excerpted from the book
The Great Unraveling
Losing our way in the new century
by Paul Krugman
WW Norton, 2003, hardcover
The comentariat mainly consists of people who live in Washington
and go to the same dinner parties. This in itself foments groupthink;
at any given moment there is a story line that shapes journalists'
perceptions. Until September 11 this story line had it that George
W. Bush was dumb but honest; after September 11 the new story
was that he was a tough-minded hero, all determination and moral
clarity, "Texas Ranger to the world." (Yes, one prominent
pundit actually wrote that.) The overwhelming evidence that neither
of these pictures bore any resemblance to reality was simply brushed
... The stock in trade of most journalists
is inside information-leaks from highly placed sources, up-close-and-personal
interviews with the powerful. This leaves them vulnerable: they
can be seduced with offers of special access, threatened with
the career-destroying prospect that they will be frozen out.
"Nothing is more important in the face of a war than cutting
House majority leader Tom DeLay
... one should regard America's right-wing movement-which now
in effect controls the administration, both houses of Congress,
much of the judiciary, and a good slice of the media-as a revolutionary
power (in Kissinger's sense) That is, it is a movement whose leaders
do not accept the legitimacy of our current political system.
... there's ample evidence that key elements
of the coalition that now runs the country believe that some long-established
American political and social institutions should not, in principle,
exist-and do not accept the rules that the rest of us have taken
Consider, for example, the welfare state
as we know it-New Deal programs like Social Security and unemployment
insurance, Great Society programs like Medicare. If you read the
literature emanating from the Heritage Foundation, which drives
the Bush administration's economic ideology, you discover a very
radical agenda: Heritage doesn't just want to scale back New Deal
and Great Society programs, it regards the very existence of those
programs as a violation of basic principles.
Or consider foreign policy. Since World
War lithe United States has built its foreign policy around international
institutions, and has tried to make it clear that it is not an
old-fashioned imperialist power, which uses military force as
it sees fit. But if you follow the foreign policy views of the
neoconservative intellectuals who fomented the war with Iraq,
you learn that they have contempt for all that-Richard Perle,
chairman of a key Pentagon advisory board, dismissed the "liberal
conceit of safety through international law administered by international
institutions." They aren't hesitant about the use of force;
one prominent thinker close to the administration, Michael Ledeen
of the American Enterprise Institute, declared that "we are
a warlike people and we love war." The idea that war in Iraq
is just a pilot project for a series of splendid little wars seemed,
at first, a leftist fantasy-but many people close to the administration
have made it clear that they regard this war as only a beginning,
and a senior State Department official, John Bolton, told Israeli
officials that after Iraq the United States would "deal with"
Syria, Iran, and North Korea.
Nor is even that the whole story. The
separation of church and state is one of the fundamental principles
of the U.S. Constitution. But Tom DeLay, the House majority leader,
has told constituents that he is in office to promote a "biblical
worldview"-and that his relentless pursuit of Bill Clinton
was motivated by Clinton's failure to share that view. (DeLay
has also denounced the teaching of evolution in schools, going
so far as to blame that teaching for the Columbine school shootings.)
There's even some question about whether
the people running the country accept the idea that legitimacy
flows from the democratic process. Paul Gigot of The Wall Street
Journal famously praised the "bourgeois riot" in which
violent protestors shut down a vote recount in Miami. (The rioters,
it was later revealed, weren't angry citizens; they were paid
political operatives.) Meanwhile, according to his close friend
Don Evans, now the secretary of commerce, George W. Bush believes
that he was called by God to lead the nation. Perhaps this explains
why the disputed election of 2000 didn't seem to inspire any caution
or humility on the part of the victors. Consider Justice Antonin
Scalia's response to a student who asked how he felt making the
Supreme Court decision that threw the election to Bush. Was it
agonizing? Did Scalia worry about the consequences? No: "It
was a wonderful feeling," he declared.
Lulled by a period of stability which
had seemed permanent, they find it nearly impossible to take at
face value the assertion of the revolutionary power that it means
to smash the existing framework. The defenders of the status quo
therefore tend to begin by treating the revolutionary power as
if its protestations were merely tactical; as if it really accepted
the existing legitimacy but overstated its case for bargaining
purposes; as if it were motivated by specific grievances to be
assuaged by limited concessions. Those who warn against the danger
in time are considered alarmists; those who counsel adaptation
to circumstance are considered balanced and sane .... But it is
the essence of a revolutionary power that it possesses the courage
of its convictions, that it is willing, indeed eager, to push
its principles to their ultimate conclusion.
