College students across the nation are “feeling the Bern.” Presidential candidate Bernie Sanders’ strongest base of support is among young voters. So I suppose I’m somewhat of an outlier in the mix. As an economics enthusiast, what bothers me the most are Sanders’ ridiculous economic promises. Economists across the globe have spoken out against Sanders’ lack of insight into key economic problems and their solutions. Even left-leaning economists like Nobel Laureate Paul Krugman have condemned Sanders. In a New York Times op-ed earlier this month, Krugman criticized Sanders as favoring “easy slogans over hard thinking.” But to get to the root of Sanders’ illogic, we must look closely at his policy goals.
One of Sanders’ rallying cries has been to “break up the big banks.” He has decried large financial institutions and Wall Street institutions as being responsible for financial crises and has advocated breaking them up. Sanders claims that large financial institutions are bad for American people. But is being big necessarily bad? What can we gain from breaking up banks and lending institutions?
To understand the answer, we must first look at what happened to cause the Great Recession and this banking regulation discussion in its aftermath. In the early 2000s, people all around the world wanted to invest in American real estate. Home prices were rising and investors wanted to capitalize. Wall Street financial institutions allowed people to easily invest in real estate by bundling mortgages into mortgage-backed securities. However, there weren’t enough mortgages available to meet the demand so in an effort to collect more mortgages, financial institutions began issuing sub-prime mortgages, which are mortgages issued to individuals who are likely to default on the loan. When the housing bubble burst and housing prices crashed, people who had taken out mortgages found their homes weren’t worth nearly as much as what they were paying on their mortgages and they began to default on their loans. Investors lost a lot of money. Many important financial institutions also had stakes in the real estate market so this lead to a ripple effect that ultimately led to an international financial downturn.
While it may be easy to pin the blame on big banks, even small banks were involved in the mistakes that precipitated the Great Recession. In fact, hundreds of small banks failed during the Great Recession. If the big banks do break up, next time we may have to deal with the poor financial practices of many small banks rather than a few of varying size. But what is the best approach then? Well why not start with what has already been done?
When Sanders’ refers to banks that are “too big to fail,” he is likely referring to “systemically important financial institutions” (SIFIs) which were designated by the Dodd-Frank Act as being financial institutions large enough that their collapse would prove to be a major detriment to the U.S. economy as a whole. The Dodd-Frank Act is a piece of legislation originally proposed by the Obama administration in order to improve financial regulation in the wake of the Great Recession. It stipulated that SIFIs must take special precautions against bankruptcy including detailing a plan for bankruptcy in a “living will” and holding additional amounts of equity to cushion investment losses. The Dodd-Frank Act hasn’t been perfect as some claim it isn’t strict enough on banks and there have been studies that suggest it has had an unintentionally debilitating effect on small banks. But Sanders’ plan to break up banks is no way to build on the Dodd-Frank Act.
Sanders has also spoken out against bank bailouts. The reason it is important to allow the government to bail out banks is that many people hold their money in banks. And especially for large banks, a bankruptcy could mean millions of people could lose their money. Having smaller banks means one bankruptcy would effect fewer people but small banks are also more prone to bankruptcy. In the Great Recession, hundreds of small banks went into financial insolvency while only a few large banks such as Lehman Brothers did the same. In response to the Great Depression, the FDIC (Federal Deposit Insurance Corporation) was formed to insure deposits in small banks. The maximum amount insured today is $250,000. Think of it as a mandatory bailout, only the bank still fails. However, this insurance is important to protect consumers against the mistakes of small banks. Whether a bank is big or small, bankruptcy represents a huge problem to American people and the economy as a whole. It’s clear that the size of the bank is irrelevant. Instead, there must be additional measures made to prevent banks from going into bankruptcy. This could include restrictions on risky behavior that could endanger consumers. Also, there is really no good reason why sub-prime lending should be allowed. Policy measures should be taken to address this.
Banks are tricky. Americans need them for all their financial needs. But at the same time, their demise could prove disastrous for all of us. There is a need for effective policy to control the practices of banks. But by calling to break up banks, Sanders misses the point of what is really important in regulating banks. It’s not the size that’s the problem, it’s the practices.
Another one of Sanders’ common promises is his idea for free tuition at public universities. Sanders said he would fund this proposal using a tax on Wall Street institutions. There have been many reports suggesting that a tax on Wall Street would not be enough money and that implementing such a tax would be too difficult, among other concerns. But let’s assume for a moment that Sanders does succeed in fully financing his proposal. Would it do any good?
Let’s look at a country that currently has free university education. Sri Lanka, my parents’ birthplace, is one such country. The government funds all costs for university education in Sri Lanka, but it isn’t the utopia that Sanders might suspect. With free education, supply of spots in universities is low and demand is high. This leads to a lot of competition. In order to gain entrance to universities, students in Sri Lanka must pass rigorous exams lest they risk being forced to find jobs without college degrees. Due to the cutthroat competition to land out on top on these exams, many students take “tuition classes” – paid out-of-school courses focused on improving scores on university entrance exams. Usually, it’s only the wealthy students that can afford to take such courses and score well on exams. Instead of making college accessible for underprivileged students, a system of free university education instead makes it even more difficult for them. Likewise, implementing such a system in the United States could drive college acceptance rates down and make it even more difficult for low-income students to find a place at a university.
Instead of Sanders’ poorly conceived plan, creating a system to increase need-based financial aid would be more beneficial. It would be much easier to implement since it wouldn’t require a complete overhaul of the current tuition system. Furthermore, it would ensure a more equitable distribution of tuition burden.
One of Sanders’ most frightening positions is his anti-trade views. He always finds some sort of excuse for why he opposes a particular trade deal but it usually comes down to his assertion that trade deals cost jobs. However, Sanders leaves out part of the picture. While trade deals cut jobs in some industries, they open up jobs in other industries. For instance, while Sanders constantly criticizes jobs that he says were lost due to NAFTA (North American Free Trade Agreement), he neglects to mention the jobs that were also gained. Aside from Sanders’ one source citing a loss of 800,000 jobs, most studies estimate that the net change in jobs due to NAFTA is about zero. Sanders demonstrates a clear lack of understanding of the fundamental principles of trade.
Trade hinges upon the idea of comparative advantage, by which some nations can produce goods or services more efficiently than other nations. If one nation has a comparative advantage in one industry, another nation will have a comparative advantage in another industry. So when a trade deal is put into effect, some industries will inevitably be undercut by industries abroad but at the same time, domestic industries that can outperform international industries will gain new consumers and grow. While one industry loses jobs, another gains jobs. Ultimately, efficiency increases will lead to lower prices from the involved industries. The more efficient distribution of resources will then lead to a stronger global economy.
However, Sanders uses the idea of the loss of jobs from trade to scare blue collar workers into voting for him. It was his primary tactic in the Michigan primary. Although trade deals do lead to the loss of some jobs, the responsible act as a U.S. policymaker would be to implement measures to reduce temporary frictional unemployment that results from trade deals. For instance, creating and supporting job training programs as well as assisting with job search could help people losing jobs from trade find jobs in other industries that can withstand international competition.
I do believe Sanders’ intentions are sincere – which is something I can’t say of all the current presidential candidates. He truly does want to help improve this country. But his lack of foresight in economic matters proves to be his Achilles’ heel – at least in my book. This country deserves someone not only with the heart to help America but the mind as well. I just don’t see that in Bernie Sanders.