The American Political Economy

Institutional Evolution of Market and State

Marc Allen Eisner

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781134612802
• Edition: 2
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

Policy debates are often grounded within the conceptual confines of a state-market dichotomy, as though the two existed in complete isolation. In this innovative text, Marc Allen Eisner portrays the state and the market as inextricably linked, exploring the variety of institutions subsumed by the market and the role that the state plays in creating the institutional foundations of economic activity. Through a historical approach, Eisner situates the study of American political economy within a larger evolutionary-institutional framework that integrates perspectives in American political development and economic sociology.

This volume provides a rich understanding of the complexity of U.S. economic policy, explaining how public policies become embedded in bureaucracy and reinforced by organized beneficiaries and public expectations. This path-dependent layering process helps students better understand the underlying historical dynamics, which provide a clearer sense of the constraints faced by policymakers now and in the future.

The revisions to the second edition include:

• Complete rewrite of the chapter on the recent financial crisis, adding in commentary on the debt ceiling, the fiscal cliff, and other recent events.

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• New material added and existing material updated in the chapter discussing the two welfare states.

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• Extensive updates to the coverage of the global economy

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• Expanded and updated discussion of Obama's economic policies.

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• Updates to figures and data throughout the text.

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Part I

Making Sense of the Political Economy

1

Beyond the Market-State Dichotomy

In 2007–8, a housing bubble collapsed bringing with it the largest investment banks on Wall Street, many of which were saved only through a massive infusion of government funds. The effects spread rapidly across the globe. Several nations, including the United States, fell into a deep and prolonged recession. General Motors, once the largest corporation in the country, entered bankruptcy (along with Chrysler). The resulting bailout left the U.S. government holding a controlling share of stock in GM, a company that was once emblematic of American capitalism. The enormous injection of money into the economy, both to bail out failing corporations and stimulate demand, forced the largest issuance of debt since World War II. It also raised some profoundly important questions. First, how much debt could markets absorb? In the past several decades, the United States had undergone a remarkable transformation from the world’s greatest creditor to the world’s greatest debtor. A seemingly insatiable appetite for imports created persistent trade deficits and fueled the rise of China as a new economic powerhouse. As a result of this reversal of fortune, the capacity of the United States to raise funds would depend, in part, on China’s willingness to continue to buy its debt.

Second, would the need to respond to the economic collapse divert attention from other long- term problems? For decades, analysts had issued dire projections about the future insolvency of Medicare and Social Security, the nation’s largest policy commitments to the elderly. With a rapidly aging population, it was clear that the trust funds associated with these policies were going to be depleted when they were most needed unless policymakers introduced significant reforms. Year after year, the Government Accountability Office and the Congressional Budget Office issued warnings before Congress, only to be met with indifference. The political costs of reform were simply too great. Each year, the unavoidable day of reckoning came closer, and now, with a new set of pressing commitments there was almost no chance that elected officials would turn to entitlement reform.

Third, the collapse raised normative questions about the proper role of the state in the economy. Since the late 1970s, many analysts and elected officials had rejected the welfare- regulatory state that emerged over the course of the twentieth century. Markets, it was argued, were self- regulating and efficiency promoting. Policy interventions could undermine its beneficial effects. “Yes, a return to the market might create higher levels of inequality and, at times, instability,” many reasoned, “but this was a small price to pay for higher rates of growth and innovation.” But the magnitude of the economic collapse had a sobering effect on even the staunchest advocates of deregulation, welfare reform, and free and unfettered trade. Alan Greenspan, the former head of the Federal Reserve who had been one of the single greatest promoters of self- regulating markets, admitted that the collapse left him in a state of “shocked disbelief.” The “whole intellectual edifice” had “collapsed.”¹

Indeed, a period that began with a seemingly unflappable faith in the marvels of the market ended with the passage of a large fiscal stimulus package and an earnest discussion of the merits of nationalization. Yet, as policymakers sought to respond to the crisis, each reform effort proved to be highly contested. While some called for a return to Keynesianism, others called for austerity, fearing that the growing debt would undermine the nation’s credit rating. Some would advocate reform only if it did not involve raising taxes; others were committed to reform as long as the largest entitlement programs were exempted. What started as a period of rapid policy change quickly turned toward impasse.