Dan Altman of The New York Times points out, if you take the administration's
tax proposals as a group, they effectively achieve a longstanding
goal of the radical right: an end to all taxes on income from
capital, moving us to a system in which only wages are taxed-a
system, if you like, in which earned income is taxed but unearned
income is not.
The young Kissinger had it right: people who have been accustomed
to stability can't bring themselves to believe what is happening
when faced with a revolutionary power, and are therefore ineffective
in opposing it.
... why we are now faced with such a radical
challenge to our political and social system. Rich people did
very well in the 1990s; why this hatred of anything that looks
remotely like income redistribution? Corporations have flourished;
why this urge to strip away modest environmental regulation? Churches
of all denominations have prospered; why this attack on the separation
of church and state? American power and influence have never been
greater; why this drive to destroy our alliances and embark on
military adventures? Nonetheless, it's increasingly clear that
the right wants to do all these things.
Journalists find it very hard to deal with blatantly false arguments;
by inclination and training, they always try to see two sides
to an issue, and find it hard even to conceive that a major political
figure is simply lying about the content of his proposals.
David Wessel of The Wall Street Journal wrote about a White House
aide who said one thing on the record and the opposite off the
record; when Wessel protested, the aide replied: "Why would
I lie? Because that's what I'm supposed to do. Lying to the press
doesn't prick anyone's conscience."
When you learn that the architects of the Iraq war have wanted
to topple Saddam Hussein for a decade, you can surmise that the
war has nothing to do with responding to September 11.
... a revolutionary power, which does not regard the existing
system as legitimate, doesn't feel obliged to play by the rules.
Are there hints of scandal regarding administration personnel?
No matter: Fox News, The Washington Times, and The New York Post
won't follow up on the story-instead they'll harass other media
outlets if they try to make it an issue. Are there complaints
about how homeland security is being handled? A sudden rash of
terror alerts will drown out the story. "But they wouldn't
do that!" protest reasonable people-and a normal regime wouldn't.
But we're not dealing with a normal regime here, we're dealing
with a revolutionary power.
A revolutionary power, which doesn't accept the legitimacy of
the existing system, also doesn't accept the right of others to
criticize its actions. Anyone who raises questions can expect
a no-holds-barred counterattack.
... those who question or criticize the administration are demonized,
their ethics questioned, their careers destroyed if possible.
"The distinguishing feature of a
revolutionary power is not that it feels threatened . . . but
that nothing can reassure it (Kissinger's emphasis). Only absolute
security-the neutralization of the opponent-is considered a sufficient
... the administration's real goal ... was to eliminate taxation
of capital income and sharply reduce if not eliminate the progressively
of the tax system ...
There must be limits somewhere to what the right will actually
attempt to accomplish. It may move us to a tax system in which
poor people pay a higher share of their income than rich people,
but it won't take us to a system where rich people actually pay
less than poor people-or will it? It may go on from Iraq to Syria
and Iran, but it won't start threatening already democratic countries
with military force-or will it? I don't know where the right's
agenda stops, but I have learned never to assume that it can be
appeased through limited concessions. Pundits who predict moderation
on the part of the Bush administration, on any issue, have been
consistently wrong. Kissier again: "It is the essence of
a revolutionary power that it possesses the courage of its convictions,
that it is willing, indeed eager, to push its principles to their
"Those who warn against the danger are considered alarmists;
those who counsel adaptation to circumstance are considered balanced
SUCCEEDING IN BUSINESS
July 7, 2002
On Tuesday, George W. Bush is scheduled
to give a speech intended to put him in front of the growing national
outrage over corporate malfeasance. He will sternly lecture Wall
Street executives about ethics and will doubtless portray himself
as a believer in old-fashioned business probity.
Yet this pose is surreal, given the way
top officials like Secretary of the Army Thomas White, Dick Cheney
and Mr. Bush himself acquired their wealth. As Joshua Green says
in The Washington Monthly, in a must-read article written just
before the administration suddenly became such an exponent of
corporate ethics: "The 'new tone' that George W. Bush brought
to Washington isn't one of integrity, but of permissiveness ....
In this administration, enriching oneself while one's business
goes bust isn't necessarily frowned upon."
