Tuesday, August 04, 2009

Watch what I do, not what I say 

Innovation has been essential to our prosperity in the past, and it will be essential to our prosperity in the future. But it is only by building a new foundation that we will once again harness that incredible generative capacity of the American people. -- Pres. Obama, August 1 2009.


I�m not convinced that there�s going to be another wave of innovation in the offing� to propel growth, leaving the economy facing a �long slog,� said [Nobel laureate Edmund] Phelps, a professor at Columbia University in New York.

Phelps foresees real, or inflation-adjusted, gains in gross domestic product of 2.5 percent in the years following the current slump. That�s weaker than the average expansion rate during any postwar decade except the current one, in which growth has been pulled down by two recessions. (August 3, 2009, Bloomberg News.)


But the mere availability of capital is not sufficient for innovation. Capital must also be mobile and stable (see property rights). Hernando de Soto explains that even in places where entrepreneurship is strong and capital is available, capital cannot serve the needs of potential innovators unless it is in a mobile form that allows various types of wealth to be converted into credit. This mobility includes �property document[s]� such as title deeds, which �represent the invisible potential that is locked up in the assets we accumulate.� Stability of capital is provided by the rule of law, by which the use of coercion in society is made regular and predictable. If investments cannot be insured against expropriation, possessors of capital are less likely to take the risk of investing in an innovation. Nations lacking a stable rule of law, including property rights, tend to be less prosperous and to have less innovation. -- Timothy Sandefur, The Concise Encyclopedia of Economics


Bankruptcies involve dividing a shrunken pie. But not all claims are equal: some lenders provide cheaper funds to firms in return for a more secure claim over the assets should things go wrong. They rank above other stakeholders, including shareholders and employees. This principle is now being trashed. On April 30th, after the failure of negotiations, Chrysler entered Chapter 11. Under the proposed scheme, secured creditors owed some $7 billion will recover 28 cents per dollar. Yet an employee health-care trust, operated at arm�s length by the United Auto Workers union, which ranks lower down the capital structure, will receive 43 cents on its $11 billion-odd of claims, as well as a majority stake in the restructured firm.

The many creditors who have acquiesced include banks that themselves rely on the government�s purse. The objectors have been denounced as �speculators� by Barack Obama. The judge overseeing the case has consented to a quick, �prepackaged� bankruptcy, which seems to give little scope for creditors to argue their case or pursue the alternative of liquidating the company�s assets. In effect Chrysler and the government have overridden the legal pecking order to put workers� health-care benefits above more senior creditors� claims, and then successfully argued in court that the alternative would be so much worse for creditors that it cannot be seriously considered.

In a crisis it is easy to put politics first, but if lenders fear their rights will be abused, other firms will find it more expensive to borrow, especially if they have unionised workforces that are seen to be friendly with the government. -- The Economist, May 7, 2009.

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