As this brief vignette suggests, these are exciting and uncertain times. How does one make sense of the problems, their sources, their interconnections, and the challenges they create for policymakers? To understand the financial crisis, for example, one needs to investigate the history of financial regulation and deregulation. One needs to consider the ways in which tax, regulatory, and monetary policy decisions created the real estate bubble, shaped corporate decisions about risk management, and magnified the impact once the bubble burst. To understand the challenges of funding the debt, one needs to consider the ways in which the post- war pursuit of international economic liberalization created the foundations for the emergence of new industrial powers willing to purchase US bonds, thereby facilitating an expansion of the national debt while placing new pressures on American policymakers. One must also understand the constraints facing policymakers. They work within a set of hard constraints imposed by the legal, budgetary and administrative resources at their disposal and established policy and political commitments. These constraints change overtime—to use an example from above, the potential impact of unfunded entitlement liabilities is far greater today, as the baby boom generation approaches retirement, than it was in 1960 when there were eight workers for each recipient of Social Security old age pensions.

The effort to make sense of the changes also demands that one explore changes in governing philosophies. As John Maynard Keynes once noted: “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else.”² Governing philosophies and political-economic doctrines are powerful. They emphasize certain clusters of values over others. Policymakers and analysts draw on them to decipher a complex reality, to contemplate the trade- offs inherent in their decisions, to understand the ways in which public policies can be used to bring this reality into alignment with larger goals, and to justify their decisions to citizens. These doctrines often find an expression in public policies and institutions. But even after one set of ideas has been discredited and replaced by another, they can continue to exert an influence and give rise to contradictions and conflicts intrinsic to the state and core policies governing the economy. Indeed, many would suggest that the economic collapse was, in part, a product of a larger institutional incoherence that created perverse incentives for economic actors and limited the capacity of regulators to respond in a timely fashion.

The State and the Economy

Political economy is the study of the interactions between the state and the economy. There are myriad approaches to political economy and those who profess to work in the field often draw on far different analytical frameworks and assumptions that shape the focus of their analyses. As the above discussion suggests, the approach to political economy that will be adopted in this book will be concerned with the relationships between public and private institutions as they change in historical time. It will be particularly interested in those moments of crisis that have occurred periodically over the course of the past century because they both reveal the limitations of existing public policies, institutions, and political- economic doctrines and create an opportunity for significant change. We may be in the midst of such a crisis today. The looming entitlement crisis, the dislocations associated with globalization, and the recent collapse of the financial system all raise profound questions about the governing philosophy that has prevailed for the past several decades and the efficacy of the policy decisions it has shaped. These issues will occupy the final chapters of this book. It is a core assumption of this book that one cannot understand these problems without having a broader understanding of the historical record and the ways in which public and private institutions—and the relationships between them—have evolved. Before we can embark on this exploration, we need to address some preliminaries.

Political economy has a long and rich history that predates the contemporary fields of political science and economics. In 1848, John Stuart Mill provided a sense of the breadth of political economy, when he observed:

Writers on Political Economy profess to teach, or to investigate, the nature of Wealth, and the laws of its production and distribution: including, directly or remotely, the operation of all the causes by which the condition of mankind, or of any society of human beings, in respect to this universal object of human desire, is made prosperous or the reverse.³

This broad vision disappeared with the professionalization of the social sciences in the late nineteenth and twentieth centuries. Political economy was fractured into separate disciplines, most importantly, economics and political science. Increasingly, economists focused on market behavior, a world of voluntary exchanges populated by rational utility maximizers and governed by the price mechanism. Most political scientists, in contrast, studied political power, coercion, conflict, and the rules and formal institutions that translate political demands into public policies. While this division of labor may have served some important disciplinary functions, it reinforced an illusion that there is a clear market- state dichotomy, a line of demarcation between two separate realms of human action governed by their own internal logics.⁴

Markets are remarkable institutions, to be certain. As Friedrich Hayek argued persuasively, the price mechanism communicates massive amounts of information that is dispersed among many actors. Changes in prices coordinate the production and consumption decisions of economic agents without their knowledge, thereby accomplishing feats that would be impossible for more centralized forms of control. As markets expand, they support a division of labor that results in higher levels of labor productivity and wealth generation, as Adam Smith illustrated with his classical example of the pin factory. Markets reward efficiency and innovation and there is little to suggest that the impressive record of growth of the past several centuries could have been realized absent market forces. There will be no effort at this point to argue against markets. Rather, the concern centers on the way in which markets have been understood relative to the state.⁵

