From today's FT.
Despite his clear electoral mandate and big Democratic majorities in Congress, politics is already blocking Barack Obama's efforts to deliver a fast fiscal stimulus. The country's political system was designed to force debate and delay action, and it works. Even when all of Washington agrees that speed is crucial - which it does - getting anything done is still difficult. Mr Obama has clout and his party is pretty much in control. But these factors are confounded by the sheer scale and complication of the stimulus plan.
Some of Mr Obama's team dared to hope that a stimulus bill would be on the president's desk awaiting his signature by the time of his inauguration on January 20. The new target is the President's Day recess on February 13, and Democrats in Congress no less than Republicans are warning that this will be hard to achieve. The American recovery and reinvestment plan will not move forward in one piece but will be written bit by bit in committee. House and Senate versions will have to be reconciled, more changes made and further votes taken. "Congress must work its will," says Nancy Pelosi, speaker of the House.
There is fundamental disagreement about strategy, too. In large part, this is the familiar Democratic-Republican divide over spending increases or tax cuts, Democrats preferring the former and Republicans the latter. Mr Obama is proposing a sensible compromise: an $800bn (€594bn, £527bn) two-year package, split roughly 60:40 in favour of spending increases.
Many Democrats resent the concession to Republican preferences. Many Republicans want the tax cuts to be permanent; others, having acquiesced for years in the fiscal incontinence of the Bush administration, have decided on the downslope of a severe recession to become fiscal conservatives.
That is an outrageous imposture and Democrats' exasperation is justified. In view of his party's majorities, why then does Mr Obama not simply ignore the Republicans? One reason is that the new influx of Democrats includes a draught of winners in close contests who tend more than the party average towards fiscal conservatism. Another is the lack of a filibuster-proof majority in the Senate. A third is that US public opinion is itself more centrist than the congressional Democratic leadership, and wary of vast new spending initiatives. The country has already seen hundreds of billions spent or committed to little apparent effect. There is no clamour for the next trillion.
Mr Obama's first big speech on his plan last week was mainly addressed to those concerns. He underlined the risks of doing nothing and the opportunity to boost the economy's longer-term growth by investing in new and better infrastructure. He is right to offer reassurance and to wish to keep voters onside. In this, some political cover from Republicans would be valuable and is worth a political price. Many in his party, though, still care more about punishing their opponents. Their instincts say that if the enemy likes it, the policy must be wrong. Many Republicans take the same view, of course. The consensus Mr Obama seeks will not come easily.
One can only hope that Democrats and Republicans wake up to the gravity of the situation and quickly compromise on the structure of the plan. Once they do that, they can attend to its real, as opposed to imagined, defects.
So far as the structure goes, a mix of temporary tax cuts and high-impact spending (albeit with a strong bias towards the latter) is wise, even though tax cuts, as Democrats say, most likely have a smaller total effect on aggregate demand. Since it is difficult to ramp up spending quickly on this scale without waste, you can make a good case for diversifying the bundle of measures to include some well-targeted tax relief. Why dig in on the wickedness of any and all tax cuts, except to annoy Republicans? It is childish. As for the Republicans' new access of fiscal responsibility, they should first have some shame, and then get the timing right: big fiscal stimulus this year and next, credible steps to reign back spending and borrowing beyond.
This is where the real problems with the Obama plan lie - not in its basic structure (though a clearer plan for dealing with the still mounting tide of home loan foreclosures, among other things, would not go amiss), but in its scale and in its unaddressed long-term implications.
If anything, $800bn over two years now looks too small. The recession appears to be accelerating and the shortfall in demand seems likely to be bigger than the $1,000bn in 2009 that Mr Obama mentioned in his speech last week. The implications for unemployment are correspondingly dire. A stimulus of $500bn to $750bn in 2009 should be the aim. The bigger the number, the stronger the case for including temporary tax cuts in the plan. In this respect, perhaps, a bigger stimulus would improve the prospects for a deal between the two parties.
Yet even without this necessary further stimulus, the longer-term outlook for the budget deficit is alarming. The current estimate for 2009 is $1,200bn, roughly 8 per cent of gross domestic product, not counting the new plan. In later years, on unchanged policies, an enormous deficit is projected to persist. Sooner than it thinks, Washington will have to change those policies. Otherwise, in the next iteration of this crisis, the global capital market will intervene. Plans for medium-term fiscal consolidation - higher taxes and lower spending - need to be framed now and must be made to conform to the short-term stimulus. Next week I will suggest how this can be done.
Copyright © 2009 by The Atlantic Monthly Group. All rights reserved.
Goodness, such self-righteousness. And yet, there are many people with Ph.D.'s in economics (like Greg Mankiw) who don't share the author's confidence. How do we know that those economists are not just wrong, but engaged in outrageous imposture, while the author is right?
