Wednesday, February 2, 2011

The Skewed Distribution of Hope

The allocation of economic risks is a crucial social dynamic, as is illustrated by the evolution of the general business corporation. It was one of the greatest innovations of the 19th Century. While few historians have ranked it with the cotton gin, steam engine, telegraph, or railroad, the general business corporation had enormous impact on the business world.

The concept of a limited liability company had existed for centuries, but such entities were individually chartered at the pleasure of a monarch and only for a limited purpose, such as the building of a bridge or colonization of a prescribed area of North America. These ventures were perceived to be of great value but to involve high risks. The protection of limited liability (under which investors could lose only what they had invested and/or had committed to invest) was offered to induce investors to take the outsized risks.

State governments in 19th Century America expanded this narrow concept of a corporation to allow anyone to obtain a limited liability charter for any business (and later, nonprofit) purpose, by observing a few simple legal formalities, filing a document or two with the state, and paying nominal fees. The sudden availability of limited liability investment vehicles created an investment boom. Savers were willing to invest in speculative industries and businesses when they did not have to risk their entire fortunes. Corporations became the dominant form of business organization, and America morphed from being an agrarian society of yeoman farmers and pioneers to an economic giant. All this, in part because of a change in risks.

Of course, the downside risks didn't disappear. Remember that risk never dies. It can be shifted, but it must fall on someone somewhere. As regards corporations, many risks and costs that formerly fell on business owners were transferred to consumers, creditors and business counterparties like suppliers and customers. Entire new bodies of law--such as state jurisdictional expansions known as long arm statutes, and products liabilities laws--evolved to balance out some of the inequities to consumers, customers and counterparties resulting from the corporate boom. Financial products, such as preferred stock and collateralized bonds called debentures, were created to offer protection to investors primarily concerned with return of capital.

Nevertheless, the corporate form of business allowed the accumulation and consolidation of massive amounts of economic power, so much so that antitrust laws and regulatory agencies such as the Federal Trade Commission and the now defunct Interstate Commerce Commission were enacted in an effort to rein in these entities. The personal wealth created for owners of corporations was a crucial reason for the social unrest that manifested itself as the populism and sometimes anarchism of the Gilded Age.

The history of the corporation illustrates how a shifting of risks can have enormous economic and social consequences. A similar shifting of risks is taking place today. The bailouts of 2008, the Federal Reserve's never-ending accommodation, and the federal fiscal stimulus programs have supported and now revived America's corporate sector. Publicly traded corporations are reporting record amounts of profits. Wall Street compensation is rising to previously unattained heights. The federal government's financial and economic policies of the past four years have shifted much and perhaps most of the risk of economic downturns away from the corporate sector. Taxpayers have borne a lot of the cost (even if some bailouts have been profitable, others have not, and the added costs of unemployment compensation, other transfer payments and other social welfare programs must be added to the costs of bailouts). Also among the losers are savers, who have been saddled with severely reduced income, as the Fed has driven down interest rates. The unemployed bear a great burden, and lose hope as improvements in worker productivity allow businesses to save themselves and increase profitability without having to hire back many that they laid off. Foreign creditors holding dollar-denominated investments have taken losses as the dollar has gradually fallen in value.

The "recovery" in America is real only for the well-off. See Current unrest in Tunisia, Egypt and other nations illustrates how explosive a problem social inequity can be. While America is nowhere near a social revolution, the increasingly clear, extensive and continued shifting of the risks of economic downturns onto Americans less able to bear such burdens, and the well-publicized benefits to the well-off, is heightening the dissonance of our social dialogue. It's not an accident that the 1950s, which were actually a pretty messed up time, are now regarded with nostalgia. Those years saw a relatively equitable distribution of income and wealth in America. Being middle class meant that you were prosperous. Today, being middle class means you're barely getting by.

Almost all federal policy and legislation related to the economic travails of the past few years has been ad hoc, drafted on the backs of envelopes, and sometimes the product of messy compromises. Because of the desire for short term results, no one, it seems, is paying attention to the long term shifting of risks. This issue goes beyond the generational transfer of costs from the burgeoning federal deficit, and the rising inequity in the distribution of income and wealth. Government policies and programs are reallocating risks to concentrate future prosperity on a relative few. This amounts to a redistribution of hope. America is a nation of dreamers and hope is essential to the American way of life. America was founded on, among other things, the right to the pursuit of happiness. Even when Americans haven't had much income or wealth, they've been able to carry on and work hard if they had hope for the future. Today's increasingly skewed distribution of hope does not portend well.

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