Unfortunately, the administration has
so far gotten the press to focus on the least important question
about Mr. Bush's business dealings: his failure to obey the law
by promptly reporting his insider stock sales. It's true that
Mr. Bush's story about that failure has suddenly changed, from
"the dog ate my homework" to "my lawyer ate my
homework-four times." But the administration hopes that a
narrow focus on the reporting lapses will divert attention from
the larger point: Mr. Bush profited personally from aggressive
accounting identical to the recent scams that have shocked the
In 1986, one would have had to consider
Mr. Bush a failed businessman. He had run through millions of
dollars of other people's money, with nothing to show for it but
a company losing money and heavily burdened with debt. But he
was rescued from failure when Harken Energy bought his company
at an astonishingly high price. There is no question that Harken
was basically paying for Mr. Bush's connections.
Despite these connections, Harken did
badly. But for a time it concealed its failure-sustaining its
stock price, as it turned out, just long enough for Mr. Bush to
sell most of his stake at a large profit-with an accounting trick
identical to one of the main ploys used by Enron a decade later.
(Yes, Arthur Andersen was the accountant.) As I explained in my
previous column, the ploy works as follows: corporate insiders
create a front organization that seems independent but is really
under their control. This front buys some of the firm's assets
at unrealistically high prices, creating a phantom profit that
inflates the stock price, allowing the executives to cash in their
That's exactly what happened at Harken.
A group of insiders, using money borrowed from Harken itself,
paid an exorbitant price for a Harken subsidiary, Aloha Petroleum.
That created a $10 million phantom profit, which hid three-quarters
of the company's losses in 1989. White House aides have played
down the significance of this maneuver, saying $10 million isn't
much, compared with recent scandals. Indeed, it's a small fraction
of the apparent profits Halliburton created through a sudden change
in accounting procedures during Dick Cheney's tenure as chief
executive. But for Harken's stock price-and hence for Mr. Bush's
personal wealth-this accounting trickery made all the difference.
Oh, and Harken's fake profits were several
dozen times as large as the Whitewater land deal-though only about
one-seventh the cost of the Whitewater investigation.
Mr. Bush was on the company's audit committee,
as well as on a special restructuring committee; back in 1994,
another member of both committees, E. Stuart Watson, assured reporters
that he and Mr. Bush were constantly made aware of the company's
finances. If Mr. Bush didn't know about the Aloha maneuver, he
was a very negligent director.
In any case, Mr. Bush certainly found
out what his company had been up to when the Securities and Exchange
Commission ordered it to restate its earnings. So he can't really
be shocked over recent corporate scams. His own company pulled
exactly the same tricks, to his considerable benefit. Of course,
what really made Mr. Bush a rich man was the investment of his
proceeds from Harken in the Texas Rangers-a step that is another,
equally strange story.
The point is the contrast between image
and reality. Mr. Bush portrays himself as a regular guy, someone
ordinary Americans can identify with. But his personal fortune
was built on privilege and insider dealings-and after his Harken
sale, on large-scale corporate welfare. Some people have it easy.
THE INSIDER GAME
July 12, 2002
The current crisis in American capitalism
isn't just about the specific details-about tricky accounting,
stock options, loans to executives, and so on. It's about the
way the game has been rigged on behalf of insiders.
And the Bush administration is full of
such insiders. That's why President Bush cannot get away with
merely rhetorical opposition to executive wrongdoers. To give
the most extreme example (so far), how can we take his moralizing
seriously when Thomas White-whose division of Enron generated
$500 million in phony profits, and who sold $12 million in stock
just before the company collapsed-is still secretary of the Army?
Yet everything Mr. Bush has said and done
lately shows that he doesn't get it. Asked about the Aloha Petroleum
deal at his former company Harken Energy-in which big profits
were recorded on a sale that was paid for by the company itself,
a transaction that obviously had no meaning except as a way to
inflate reported earnings-he responded, "There was an honest
difference of opinion... sometimes things aren't exactly black-and-white
when it comes to accounting procedures."
And he still opposes both reforms that
would reduce the incentives for corporate scams, such as requiring
companies to count executive stock options against profits, and
reforms that would make it harder to carry out such scams, such
as not allowing accountants to take consulting fees from the same
firms they audit.
The closest thing to a substantive proposal
in Mr. Bush's tough-talking, nearly content-free speech on Tuesday
was his call for extra punishment for executives convicted of
fraud. But that's an empty threat. In reality, top executives
rarely get charged with crimes; not a single indictment has yet
been brought in the Enron affair, and even "Chainsaw Al"
Dunlap, a serial book-cooker, faces only a civil suit. Arid they
almost never get convicted. Accounting issues are technical enough
to confuse many juries; expensive lawyers make the most of that
confusion; and if all else fails, big-name executives have friends
in high places who protect them.