Something that the econo-pundits are truly missing the boat on is the relative impact of tax-cuts versus spending, i.e., their economic multipliers. The notion that tax cuts will have a lower multiplier (as low as 1.0, or no added effect) is only valid if that tax cut is accompanied by an equal drop in government spending. When you have a tax cut that is financed by deficit spending, as in the current proposal, the multipliers should in fact be equal (I hear an accepted value is 1.5), or at least indiscernible.
A deficit spending financed tax cut (which we have been doing for nearly 8 years now) IS a government spending plan. Given a shortage of "shovel-ready" projects (which is what I have heard we are facing) it is only sensible to allow businesses and private individuals to dictate the manner in which the stimulus money is spent. If one could argue that there were more (or less) shovel-ready projects, then a case could be made for altering the current ratio.
Clive, you didn't put in a link to the FT story.
And a question: presuming the short-term stimuli work, shovel-ready projects get going, states stabilize their budgets enough to quit the slash-and-burn budget cuts, etc., wouldn't the resulting confidence and need provide additional growth?
I'm looking for a lot of new business to be launched, particularly by folks who need to create jobs for themselves. Some of the industries I think will grow include:
- the construction-related industry with a focus on improving home efficiencies; an industry for closing in all those hard-to-heat cathedral ceiling in McMansion great rooms;
- auto-mechanics trades; with a lot of innovation going into converting older cars to bio-fuels and diesel; salvaging the lighter cars built up to the early 1990's for another life on the road. Perhaps conversions to electric;
- DIY suppliers -- companies that sell fabric and tools for people making their own clothing and home-decorating items;
- Alternative-health care industries -- the experience of a prescription that's prescribed to solve a problem and creates even worse problems is too common and expensive. "Traditional" Western health care is often no longer available or affordable to many folks. Alternative healers offer products that don't seem so toxic, and their time and attention, the greatest healer of all.
I'm also expecting big growth in the foreclosure, bankruptcy, credit-counseling industries, divorce, and (hopefully) marriage counseling industries.
But most of the growth I'm expecting is in small business; from men and women who have families to support, lives to build, and their only means of doing so is to build their own business based on the needs they see in their own communities.
I'd lay part of the blame for our current conundrum in too many businesses getting too big, and too much regulation that favors those big businesses with their expensive lobbyists. (Did you ever wonder why car safety regulation almost forced parents with children in car seats to buy the cars Detroit made money selling?)
I have seen the "shortfall in demand" -- which I take to mean the difference between 2009 demand and the production capacity of a "healthy" economy -- used as justification for a larger stimulus package in a couple of places now, and I am fairly certain that it is a mistake.
Suppose a stimulus was sufficient to make up this shortfall; i.e., to temporarily restore aggregate demand to its pre-recession level. Then the basket of goods we are capable of producing could all be consumed. But in many categories we are producing too much!
Medium-term economic health depends on changing the basket of goods produced to better match what is actually needed. If the dislocations and lost income from this transition could be minimized by stimulus, that would be a powerful argument for stimulus: but a stimulus aimed at filling the "demand gap" will simply slow the adjustment, exacerbating the mismatch between capacity and need and increasing the eventual dislocation.
(Long-term economic health depends on preserving the mechanisms which allow the economy to adapt to changing needs, and government intervention is profoundly deleterious in that respect.)
Consideration of foreign trade only makes this failing stronger. The less the U.S. economy looks like a closed system, the more the nation's financial position becomes analogous to that of an individual or family. The "demand gap" prescription is like stating that, regardless of our wealth or ability to pay, we should not reduce our spending. (For "pay" substitute "collect taxes"; for "our" substitute "aggregate".)
Suppose that debt-financed private spending and deficit-financed government spending are roughly interchangeable. The market participants have discovered that the former was unsustainable, and now the government is stepping in to effectively overrule them.
In sum, the idea that stimulus should fill the demand gap is utterly wrong, and leads one to greatly overestimate the optimal amount of deficit spending.
The argument that tax cuts boost aggregate demand less than does government spending is worth thinking over a little. I presume the mechanism for this difference is that the tax cuts will not all be spent immediately.
The recipient of a tax cut holds a real option -- to spend the money now, or to save it for some opportunity that may arise in the future. It may be that, in today's environment of fear, individuals are overvaluing that real option, thus suppressing spending and damping the effect on aggregate demand.
However, it is certainly the case that government spending, by its very nature, assigns the real option no value at all. To favor government spending based on the higher multiplier is to repeat this error of reasoning. You must argue that, for an option known to have some value, the best estimate of that value from individuals' revealed preferences is a worse estimator than the government value: zero.
