Crowding out the Confidence Fairies

David Dayen wrote a nice -- and depressing -- piece on the state of our national economic discourse this past Monday in the American Prospect, I Ruined the Economy and All I Got Were These Lousy Tax Cuts.


The takeaway:
“Curtailing the one major consumer [the federal government] that is continuing to consume—it’s just a terrible idea, especially when you have a major demand gap,” says Michael Linden of the Center for American Progress.  Unfortunately, Dayen concludes, the Obama administration seems to have conceded that terrible idea; what remains is a negotiation over how 'terrible' to make it.


When the debt ceiling deal is done (or even if it isn't), it appears we are about to disappear into a Japan-style economic black hole.  One possible result of this might be a political re-alignment that brings to the foreground all the critical issues about our political economy that we have neglected for so long -- sustainability, inequality, etc.  A more likely outcome is that the American voters will respond by giving more power to those portions of the GOP that dug the hole in the first place, and who promise to keep digging.  The Democrats will promise to dig with a smaller shovel.  The shovel will be sold by an American corporation, but manufactured abroad.  We will buy it with a credit card.


The GOP leadership routinely uses the phrase 'job-killing government spending,' claiming that that spending crowds out private investment, thus destroying jobs.  Obviously the flip-side of this argument is that employment will soar with massive cuts in public spending -- essentially giving us the Republican position on the debt and deficit at the moment.  Of course, it is entirely reasonable for conservatives to question the size of government.  They believe that there is an inverse relationship between big government and individual freedom (and a robust civil society).  While I think this view is ill-informed in a modern economy -- it misunderstands the material preconditions of both individual liberty and community viability -- I don't want to dispute it here.  Clearly the conservative view creates a predisposition against public spending.  That predisposition plays a valuable role in public discourse.  Indeed, one hopes that people from all parts of the political spectrum desire government intervention to be efficient, effective, and only as big and enduring as is necessary.


But what is going on right now is not a debate about the size of government.  It has been said many times that budgets are philosophical documents; embedded within them are assumptions about both 'is' and 'ought,' and a path from one to the other.  David Leonhardt puts it well:

The goal of deficit reduction can’t simply be arithmetic. It has to be philosophical, as well. In what ways is the private sector incapable of planting the seeds of future economic growth — and what, therefore, must the government do? What’s the least amount of spending needed to ensure a decent life for even the most vulnerable citizens? Who is in the best position to pay that money? 

As I argue below, I think the present emphasis of our political elite on reducing the deficit is misplaced, particularly if we refuse to understand its sources, the logical remedies, and the vital role that addressing the present downturn aggressively must play in future deficit reduction.  Republicans are making a series of empirical claims that are demonstrably false.  Democrats -- the White House in particular -- has failed to challenge these claims.  Leonhardt makes a useful distinction between the "deficit we have" and the "deficit we imagine."  The one we 'imagine' is a deficit caused by "waste, fraud, abuse, foreign aid, oil industry subsidies and vague out-of-control public spending."  This view is fueled by the hyperbolic (and false) claims of the Tea Party wing of the GOP that President Obama has massively expanded the size of government, threatening the very existence of American capitalism.  The 'deficit we have' is caused by the world’s highest health costs (by far), the world’s largest military (by far), irresponsible tax cuts — and "to pay for it all, the lowest tax rates in decades."  One might also add in decades of wage stagnation for most American families.


The end result is that we continue to avoid the philosophical issues raised above, relying instead on demonstrably false assumptions about government spending, taxation, job growth, and the relationships between them.


Of course, we could just do nothing, too, couldn't we?  Take a look at the CBO's long-term budget outlook, below:





If Congress lets the Bush tax cuts expire (or offsets their extension in some way), implements the Affordable Care Act as scheduled, and makes or offset the Medicare cuts prescribed by the 1997 Balanced Budget Act — which CBO calls the “extended baseline scenario” — the national debt will be totally manageable, as Ezra Klein points out.  If Congress extends the Bush tax cuts with no offsets, repeals ACA and its cost controls, and protects doctors from Medicare cuts without making up the savings elsewhere (the 'alternative fiscal scenario'), then the national debt goes out of control.


Is government spending killing jobs, as Rep. Boehner and others assert?   If public spending were financed by large tax increases or high interest rates, this position might be reasonable.  But the Obama stimuli have involved deficit spending, with interest rates up against the zero-bound.  Given that, there is no reason to think that government purchases of equipment (or labor) destroy jobs, while private purchases don't.  As Alan Blinder has recently pointed out, business investment in equipment and software has been booming, not sagging.  While real GDP grew only 2.3% over the last 4 quarters, business spending on equipment and software jumped 14.7%.  There is no 'crowding out.'  Indeed, the more reasonable position -- take a look at the retraction of spending at the state and local level -- is that in the present environment, budget cuts are killing jobs.  In this environment, the 'crowding out' argument isn't relevant; it seems to be based on ideology rather than evidence.  Worse, the budget cuts open for discussion at the moment tend be from those (discretionary) parts of the government with the best track record of "turning today’s spending into tomorrow’s economic growth," as Leonhardt puts it.  But if one assumes that all public spending is wasteful, we force ourselves to wait (how long?) for some other force to magically generate economic growth.