In this as in so much of the corporate
governance issue, the current wave of scandal is prefigured by
President Bush's own history.
An aside: Some pundits have tried to dismiss
questions about Mr. Bush's business career as unfair-it was long
ago, and hence irrelevant. Yet many of these same pundits thought
it was perfectly appropriate to spend seven years and $70 million
investigating a failed land deal that was even further in Bill
Clinton's past. And if they want something more recent, how about
reporting on the story of Mr. Bush's extraordinarily lucrative
investment in the Texas Rangers, which became so profitable because
of a highly incestuous web of public policy and private deals?
As in the case of Harken, no hard work is necessary; Joe Conason
laid it all out in Harper's almost two years ago.
But the Harken story still has more to
teach us, because the S.E.C. investigation into Mr. Bush's stock
sale is a perfect illustration of why his tough talk won't scare
Mr. Bush claims that he was "vetted"
by the S.E.C. In fact, the agency's investigation was peculiarly
perfunctory. It somehow decided that Mr. Bush's perfectly timed
stock sale did not reflect inside information without interviewing
him, or any other members of Harken's board. Maybe top officials
at the S.E.C. felt they already knew enough about Mr. Bush: his
father, the president, had appointed a good friend as S.E.C. chairman.
And the general counsel, who would normally make decisions about
legal action, had previously been George W. Bush's personal lawyer-he
negotiated the purchase of the Texas Rangers. I am not making
Most corporate wrongdoers won't be quite
as well connected as the young Mr. Bush; but like him, they will
expect, and probably receive, kid-glove treatment. In an interesting
parallel, today's S.E.C., which claims to be investigating the
highly questionable accounting at Halliburton that turned a loss
into a reported profit, has yet to interview the C.E.O. at the
time Dick Cheney.
The bottom line is that in the last week
any hopes you might have had that Mr. Bush would make a break
from his past and champion desperately needed corporate reform
have been shed. Mr. Bush is not a real reformer; he just plays
one on TV.
THE OUTRAGE CONSTRAINT
August 23, 2002
The high pay of America's C.E.O.'s reflects
intense competition among companies for the best managerial talent.
Stock options and other typical forms of executive compensation
are designed to provide incentives for performance. These incentives
align the personal interests of managers with those of shareholders.
Nothing in the preceding paragraph is
true. That's the message of an extraordinary research paper circulated
by the National Bureau of Economic Research, an economics think
tank. The paper is must reading for anyone trying to understand
what's really going on in our economy.
I first read this paper, "Executive
compensation in America: Optimal contracting or extraction of
rents?" by Lucian Bebchuk, Jesse Fried and David Walker (of
Harvard, Berkeley and Boston University respectively), last December.
It was largely due to their analysis that I concluded, early in
the game, that Enron would be only the first of many scandals.
What they show is that the official theory
of the corporation, in which the C.E.O. serves at the pleasure
of a board that represents shareholder interests, is thoroughly
misleading. In practice, modern C.E.O.'s set their own compensation,
limited only by the "outrage constraint"-outrage not
on the part of the board, whose members depend on the C.E.O.'s
good will for many of their perks, but on the part of outside
groups that can make trouble. And the true purpose of many features
of executive pay packages is not to provide incentives but to
provide "camouflage"-to let C.E.O.'s reward themselves
lavishly while minimizing the associated outrage.
The most obvious case in point is stock
options. There is a good argument for linking an executive's pay
to his company's stock price, but a true incentive scheme would
have features that one almost never sees in practice. For example,
an executive's pay should depend on his company's stock price
compared with a benchmark index composed of other, similar companies,
so that what he gets reflects the job he is doing, not general
In fact, however, a C.E.O. almost always
receives stock options at the current market price-end of story.
If the stock price goes up, he cashes in. If it goes down, he
receives new options at the lower price. There are, to be fair,
quirks in the tax law that encourage this practice. But the main
reason executives are paid this way is that it gives them an almost
sure thing-unless the stock falls steadily, sooner or later an
executive who keeps getting options at the current price makes
a lot of money-yet does so in a way that camouflages the sweetness
of the deal. The options grant often isn't even counted as a corporate
expense, and the payoff, when it comes, can always be represented
as a reward for achievement.
Thanks to the growing skill of companies
at camouflage, and also to a steady erosion of old inhibitions
against apparent excess, the average pay of C.E.O.'s at major
companies has skyrocketed. It was "only" 40 times that
of an average worker a generation ago; it's 500 times as much
today. That's a lot of money, but the direct expense is not the
main problem. Instead, it's the fact that the tricks used to camouflage
exorbitant pay give executives an enormous incentive to get the
stock price up in time to cash in their options.
