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The third principle of the concentration of wealth and power is “Redesign the Economy,” i.e., use your political influence to change the rules of the economic system, so that it favors the already advantaged class in new and more powerful ways. Noam Chomsky identifies two major factors under this principle: (1) financialization of the economy and (2) the offshoring of production.

Financialization

Writing in Forbes, Mike Collins defined the term financialization as “growing scale and profitability of the finance sector at the expense of the rest of the economy and the shrinking regulation of its rules and returns.” In the film, Chomsky says that financial institutions—”banks, investment firms, insurance companies, and so on”—have a legitimate role to play in the economy, but starting in the 1970s they started to expand their power and influence beyond that legitimate role, thereby enriching the wealthy and making the economy vulnerable to crashes. During this period, the U.S. economy weakened due to the shift from manufacturing to finance, until, in the words of Mike Collins, “The emphasis was no longer on making things—it was [on] making money from money.” According to Chomsky:

By 2007, right before the latest crash, they had literally 40% of corporate profits—far beyond anything in the past. Back in the 1950s, as for many years before, the Unites States’ economy was based largely on production. The United States was the great manufacturing center of the world.Financial institutions used to be a relatively small part of the economy, and their task was to distribute unused assets, like bank savings, to productive activity. That’s a contribution to the economy. Regulatory system was established. Banks were regulated, the commercial and investment banks were separated [to] cut back their risky investment practices that could harm private people. There were, remember, to financial crashes during the period of regulation. By the 1970s that changed.

In the United States, the history of growing inequality is really a history of the systematic dismantling of the New Deal. Chomsky points out that Richard Nixon was the last New Deal President, though he is rarely recognized as such. Starting from Franklin D. Roosevelt in the early 1930s all the way to Richard Nixon in the early 1970s, the United States Government’s domestic spending shows a continuous upward trend. This trend started to reverse with Jimmy Carter, who was also the first President to increase the social security tax, reduce the capital gains tax, and started the process of deregulation. The dismantling of the New Deal became an increasingly important priority in the successive administrations of Ronald Reagan, George H. W. Bush, and Bill Clinton. Since the mid 1970s, both the Republicans and the Democrats have played an active role in this dismantling.

Many of the financial regulations put in place by President Roosevelt under the New Deal were intended to prevent risky behavior on Wall Street, and these regulations functioned well in preventing financial bubbles and crashes.The most of famous of these was the Glass–Steagall legislation (named after Senators Carter Glass and Henry Steagall), also known as the Banking Act of 1933 (revised in 1935). Among other financial reforms, the Glass–Steagall Act established a firm separation between commercial and investment banking. Commercial banks could issue short-term loans but were prohibited from speculating with depositors’ money, while investment banks could invest in equity and long-term loans but were not allowed to take deposits. These provisions of the Glass–Steagall Act were repealed under Bill Clinton as part of his drive towards deregulating the financial sector.

glass-steagall_1933

President Franklin Roosevelt at the signing of the Banking Act in 1933.

 

The role of the United States Congress in the dismantling of the Glass-Steagall Act is especially instructive. Since the mid 70s, no fewer than 25 attempts were made to repeal that law. In 1991, the George H. W. Bush administration tried to amend the law so that commercial banks could participate in investment activities. The House voted 216–200 against the proposed amendment. Seven years later, in 1998, the House passed a very similar legislation 214–213. However, these numbers don’t tell the full story.

As Roslyn Fuller explains in her book Beasts and Gods: How Democracy Changed its Meaning and Lost its Purpose (2015), there was a critical difference between the two pieces of legislation. The 1991 reform effort favored banking interests while the one in 1998 favored insurance and investment interests. The latter were against the 1991 reform, and so they gave substantial donations to Congressional Democrats, who were in the majority, in order to prevent the law from being passed. Their spending paid off, as 74% of Democrats opposed the amendment, as compared to only 22% of Republicans. The same interests then supported the 1998 version of the legislation and, to ensure success, significantly increased their financial contributions to Congressional Republicans, who were now in the majority. As a result, this time 77% of Republicans supported the amendment, as compared to only 38% of Democrats.

Out of the 182 representatives who voted in both 1991 and 1998, two-thirds switched their votes depending on which way the wind was blowing. In 1991, Democrats voted in favor of the insurance and investment companies from whom they were receiving substantial sums of money, but by 1998 the money supply had shifted in favor of the Republicans, which made it rational for the Democrats to start favoring their more reliable donors from the banking industry. On the other hand, the Republicans supported the banking interests in 1991, but changed their votes seven years later in response to the increased generosity of the insurance and investment interests.

