary Progressivism of Wilson and the radical Progressivism of Roosevelt.

That said, there was a devolution of Progressive ideas that occurred in the twentieth century's subsequent 8 decades. Progressivism was largely concerned with molding of the system of regulation of business. Theodore Roosevelt was most concerned with balancing labor and corporate interests, and all the Progressives were interested in developing a system of business regulation and corporate enterprise that would be dynamic and productive but would not permit excessive power to corporations. However, the Progressives were overly impressed with the size and power of contemporary business. They did not realize that technology had the potential to overturn large firms fairly quickly. Thus, they implemented systems of support and structure that served to protect the very power of big business that they claimed to wish to minimize. The establishment of regulatory systems raised entry costs; the establishment of the income tax created barriers to capital formation among the poor and small business interests; the establishment of the Federal Reserve Bank facilitated a monopoly of capital by big business, commercial banking and the investment banks that tended to foreclose entrepreneurship; and the labor regulations that Roosevelt, Herbert Croly and other Progressives advocated that saw much of its realization later in the 20th century, also created entry barriers and high fixed costs for small business. The result was excessive protection to big business.

The model of manufacturing that the Progressives reinforced was mass production or continuous flow, in the terminology of Joan Woodward. This model was characteristic of the late nineteenth through the mid twentieth century. It involved a degree of technology and managerial sophistication, but it relied on large scale production runs. This kind of technology requires consistency of output. Its apex was the Model T Ford, which had little variation and could be produced at low cost but had poor quality. The American regulatory system thus geared itself to protecting the modernist, mass production model by allocating credit; at various times via protectionism; and by creating entry barriers.

Franklin D. Roosevelt's New Deal of the 1930s reinforced the Progressive model in a number of key respects. First, it established a modernist labor regulation system which assumed that labor unions that required large bargaining units would represent employees. In response, the industrial labor unions of the Congress of Industrial Organizations was formed. In short order following the National Labor Relations Act the number of unionized workers more than doubled and by 1945 about 35% of the workforce was unionized. The NLRA labor system assumed that unions would face the same modernist model that the Progressives thought firms would eternally face: large work units characterized by low skill workers who could be organized in large groups by industrial unions (unions that represent all the workers in the plant) such as the United Auto Workers union. However, this model was not to materialize.

The chief problem facing union organization is the same as the chief problem facing the Progressive regulatory regime. Within 40 years of the establishment of the Progressive regime Toyota Motor Company in Japan began experimenting with a process known as lean production. Taiichi Ohno, Toyota's executive vice president for manufacturing in the post-World War II era and the creator of lean production says that he worked on the lean production or kanban model for 15 years, from the late 1940s until the early 1960s, before Toyota finally iron out the process. The important point about lean manufacturing is that it inverts the assumptions of modernism. It depends on producing one unit at a time; it depends on teamwork; it depends on highly committed workers who cannot be in a conflictual relationship with the firm and who need to feel secure in their jobs; it emphasizes not mass production but coordination; and it views the factory as a series of supermarkets where line workers are consumers who obtain just enough inventory from the next lower level of the production process. Thus, information becomes critical, and highly trained workers who are flexible are equally crucial. Likewise, single units are produced at a time.

The characteristics of Ohno's lean manufacturing are amplified by the ideas of Edward I Deming, who was also appreciated in Japan before being recognized in the United States in the 1980s and 1990s. Deming argued that quality is a process rather than an outcome; that quality depends on both management and employee; that teamwork is crucial; that systems are the foundation of quality and that employees need to be trained and have long term relationships with their firms. Decision making is profound and subtle, and often criteria used to improve processes are impossible to communicate to outsiders. They depend on the knowledge that only workers possess. Therefore, the assumption of Progressivism that rational knowledge is fundamental to good management is overturned by quality management processes. No expert can replace the profound knowledge of simple line workers who are familiar with machinery.