We're only beginning to see the extent
to which that incentive distorts corporate behavior. We now know
that some companies engaged in grandiose programs of acquisition
and expansion that ended in grief-but only after top executives
had profited immensely. We also know that companies eager to meet
or surpass analysts' expectations engaged in creative accounting
on a grand scale: in each of the last few years of the bubble
most big companies reported double-digit profit growth, yet national
statistics show that true corporate profits were hardly growing
I'm not claiming that C.E.O.'s are conscious
villains, twirling their mustaches and chortling over their evil
doings. People are very good at rationalizing their actions-even
Jeff Skilling reportedly regards himself as a victim-and the great
majority of C.E.O.'s surely stayed within the letter of the law.
But the fact is that we have a corporate
system that gives huge incentives for bad behavior.
BUSINESS AS USUAL
October 22, 2002
The mood among business lobbyists, according
to a jubilant official at the Heritage Foundation, is one of "optimism,
bordering on giddiness." They expect the elections on Nov.
5 to put Republicans in control of all three branches of government,
and have their wish lists ready. "It's the domestic equivalent
of planning for postwar Iraq," says the official.
The White House also apparently expects
Christmas in November. In fact, it is so confident that it has
already given business lobbyists the gift they want most: an end
to all this nonsense about corporate reform. Back in July George
W. Bush declared, "Corporate misdeeds will be found and will
be punished," touting a new law that "authorizes new
funding for investigators and technology at the Securities and
Exchange Commission to uncover wrongdoing." But that was
then; don't you know there's a war on?
The first big step in undermining reform
came when Harvey Pitt, chairman of the S.E.C., backtracked on
plans to appoint a strong and independent figure to head a new
accounting oversight board.
But that was only a prelude. The S.E.C.
has been underfunded for years, and most observers-including Richard
Breeden, who headed the agency when Mr. Bush's father was president-thought
that even the budget Mr. Bush signed back in July was seriously
inadequate. But now the administration wants to cancel most of
the "new funding" Mr. Bush boasted about.
Administration officials claim that the
S.E.C. can still do its job with a much smaller budget. But the
S.E.C. is ludicrously underfinanced: staff lawyers and accountants
are paid half what they could get in the private sector, usually
find themselves heavily outnumbered by the legal departments of
the companies they investigate, and often must do their own typing
and copying. Officials say there are investigations that they
should pursue but can't for lack of resources. And the new law
expands the S.E.C.'s responsibilities.
So what's going on? Here's a parallel.
Since 1995 Congress has systematically forced the Internal Revenue
Service to shrink its operations; the number of auditors has fallen
by 28 percent. Yet it's clear that giving the I.R.S. more money
would actually reduce the federal budget deficit; the agency estimates
that it loses at least $30 billion a year in uncollected taxes,
mainly because high-income taxpayers believe they can get away
with tax evasion. So starving the I.R.S. isn't about saving money,
it's about protecting affluent tax cheats.
Similarly, top officials don't really
believe that the S.E.C. can do its job with less money; the whole
point is to prevent the agency from doing its job.
In retrospect, it's hard to see why anyone
believed that our current leadership was serious about corporate
reform. To an extent unprecedented in recent history, this is
a government of, by and for corporate insiders. I'm not just talking
about influence, I'm talking about personal career experience.
The Bush administration contains more former C.E.O.'s than any
previous administration, but as James Surowiecki put it in The
New Yorker, "Almost none of the C.E.O.'s on the Bush team
headed competitive, entrepreneurial businesses." Instead
they come out of a world of "crony capitalism, in which whom
you know is more important than what you do and how you do it."
Why would they turn their backs on that world?
And don't forget the personal incentives.
Almost all of those ex-C.E.O.'s in the administration became wealthy
thanks to the connections they had acquired in Washington; the
exception is Mr. Bush himself, who became wealthy thanks to the
connections his father had acquired in Washington. This process
continues. Senator Phil Gramm, who pushed through legislation
that exempted Enron's trading practices from regulation while
his wife sat on the company's board, is retiring and taking a
new job: he's going to UBS Warburg, the company that bought Enron's
trading operation. Somehow, crusaders against business abuse don't
get similar offers.
The bottom line is that you shouldn't
worry about those TV images of men in suits doing the perp walk.
That was for public consumption; now that the public is focused
on other things, it's back to business-insider business-as usual.