Finally, in 1999, the Congress passed the Financial Services Modernization Act with bipartisan support, putting the final nail in the coffin of the Glass-Steagall Act. By this time, the interests of both banking and investment companies had converged, and this was reflected in how the House voted: 362–57 in favor.

clintonrepeal

President Bill Clinton signing the Gramm–Leach–Bliley Act in 1999.

As the New York Times reported at the time, Treasury Secretary Larry Summers was ecstatic when the Congress passed  the Financial Services Modernization Act (also known as the Gramm–Leach–Bliley Act) : “This historic legislation will better enable American companies to compete in the new economy.” Senator Charles E. Schumer (D-New York) praised the new legislation: “There are many reasons for this bill, but first and foremost is to ensure that U.S. financial firms remain competitive.” In contrast to these optimistic assessments, Senator Byron L. Dorgan (D-North Dakota) made the following prescient comment: “I think we will look back in 10 years’ time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930’s is true in 2010.” Today, President Clinton’s repeal of the Glass-Steagall Act is widely believed to have paved the way for conditions that made the financial meltdown of 2008 much worse than what it might have been; others believe that the meltdown would not have happened if that New Deal legislation were still in place.

As already mentioned, however, the trend toward financial deregulation had started much earlier—specifically, during the Carter administration. The landmark event was a 1978 decision by the US Supreme Court that practically ended all limits on interest rates. In Marquette National Bank v. First of Omaha Service Corp., the Supreme Court ruled that national banks did not have to follow the interest rate regulations of the borrower’s state but only those of their own home states. This decision provided a powerful incentive for financial companies to relocate to the states with the least onerous regulations, thereby encouraging states to do abolish anti-usury laws and end interest rate ceilings. Two years later, the U.S. Congress passed the Depository Institutions Deregulation and Monetary Control Act, which included a provision exempting federally chartered savings banks, installment plan sellers, and chartered loan companies from state mandated anti-usury laws. As a result, both the federal judiciary and the legislature effectively ended the age-old practice of capping interest rates. The resulting competitive pressure led to an explosion of financial services, since a lot more money could now be made through lending than through investing in the real economy.

Writing in Harper’s, Thomas Geoghegan explained “how the dismantling of usury laws” produced such as results as “the loss of our industrial base” and “the loss of our best middle-class jobs.”

First, thanks to the uncapping of interest rates, we shifted capital into the financial sector, with its relatively high returns. Second, as we shifted capital out of globally competitive manufacturing, we ran bigger trade deficits. Third, as we ran bigger trade deficits, we required bigger inflows of foreign capital. We had “cheap money” flooding in from China, Saudi Arabia, and even the Fourth World. May God forgive us — we even had capital coming in from Honduras. Fourth, the banks got even more money, and they didn’t even consider putting it back into manufacturing. They stuffed it into derivatives and other forms of gambling, because that’s the kind of thing that got the “normal” big return; that is, not five percent but 35 percent or even more.

As the financial sector became more profitable than manufacturing, it started to bloat up in unprecedented ways. In the documentary, Noam Chomsky describes the results of financialization as follows:

You started getting that huge increase in the flows of speculative capital—just astronomically increase—enormous changes in the financial sector from traditional banks to risky investments, complex financial instruments, money manipulation, and so on. Increasingly, the business of the country isn’t production, at least not here. The primary business here is business. … By the 1970s, [U.S. corporations], say General Electric, could make more profit playing games with money than you could by producing in the United States. You have to remember that General Electric is substantially a financial institution today. It makes half its profits just by moving money around in complicated ways. And it’s very unclear that they are doing anything that’s of value to the economy.

The following graphs tell the story of how the decline of American manufacturing has been accompanied by the rise of American finance.

manufacturing_finance

Finance & Manufacturing share of domestic corporate profits.

Offshoring of Production

The second factor in how the economy was redesigned to suite the wealthy was the offshoring of production. This consists of two basic components: (1) lobbying governments to deregulate the movement of goods and capital across national borders; (2) moving factories out of countries that have strong labor and environmental protection laws to countries were workers can be made to work longer hours and at lower wages.

2010-09_cartoon

Chomsky explains:

The trade system was reconstructed with a very explicit design of putting working people in competition with each other all over the world. And what it’s led to is a reduction in the share of income on the part of working people. It’s been particularly striking in the United States, but it’s happening worldwide. It means an American worker is in competition with the super-exploited worker in China. Meanwhile, highly paid professionals are protected. They are not placed in competition with the rest of the world—far from it. And, of course, the capital is free to move. Workers aren’t free to move; labor can’t move, but capital can. Well, again, going back to the classics like Adam Smith, as he pointed out, the free circulation of labor is the foundation of any free trade system. But workers are pretty much stuck. The wealthy and the privileged are protected, so you get obvious consequences.