While these management developments were occurring, there were no changes in the Progressive and New Deal regulatory formation. Indeed, quite the opposite. In 1931 Franklin D. Roosevelt abolished the gold standard, which released banking from market discipline. Banks could lend entirely on the basis of personal relationships rather than market performance, and firms could be rewarded with capital infusions regardless of performance. At the same time, American firms did not suffer from competition in part because of World War II and in part because firms had not yet reached the scale sufficient to compete with the American firms. However, continued American ascendency would have depended upon competitive quality developments; rapid innovation; and a market-drive economy, and these patterns were increasingly absent from the economy. Small businesses had increasing trouble forming because of high marginal tax rates, regulation and inability to obtain credit, which was locked by the Fed and given to connected large banks and their client large corporations. The corporations, such as General Motors, felt no need to compete with smaller foreign firms that were still learning how to manufacture. This began to end in the 1950s, when Ford built the Falcon which imitated Volkswagons, but American manufacturing firms had little concept of lean manufacturing or TQM until these processes were well familiar to Japanese firms. Thus, American firms lost their ascendency due to the protective, stable system that the Progressives and the New Deal had created; the lax management in fields like steel and autos that flourished because of the stable system and lack of competition; and the inability of the US government which oversaw the Progressive regulatory model to understand or to anticipate the fundamental changes in production knowledge that the Japanese were accruing.

Thus, the early twentieth century saw the formation of a Progressive regulatory model that aimed to adjust the economy to the rise of big business. But the system the Progressives created did not contemplate the possibility of progress. The Progressives could not foresee that Franklin D. Roosevelt would ratchet up the degree of regulation and take a number of steps that inhibited the formation of new businesses. But the Progressives also did not grasp that the big business system of large scale mass production was only a step in the development of industry, a process which will continue well beyond this and the next centuries.

Progressivism's rigidity and inability to attract experts with the requisite ability to understand developments like lean production was only part of the reason for the inability of the Progressive model to anticipate progress. The model of Progressivism is based on a faulty concept of planning. It contemplated the existing business structure as capable of innovation and that scale rather than process and new ideas were the key variables. AS the twentieth century progressed, though, it was new ideas, the ability to anticipate change and the ability for nimble, often small firms, to cooperate in innovation that mattered most. Yet, such firms are crippled by the banking and credit systems, which allocate credit to secure risks such as large corporations and real estate developers. Thus, the American economy has seen a frenzy of large retail and home building but considerably less innovation in a wide range of fields outside of electronics and telecommunications that might have occurred.

Moreover, there are a number of artifacts of Progressivism that the Progressives themselves attribute to markets, but can do so only by claiming that the Progressive/New Deal model had not been established in the first place by Taft and Franklin D. Roosevelt. First, the skewness in accessibility to credit has facilited a higher degree of income inequality than would exist in a market economic system. This has occurred because the Federal Reserve Bank has inflated asset levels, notably the stock and real estate markets, at the expense of wages. Second, relatively high paid manufacturing jobs have left the United States because of financial manipulation by the Fed, most directly the propping of the value of the dollar through encouragement of foreign governments to hold United States bonds. Third, the stimulaton of the stock market coupled with corporate emphasis on stock options has made executives sensitive to low-risk means of increasing short term profits, which would suggest moving plants to Mexico and overseas. This was done while the Progressive system provided loan guarantees to Chrysler and various protectionism measures to the automobile firms in the 1970s and 1980s.

Thus, Progressivism is responsible for US manufacturing firms' lack of emphasis on quality management, which they felt little pressure to adopt during the 1960s and 1970s, and the rewarding of corporate executives despite their firms' poor performance because of outsourcing. Indeed, Progressivism devolved into a system of special interest brokerage which ensures that little of benefit occurs on the public's behalf; that large firms benefit at the expense of small; and that the public is harmed by the Progressive regulatory regime.

Monday, March 17, 2008

Of Market Bottoms and Economic Literacy

This past Monday my friend Howard S. Katz has called a market top in gold and commodities and an incipient intermediate term bull market in stocks. This is because, he argues, the recession fears and investment banking losses have caused a primarily psychological market correction and the Fed's injection of large amounts of liquidity (counterfeit paper money) into the economy will stimulate a new stock market bubble. It will likely be of shorter duration than the most recent 5 year run-up, in Howard's view. Howard has gone long on several construction stocks which had quite roller coaster ride. He bought on Monday and the stocks went up 10 to 20% in a single day on Tuesday. On Wednesday they fell a similar amount, on Thursday they rose a similar amount and on Friday they were down slightly. Should Howard's prediction of a bottom this week turn out to be true, these stocks will have risen in the 100% range.

Financial drama aside, my business seminar class today surprised me. Not a single student in the class had heard of David Ricardo's theory of comparative advantage. It is difficult to discuss business, trade and current events when college graduates in business programs lack a modicum of economic literacy. I am curious as to whether the students' lack of knowledge of the most elementary theory of trade is due to ideological bias in their education; their failure to do their homework; or some other cause.