Republicans argue that cutting the deficit in the near term (exclusively through budget cuts, it appears) will cue the Confidence Fairies, spurring investment, economic growth and job creation all by itself.  Of course, there are plenty of good reasons to doubt this ”expanding by contracting” theory.  David Cameron's Britain cut $180 billion from its budget last year; the economy shrank, and real household income dipped to its lowest level since the 1930s.  We don't have to cross the Atlantic for case studies, however.  Just take a look at our state governments, most of which are forced by their constitutions to maintain balanced budgets.  As study after study has indicated, state-level layoffs and cuts have deepened and prolonged the recession, overwhelming Obama's inadequate stimulus.  At a time when government at all levels needs to jump into the demand breach -- or at least not exacerbate it -- we have seen nothing of the kind.  Dubious GOP complaints of a massive expansion of government under Obama notwithstanding, our problem is very much the opposite.


Bond trader Bill Gross of PIMCO -- hardly a liberal -- essentially made the same case the other day, in a mid-month note to his investors.  Gross criticized the “anti-Keynesians” in both parties who believe “that fiscal conservatism equates to job growth.”  The truth, he says, is just the opposite. “Fiscal balance alone will not likely produce 20 million jobs over the next decade. The move towards it, in fact, if implemented too quickly, could stultify economic growth.”  What is needed, rather, is for government to "temporarily assume a bigger, not a smaller, role in this economy, if only because other countries are dominating job creation with kick-start policies that eventually dominate global markets.”  Deficit reduction "can wait for a stronger economy and lower unemployment. Jobs are today’s and tomorrow’s immediate problem.”


Deficits matter in the long run, but first we must survive the short run.  As Keynes once put it, "in the long run, we are all dead."


One wonders where the GOP thinks employment will come from?  Presumably we can all find work drowning the government in Grover Norquist's bathtub?  Perhaps this is what Schumpeter meant by 'creative destruction.'  Let's burn down the house, and groove on the ruins, man.  Sometime I wonder if they hope that the economic apocalypse that may result from debt default will itself stimulate demand, by causing all of us to party like there is no tomorrow in anticipation of the impending (Ayn) Randian rapture...


Sadly, the Obama Administration appears to have swallowed the idea that the Austerity Angels will soon descend, if only we give them the proper burnt offering.  Last week, several White House officials, including Director of the National Economic Council Gene Sperling, stressed deficit reduction as the primary component of their economic-growth strategy, and repeatedly claimed that reducing the deficit would generate “confidence."


It isn't entirely clear how 'confidence' is supposed to lead to job creation -- particularly when business surveys leave little doubt that hiring is presently limited by a lack of demand, not fears of regulation, taxation, and government spending.  The most recent National Federation of Small Business Confidence Survey starts out like this:

“The proximate cause [of the decline in small biz optimism] is the fact that 1 in 4 owners still reports weak sales as their top business problem. Consumer spending is weak, especially for “services,” a sector dominated by small businesses.”

Dayen usefully points out that since Larry Summers left, Obama's economic team is now fully controlled by financiers and political operatives.  The former, not surprisingly, fear bondholders more than they fear voters; the latter seem to view debt and deficits through a moral lens (rather than an empirical and long-term one), and believe that independents will only respect Democratic administrations that model 'toughness.'  I believe it was Groucho Marx who once described politics as "the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies."  Obviously we have profound long-term deficit and debt issues.  It is unclear to me how near-term austerity -- which will assure us anemic economic growth for years, while limiting our ability to investment in infrastructure and human capital -- can address this.  Indeed, cuts now will make it harder for us to address these issues, not easier.


I still maintain that this crisis has presented us with a great opportunity, a chance to plant the seeds for a new political economy, one that is sustainable in every sense (economically, political, ecologically, morally).  There’s a lot of slack in the economy and borrowing costs are historically low -- if the government financed this borrowing at the 30-year TIPS rates, we’d be looking at an interest rate of 1.79% as of last Friday!


What would those 'seeds' look like?  I'll say a lot more about this in a future post, but for starters:


*  Massive investment in public, universal and high quality early childhood education
*  An infrastructure bank, as Senator John Kerry has proposed
*  Investment in and modernization of our public health infrastructure
*  Real financial reform (see Simon Johnson and Elizabeth Warren)
*  Using tax incentives, regulations and the federal purse to expand the rental and cooperative sectors of the housing market
*  Moving away from sprawl, and racial/economic segregation in our metropolitan areas 


Do you hear that crunching?  That's your political elite, eating your seed corn.