As the world is increasingly integrated into the global economy, large business corporations are able to lower their labor costs by manufacturing their products in relatively poor countries. This allows them to bypass the rights that working people have won in more developed countries, as well as avoid the various environmental regulations. Exploitation of labor goes on in places like India, China, Bangladesh, and Mexico, while unemployment rises in the United States. Capital can move anywhere in the world in search of higher profits, but workers aren’t allowed to go from one country to another in search of higher wages or better working conditions.

chinese_factory

Workers in a Chinese iPhone factory.

Globalization protects the owners of capital while further degrading those who have nothing to sell but their labor. The consequences include increasing wealth for the already wealthy and diminishing prospects for the working class. Chomsky notes that such consequences are not accidental; they are the intended goals for which offshoring of production is pursued in the first place. Indeed, it is not uncommon for economic policy-makers to proudly take credit for institutionalizing policies that intensify the financial insecurity of the lower and middle classes. Such insecurity helps maintain obedience on the part of the population.

Alan Greenspan, when he testified to Congress [in 1997], he explained his success in running the economy as based on what he called “greater worker insecurity.” Keep workers insecure, they’re going to be under control; they’re not going to ask for, say, decent wages or decent working conditions, or the opportunity of free association, meaning unionize. Now, for the “masters of mankind,” that’s fine—they make their profits, but for the population it’s devastating.

The Greenspan quotation that Chomsky is referring to is from “Monetary Policy Report to the Congress,” dated February 26, 1997. Greenspan, who was chairman of the Federal Reserve from 1987 to 2006, had made the following comment: “Atypical restraint on compensation increases has been evident for a few years now and appears to be mainly the consequence of greater worker insecurity.”

buckley_chomskyAt this point in the narrative, the film digresses a bit from the main discussion to provide an introduction of Noam Chomsky himself. We learn about Chomsky as a groundbreaking intellectual who transformed the field of linguistics in the 1950s before becoming famous for his public opposition to the Vietnam war during the mid 1960s. We watch a short clip from William F. Buckley’s interview of (and/or debate with) a much younger Noam Chomsky that took place in New York on April 3, 1969, as part of the TV show “Firing Line.” The video of the debate is available here, while a complete transcript can be found here. In “Requiem,” Buckley is seen introducing a younger Chomsky as follows:

Professor Noam Chomsky is listed in anybody’s catalog as one of the half-dozen top heroes of the New Left. This standing he achieved by adopting over the past two or three years a series of adamant positions rejecting at least American foreign policy, at most America itself.

The older Chomsky then responds to the charge of “anti-Americanism,” which is fun to watch. He points out that in all societies anyone who criticizes the status quo usually becomes a target of various types of attacks, but it is only under totalitarian rule that the critics of concentrated wealth and power are accused of being enemies of their own countries—as in “anti-Soviet” or “anti-American.” The very existence of such forms of verbal abuse in a “democratic” society is rather revealing.

Systemic Problems (2)

The following discussion is based on, and inspired by, the work of Jack Harich and associates, which can be accessed here.

A systemic problem is one that originates in the structure of a system rather in the behavior of individuals participating in the system. This does not mean that individuals play no role in causing the problem; rather, it means that replacing the individuals or attempts at changing their behavior, without changing the system’s structure, will not solve the problem. This is because in any social system there is a dynamic and dialectical relationship between the structure of the system (including all the interconnections, feedback loops, explicit or implicit rules, goals, etc.) and the individuals who participate in the system. The human factor is important—it is, after all, the people whose aggregate behavior is largely responsible for bringing the structure into existence and whose continuing participation is what maintains that structure over time. The structure, however, tends to acquire a reality of its own—becoming stronger than its individual participants in many ways—that both influences and limits the behavior choices of the people operating within the system. The structure not only encourages and rewards certain behavioral tendencies but also makes alternative choices harder to imagine, let alone implement.

social-system-diagram

A social problem that persists—and often gets worse—over time, despite the application of various intuitive or commonsense solutions, is likely to be a systemic problem whose root causes lie in the structure of the system. Such a problem cannot be solved unless its root causes are accurately identified and the appropriate solution elements devised to push at high leverage points in order to address those root causes. A root cause is defined as the deepest element in a causal change that is susceptible to resolution.