The market- state dichotomy often carries with it a set of additional assumptions. If we assume that the market is an autonomous, self- constituting and self- regulating entity that functions according to its own intrinsic logic, and if we assume, furthermore, that the market has a privileged status, then there is an automatic bias against any policies that would constrain the behavior of economic actors. Charles E. Lindblom, for example, suggests that the market “seems to have imprisoned our thinking about politics and economics.” Rather than seeing the market as a variable, analysts tend to “treat it as the fixed element around which policy must be fashioned.”⁶ Indeed, policy debates are often grounded, explicitly or implicitly, within the conceptual confines of the market- state dichotomy. They are replete with discussions of the limited conditions under which the state’s intervention in the market can be justified. As David L. Weimar and Aidan R. Vining explain:

When is it legitimate for government to intervene in private affairs? In the United States, the normative answer to this question has usually been based on the concept of market failure —a circumstance where the pursuit of private interest does not lead to an efficient use of society’s resources or a fair distribution of society’s goods.⁷

And yet, even market failure may not provide a sufficient justification for intervention. It may impose greater costs than market failure. The choice is often between imperfect alternatives, and thus analysts must compare the costs and benefits of each.⁸

The conceptual bifurcation intrinsic to the market- state dichotomy also carries significant analytical costs. If we equate the economy with the market, it becomes difficult to explore the variety of institutions subsumed by “the market.” There is a rich literature in economic sociology, for example, that explores the various means by which economic organizations coordinate their behavior. They may employ a variety of governance mechanisms (e.g., trade associations, interlocking directorates, long- term contracting arrangements, collective bargaining) to manage uncertainty and increase stability. These arrangements have little in common with the anonymous, self- liquidating transactions that occur in classic markets. To the extent that they affect economic performance and the distribution of economic power, they are worthy of careful examination. Moreover, the bifurcation draws attention away from the role that the state plays in creating the institutional foundations of economic activity. Rather than constituting a natural outgrowth of the innate human “propensity to truck, barter, and exchange,”⁹ the economy is, in a real sense, an expression—both intended and unintended—of public policies and institutions.

At first glance, this may seem counter- intuitive so let us explore the role of the state through the lens of property rights. Markets facilitate the exchange of property. Property rights are commonly understood as having three dimensions.¹⁰ First, they must be defined . What kinds of things can be legitimately held and exchanged as property? Second, they must be defensible, that is, property holders must be able to defend their rights against the intrusion of others. Third, property rights must be divestible . Property holders must be able to exchange their property with others for markets to function. The state plays an indispensable role in each of these dimensions. Property is defined through legislation and court decisions; government institutions are central to the defense and exchange of property and the adjudication of contractual disputes. A failure of the state to establish a functional set of property rights can undermine economic growth. Without enforced property rights, individuals are subject to ongoing uncertainty over whether others will take their property through force rather than engaging in voluntary exchanges, and this undermines the incentives to invest and innovate. Indeed, the importance of property rights has become salient in recent years as analysts have sought to understand the factors that have impeded growth in some poorer nations.¹¹

If property rights—as defined by the state—are fundamental to transactions even in classical markets, it is impossible to defend the notion that the market and state constitute separate realms of human action. The role of the state becomes even clearer when we consider the complex organizations that populate the economy. The most important actors in the economy—corporations, financial institutions and labor unions—are legally constituted entities. Incorporation is a legal act that conveys distinct benefits on a corporation while imposing conditions on organization and governance. Laws and regulations circumscribe the means corporations can adopt in seeking profit. Commercial banks must be chartered and, once again, abide by regulations regarding organization, governance, levels of capitalization, and the kinds of product they can offer. In the United States, the National Labor Relations Board must certify unions; its regulations delineate what can and cannot be addressed through industrial relations. Without exception, the economic organizations that constitute the economy are embedded in a dense network of public policies and institutions.

Some analysts have described property rights and public policies as a “membrane” connecting the state and economy.¹² The use of the term “membrane” is apt, given that the state and economy do not evolve in isolation. Rather, the two are best viewed as evolving together. New policies can dramatically alter the conditions under which economic production and investment occur, thereby shaping the trajectory of economic development. Corporations may alter their major capital investment or product and process design decisions in response to changes in regulations, and these decisions may have profound consequences for strategic and investment decisions. They may be forced to seek out new means of coordinating their behavior with other firms in response to changes in antitrust policy.

At the same time, as policymakers assume new responsibilities for responding to economic crises or regulating the negative externalities of industrial production, the state must develop new administrative capacities and policy instruments. New public policies often require bureaucratic expansion. Once they are in place, they are embedded in organizational routines and insulated by constituencies that seek to preserve or expand on existing commitments. This creates what is commonly referred to as a pattern of “path dependent development.” That is, past decisions about policy and administration narrow the set of options o...