Your last two posts have indicated that we will get more bang for the buck from spending increases than from tax cuts. I am not an economist so I am not well-positioned to evaluate the competing claims, but this post from Greg Mankiw (http://gregmankiw.blogspot.com/2008/12/spending-and-tax-multipliers.html) indicates just the opposite: that the multiplier effect from tax cuts is substantially higher than the multiplier from government spending. If this is correct, then shouldn't the stimulus package be weighted more heavily to tax cuts, particularly given that much of the spending will come in the form of infrastructure projects that will take time to ramp up?
Jbd:
Good point. I've done a new post on Greg's recent observations on this. I still think that the consensus of estimates holds that spending is more stimulative than tax cuts--but at the very least it is odd that research by Christina Romer, of all people, calls this into question.
Given the size of the likely package, and the issues of "absorptive capacity" that this raises, I continue to favor a mix of spending increases and tax cuts, with a bias toward the former.
Re others' comments on the job-creation tax credit, yes, there would be leakage and unintended consequences. That is true of anything one can propose. If we are going to have a big stimulus--which I favor--this is something we must put up with. On balance, would a marginal jobs subsidy boost employment? I think so. I'm sorry to see that the team has apparently dropped the idea.
(zic: I posted the FT piece in full, but here's the link: http://www.ft.com/cms/s/0/8b2f754e-e012-11dd-9ee9-000077b07658.html)
The argument over whether tax cuts or spending will create a better stimulus is moot. If tax cuts were as great as claims, then the extensive tax cuts of the Bush administration would have not created a jobless recovery and a widening disperity in incomes--the affect of the tax cuts was to help the bottom line of corporations not improve the living standards of labor.
Since this recession is not like the 2001 recession and probably not like any recession since the great depression--counting the number of angels that can stand on the point of a pin is not productive.
Tax cuts can help those of us that still have jobs to repair our balance sheets, but it is unlikely that they will create sufficient demand to encourage companies to start hiring--especially with the on-going credit crises. Unfortunately, tax cuts will not help people who are unemployed and their spending will remain impaired.
Unfortunately the real problem is a declining standard of living in the USA which was postponed by the extensive use of leverage by the American public. The bill has now come due.
There's a lack of shovel-ready projects, and that complicates our ability to implement fiscal stimulus quickly and effectively. We haven't been asking the obvious question: Why is that? Do we have a Federal Government so incapable of preparing for emergencies or anticipating future contingencies that no one has even thought to have such plans in the wings? And if that is true of our government (i.e. every unexpected event is another Hurricane Katrina), then how did we get to this point? Is it part of our ideological fixation that government is always bad, and thus we shouldn't even try to make it work?
In many other developed countries, they have fiscal stimulus projects ready to go in response to business cycle fluctuations. And that's a smart approach: when the economy is weak, costs are lower for public works projects. And if you plan intelligently, you'd be building projects that would be needed anyway.
Is this too much to expect from our government? It's not as if recessions haven't been recurring at regular intervals for as long as anybody can remember. (And I suppose you could say the same thing about hurricanes.) Why can't we be prepared?
You say plans for fiscal consolidation "need to be framed now."
Why? Why not wait until we see signs of recovery firmly established and then look at the fiscal position in the light of the economy as it is ten? Drawing attention to an imminent fiscal tightening just weakens the impact of a stimulus.
I always distrust claims that something "must" be done when the author actually means it would be a good idea to do it.
In Britain the government announced that it would raise taxes after the next election to pay for its current stimulus and that overshadowed the good the measures might have done.
I too am not an economist, but here is my 2 cents:
Target some big tax cuts/subsidies to deal with the energy-independence problem. Let private industry figure out how to spend that money quickly. Incent them to put up windmills and solar farms, and to start building more plants to build windmills and solar panels. Clear away red-tape for transmission-line corridors. Hopefully, all of this starts to produce results at the same time as we need to start focusing on getting our fiscal house back in order. Cutting the shipment of dollars out of the US for oil can only help there.
Robert Burgholzer "Given a shortage of "shovel-ready" projects (which is what I have heard we are facing) it is only sensible to allow businesses and private individuals to dictate the manner in which the stimulus money is spent. If one could argue that there were more (or less) shovel-ready projects, then a case could be made for altering the current ratio."
Regret to point out this is not the 30's. All infrastructure projects need not be shovel ready. Solar hot water for homes and certain industries e g dairy or industrial painting are quite feasible; not difficult; will save money and energy; can be geographically dispersed ; have great employment multiplier; will give money to those who will consume not save;are mostly small and medium enterprises; are in the private sector;
and give long term energy security based on a free nonpolluting source! How long does one have to think about this?