When a social system operates in a way that produces desirable outcomes, we can say that it is functioning in the right mode; when it operates in way that produces undesirable outcomes, we can describe it as functioning in the wrong mode. Solving a social problem is therefore a matter of shifting the mode of the relevant social system from wrong to right. But the persistence of a social problem over a long period of time, despite huge efforts to solve it, indicates not only that the relevant social system is operating in the wrong mode, but that it has somehow become locked into that undesirable state. In other words, structural mechanisms such as feedback loops have developed that prevent the system from changing in the desired direction. As soon as any effort to shift the system’s mode starts to succeed, these mechanisms spring into action and immediately reverse those gains. When effort after effort fails to change the mode of the system, activists ought to realize that trying harder is not the solution. They need to go back to the drawing board and examine their own assumptions about the causes of the problem. In most cases of stubborn social problems, the lack of success is not due to a deficiency of effort on the part of the activists but due to their incorrect diagnosis.

To arrive at the correct causal analysis of a persistent large-scale problem, social diagnosticians must consider three types of causal forces: (1) root cause forces, (2) superficial solution forces, and (3) fundamental solution forces. These forces (as well as new root cause forces) appear in blue text in Jack Harich’s “Standard Social Force Diagram” depicted below.

Standard-Social-Force-Diagr

When a social system is locked into the wrong mode, that’s because root cause forces arising from root causes are operating to keep the system in that mode and to oppose and defeat any and all efforts to bring about a mode change. A system operating in the wrong mode produces undesirable outcomes or symptoms, such as deforestation, high morbidity, ineffective government, too many industrial accidents, lack of sufficient housing, and so on. Concerned citizens, who find these outcomes disturbing and unacceptable, reason their way backwards from the symptoms to their possible causes. Most of the time, however, they end their analysis prematurely—as soon as they have identified what appears to them as a plausible explanation for the symptoms but is, in reality, only a set of intermediate causes. Thinking that they have found what they were looking for, they focus their efforts at unleashing superficial solution forces, which leads them to devise superficial solutions that push on low leverage points in order to address the intermediate causes. As expected, their strategy fails to solve the problem since superficial solution forces are, by definition, weaker than the root cause forces. The error, of course, lies in the incorrect diagnosis.

A successful strategy to bring about a systemic change must begin with the correct diagnosis. Instead of ending their analysis as soon as they’ve found the first plausible explanation, activists must keep digging until they have identified the root causes of the problem that lie hidden in the system’s structure, sometimes deep underneath the intermediate causes. Once the activists have identified the root causes, they will be able to focus their efforts at unleashing fundamental solution forces, which will lead them to devise fundamental solutions that push on high leverage points in order to address the root causes. Since fundamental solution forces are, by definition, stronger than root cause forces, this is the only strategy that can bring about an actual mode change in the system. As the fundamental solution forces introduce into the system new root causes, the latter give rise to new intermediate causes, which, in turn, produce new symptoms (or desirable outcomes). The new root cause forces will also give rise to new structural mechanisms including feedback loops that will keep the system locked into the right mode.The persistence of the desirable outcomes over time, and the ability of the system to maintain itself in the right mode despite any opposing efforts, will indicate that the system has, in fact, permanently shifted from being in the wrong mode to being in the right mode. This is the definition of a systemic change. Anything short of that does not deserve to be called a “success.”

The_fifth_discipline_coverThe following post consists of quotations from Peter Senge’s book, The Fifth Discipline: The Art and Practice of the Learning Organization, along with my own attempts at paraphrasing them. My purpose is to put in one place the most important lessons that I think I should learn from reading The Fifth Discipline, and so the following material is best described as consisting of my personal notes more than anything else. Since this isn’t a summary of the book, I will select passages that appeal to me for one reason or another, and not necessarily because they’re central to the author’s argument.

There are three basic principles of systems thinking, as described in chapter 3.

Structure Influences Behavior: Different people in the same structure tend to produce qualitatively similar results. When there are problems, or performance fails to live up to what is intended, it is easy to find someone or something to blame. But, more often than we realize, systems cause their own crises, not external forces or individuals’ mistakes.

Structure in Human Systems is Subtle: We tend to think of “structure” as external constraints on the individual. But structure in complex living systems … means the basic interrelationships that control behavior. In human systems, structure includes how people make decisions—the “operating policies” whereby we translate perceptions, goals, rules, and norms into action.

Leverage Often Comes from New Ways of Thinking: In human systems, people often have potential leverage that they do not exercise because they focus only on their own decisions and ignore how their decisions affect others.

