Saturday, February 07, 2009

Ideology as policy...

Many folks who haven't lost their jobs or retirement fund yet are interpreting economic data through ideological filters that may arise from devotion to a political philosophy or even religious conviction (am I the only one getting the apocalyptic e-mails?).  For instance, in the most recent newsletter Pro Farmer Editor Chip Flory announces the Right Answer.
"Economic stimulus comes from spending...but NOT government directed spending.  It comes from consumer and private sector business spending." [His emphasis] [Sorry, subscription only]
This seems extreme, especially looking at data from the Great Depression.

Many economists and most citizens (even on the right) think wartime spending revived the economy, in direct contradiction to Chip's pronouncement. While I have heard stimulus skeptics cite WWII as proof New Deal policies really didn't help end the Great Depression, some voices now say government spending gearing up for war did not affect the emergence to growth either 

OK, then you are left with three choices: it was WWII, New Deal stimuli, or we just climbed out on our own despite both of the above.  I think the latter as a real long shot, and the answer to be mostly attributed to wartime spending.  The point is both the former causes were "government directed" spending.

We may argue (boy, are we!) about the relative multiplier value of various forms of stimulus, but the multiplier for government spending is clearly not zero. Most of all, while theoretically possible, a zero multiplier is really hard to get.
In order to get a zero multiplier (see the Barro article and Barro’s textbook, “Macroeconomics: A Modern Approach” published by Thomson South-Western), one must argue that economic units will anticipate the increased real economic costs, real future taxes, or inflation that results from the way in which the stimulus package is financed. Then, they must re-arrange their economic and financial activities in order to be able to cover the future government levies. A zero multiplier means that for every $1.00 the government puts into the stimulus plan, economic units will remove $1.00 from the spending stream. Thus, the $825 billion stimulus plan would increase real Gross Domestic Product by…ZERO DOLLARS! [More]

 Let me offer countering arguments and actual explanations. Here are some opinions I found useful:
One excellent post by Prof. Chinn has direct relevance to governmental policy initiatives to deal with the economic problems. Her post is based on work by Mark Zandi of The question is: given that the economy needs to be stimulated, what method of stimulation yields the largest economic benefit. The benefit here is expressed as the stimulus multiplier, which is the amount of increase in GDP per unit of stimulus. For example, if we simply gave every person in the country $1, each could go out and buy a McDonald's value menu item. But the benefit doesn't stop there because with the increased consumption, McDonald's has to hire more workers, who in turn consume more; purchase more supplies from its suppliers, who in turn hire more workers, etc. So in principle, a $1 stimulus package can have more than $1 benefit to overall production.

So which economic stimuli had the greatest benefit? The top three were:

  • Temporarily Increase Food-stamps (multiplier 1.73)
  • Extend Unemployment Insurance Benefits (multiplier 1.64)
  • Increase Infrastructure Spending (multiplier 1.59)
The first two items have the obvious benefits of keeping people on their feet, but also provide an extra 64-73% advantage beyond the direct stimulus. Of course these benefits can only be temporary. On the other hand, the third item has the advantage of improving neglected infrastructure -- a long term "capital gain" -- while at the same time providing an extra 60% bang for our buck.

Now for the worst stimulus concepts:
  • Make Bush Tax Cuts Permanent (multiplier 0.29)
  • Cut Corporate Tax Rate (multiplier 0.30)
  • Make Dividend Tax Cuts Permanent (multiplier 0.37)
Since these multipliers are less than unity, it means that for every dollar of tax break, the country's production actually goes down. Of course some small segment of the population may benefit from such tax cuts, but in hard economic times, it's not clear why they would deserve a benefit when the broad population and the overall economy do not. To be fair, a few of the tax cut concepts do a little bit better, most most are break-even at best. [More]

Of course, the actual values are debatable - and that's what is tying us in knots, but to simply see the problem as Good/Bad is a gross oversimplification and freighted with social and political dogmatism. Moreover, we now have evidence the Bush stimulus - a form Chip would approve - was less than a howling success.

Harvard's Martin Feldstein, head of the National Bureau of Economic Research, was one of many economists last winter calling for federal action to avert a recession. "What's really needed is a fiscal stimulus, enacted now and triggered to take effect if the economy deteriorates substantially in 2008," he wrote. He liked the idea of tax rebates, which is what Congress and the president eventually agreed on. How did that turn out? According to Feldstein, it's a failure.

In fact, the news seems to even get worse for economic ideologues.
Yet when the scores are totted up in a few years’ time, the prize for deepest recession may go, not to Britain, but to Germany. Europe’s industrial powerhouse is in freefall. Figures released today showed that German industrial production fell by 4.6% in December, following big declines in earlier months. For a long time Germany’s capital-goods producers thrived on sales to cash-rich oil exporters and fast-growing Asia. No longer. Orders for German manufactures are down by quarter from a year ago. Forecasters think figures released on February 13th will show that German GDP fell at an annualised rate of 8% in the fourth quarter, twice as steep as the drop in America, and worse than in Britain.
Is there no justice? During the good times for the global economy, Germany avoided a housing boom, cut its budget deficit, kept its real wages low and ran a current-account surplus. Its consumers resisted the lure of cheap credit. Yet the German economy seems to be doing far worse than its imprudent peers in America and Britain are. (Japan, another country that avoided the housing and credit booms, is suffering badly too.) Macroeconomics, it seems, is not a simple morality tale, where “bad” borrowers are punished and “good” savers are rewarded. On the contrary: rich economies that depend on foreign demand are more vulnerable than those that rely on foreign capital. [More]

The recession has unleashed a tidal wave of fear which too often manifests itself as unwillingness to move from preset beliefs even when facts suggest otherwise. It is also why the tenor of argument rises to stridency.  We feel we can't afford to be apathetic.

Now throw in the desire to be proven right because we chose the path of virtue and thrift, only to see our investments wither and even our employment threatened. The desire for philosophic retribution is often stronger than our commitment to rational thinking.

But just like we observed when mixing social conservatism with economic policy (Damn the deficit if it advances gets Supreme Court appointments!) the result when mixing rigid and often misunderstood economic ideology with government policy will be just as wasteful and unpleasant.

And this time the consequences could be very painful indeed for most Americans.


Anonymous said...

There are simalarities between this Recession and the Great Depression .... the roaring 20's and roaring 00's ....both were preceeded by extreme affluence, excessive irresponsibility (in personal, business and government sectors) and over "stimulation" (spending beyond the ability to repay). Do we really think we can spend and borrow our way to prosperity? That only works short term. Violating long standing principles of economics (ie, earn, save, then spend) will not go unrewarded. We can look to the government for our next fix (stimulus hand out) like a junkie but the high won't last and we or our kids will ultimately get rewarded. We will relearn the lessons every generation has to learn that we can't reach beyond our grasp and you can't buy what you can't pay for. So will we pay now or pay later?.... our nature and history says we'll postpone the pain and gamble on the next fix.

John Phipps said...


Many others share your convictions that what is occurring is just deserts for those who could not obey the economic/moral strictures you outline.

There is only one problem for me with your outlook: if no one borrows, no one pays interest.

In other words, unless you are willing to accept zero return on your virtuous savings, it's best not to despise those who borrow.

This is why folks who managed money very conservatively will still suffer collateral damage from this downturn. You may think it unfair, but it seems very likely nonetheless.