The structure of a system is found in the pattern of the interrelationships among the system’s key variables. We can easily identify the key variables of a system, but it takes time and effort to understand how they influence each other and how the patterns of their mutual influence changes in response to a change elsewhere in the system. Even though structures are not obvious, we can discern their power simply by noticing the feeling that compels us to act in particular ways and do what is expected of us. When you find yourself saying or thinking “I have no choice but to …,” it is very likely that you’re facing a structural constraint or imperative.

pogoIndeed, the most important factor that shapes people’s actions is the structure of the system within which they are operating. This is why very different individuals often end up behaving in very similar ways when they are placed within the same position in a system—for instance, an otherwise peaceful person can turn overnight into an arrogant bully  when assigned the position of a prison guard. Yet, it would be incorrect to assume that people are merely cogs in a machine with no agency of their own. In the case of a human system—such as a school, a company, or a prison—individuals do not exist apart from the system’s structure; rather, they are very much an integral part of it. This means that blaming someone or something else is not helpful since it doesn’t take us off the hook; nor is blaming the “system” a legitimate excuse. It also means that we are not at the mercy of external forces that are lie somewhere else, above and beyond our control; rather, we have considerable leverage precisely because we are intimately connected to the web of influences that defines a system’s structure. Just as the system’s structure influences and shapes our behavior, we too have the power to change some of the structure within which we function. The flow of influence is active in both directions.

Towards the end of chapter 3, Senge discusses the three levels at which any complex situation can be analyzed and explained. The resulting explanations may all be valid, but they do not have the same usefulness. Event explanations focus on gathering such information as “who did what to whom” and tend to trap us in a reactive mode. Pattern of behavior explanations focus on identifying long-term trends and figuring out their implications; this approach begins to liberate us from the reactive mode and allows us to deliberately respond to the situation. Structural explanations are the least common and the most powerful. They focus on understanding the system’s structure in order to find the deeper causes that generate the observed patterns of behavior; such explanations can help us identify the root causes of the situation, thereby empowering us to take the appropriate corrective action. According to Senge:

The reason that structural explanations are so important is that only they address the underlying causes of behavior at a level that patterns of behavior can be changed. Structure produces behavior, and changing underlying structures can produce different patterns of behavior. In this sense, structural explanations are inherently generative. Moreover, since structure in human systems includes the “operating policies” of the decision makers in the system, redesigning our own decision making redesigns the system structure.

It seems that one progresses through these levels of explanation by repeatedly asking the “why” question. Suppose a particular event happened—a relatively new car broke down, a marriage disintegrated, a child contracted an illness that is supposed to have been eradicated, a family lost their home to foreclosure. When we ask “why” for the first time, the answer will provide an event explanation, consisting of the specific and immediate chain of causation that led to the particular event. Thus, the house was foreclosed because Mr. Smith was laid off by his employer, which prevented him for continuing to make his mortgage payments.

Asking “why” a second time will broaden our view and help us see that the specific behavior of particular individuals that caused the event in question was not a rare or isolated occurrence; rather, similar behavior could be observed in many other cases as well. In other words, we find that we are dealing with a relatively common phenomenon resulting from the same overall pattern of behavior. There are larger processes and long-term trends at play. It turns out, for example, that it wasn’t just Mr. Smith who lost his home; tens of thousands of similar cases were happening across the nation, all at the same time, mainly because of certain reckless practices by creditors.

Understanding the pattern of behavior explanation is empowering, for it allows us to see broader trends, which helps us anticipate future events and plan accordingly—but we have not yet arrived at the root causes. The second level of explanation calls for asking the “why” question a third time. Why is this particular pattern of behavior occurring? What elements of the system are allowing and/or incentivizing people to act in this way? To answer this question, we’d have to go into the structure of the system where the underlying  causes are to be found.

The structural explanation will help us see, for example, that the reckless practices by the creditors were made possible by the popularity of certain financial instruments on Wall Street, which in turn was due to financial deregulation many years earlier as well as decline in government oversight, and that these two trends were themselves caused by other processes or mechanisms. We would have to keep digging until we reach the root causes, i.e., the set of final elements in the causal chain that are susceptible to resolution. This is the level at which we must apply the corrective action if we are to have any real impact on the situation.

levels-of-explanation

To summarize, focusing on a particular event and asking “why” produces an event explanation, revealing only the immediate causes; problem-solvers are trapped in a reactive mode. Asking “why” a second time yields a pattern of behavior explanation, revealing the intermediate causes; problem-solvers can now respond to shifting trends instead of reacting to particular events. Asking “why” a third time leads to a structural explanation, revealing the root causes; such an explanation is generative, since it empowers the problem-solvers to exercise maximum leverage.