Amar Bhide on Fearmongering and the Economy
In the Wall Street Journal Professor Amar Bhide writes,
Our ignorance of what causes economic ailments — and how to treat them — is profound. Downturns and financial crises are not regular occurrences, and because economies are always evolving, they tend to be idiosyncratic, singular events.
After decades of diligent research, scholars still argue about what caused the Great Depression — excessive consumption, investment, stock-market speculation and borrowing in the Roaring ’20s, Smoot-Hawley protectionism, or excessively tight monetary policy? Nor do we know how we got out of it: Some credit the New Deal while others say that that FDR’s policies prolonged the Depression.
Similarly, there is no consensus about why huge public-spending projects and a zero-interest-rate policy failed to pull the Japanese out of a prolonged slump.
The economic theory behind the nearly $800 billion stimulus package may be cloaked in precise mathematics but is ultimately based on John Maynard Keynes’s speculative conjecture about human nature. Keynes claimed that people cope with uncertainty by assuming the future will be like the present. This predisposition exacerbates economic downturns and should be countered by a sharp fiscal stimulus that reignites the “animal spirits” of consumers and investors.
But history suggests that dark moods do change on their own. The depressions and panics of the 19th century ended without any fiscal stimulus to speak of, as did the gloom that followed the stock-market crash of 1987. Countercyclical fiscal policy may or may not have shortened other recessions; there are too few data points and too much difference in other conditions to really know.
Unfounded assertions that calamitous consequences make opposition to the rapid enactment of a large stimulus package “inexcusable and irresponsible” are likely to offset any placebo effect the package might have. Shouting “fire” in a crowded theater, as our last Treasury secretary did to peddle the Troubled Asset Relief Program (TARP), didn’t restore financial confidence. Similarly, a president elected on a platform of hope isn’t likely to spark shopping sprees by painting a bleak picture of our prospects.
Not only that, but I think the “jolt the economy”, “jump start the economy” etc. type of rhetoric is misleading as well. For example, the CBO’s analysis shows that even in the best of cases the stimulus will make a bad situation a little bit less worse, not good, great, or even acceptable. This is typical politico speak we are getting from Obama. Exaggerate the current state, and exaggerate the potential effects of his policy prescription.
Large increases in public spending usurp precious resources from supporting the innovations necessary for our long-term prosperity. Everyone isn’t a pessimist in hard times: The optimism of many entrepreneurs and consumers fueled the takeoff of personal computers during the deep recession of the early 1980s. Amazon has just launched the Kindle 2; its (equally pricey) predecessor sold out last November amid the Wall Street meltdown. But competing with expanded public spending makes it harder for innovations like the personal computer and the Kindle to secure the resources they need.
This is the crowding out effect. It is something that can reduce economic growth in the future. Further, our fiscal situation was bad even before George W. Bush. Sure we had a few trillion in surplus, but we also have a huge problem with Medicare and a somewhat smaller problem with Social Security. Factor in the much, much higher budget deficits and that taxes will likely have to be higher in the future adding on even more right now and in ways that are doubtful to help long term growth and productivity could reduce future economic growth. Further, this stimulus is unlikely to have much impact on the financial sector (more on this in another post hopefully).
Hastily enacted programs jeopardize crucial beliefs in the value of productive enterprise. Americans are unusually idealistic and optimistic.
To sustain these beliefs, Americans must see their government play the role of an even-handed referee rather than be a dispenser of rewards or even a judge of economic merit or contribution. The panicky response to the financial crisis, where openness and due process have been sacrificed to speed, has unfortunately undermined our faith. Bailing out AIG while letting Lehman fail — behind closed doors — has raised suspicions of cronyism. The Fed has refused to reveal to whom it has lent trillions. Outrage at the perceived use of TARP funds to pay bonuses is widespread.
The Obama administration assures us that it will only fund “worthwhile” and “shovel-ready” projects. But choices will have to be made by harried and fallible humans; witness the nominees who failed to calculate their taxes properly. What’s more, subjecting projects to scrutiny conflicts with a strategy of sparking the economy with a jolt of new spending. We may get the worst of all worlds — savvy and well-connected operators get funding while good projects languish.
Yes, rent seeking is always a problem and it could limit whatever benefits the stimulus spending could bring about. After all these decisions are made by politicians and what do politicians worry about above all other things? Getting re-elected. For this they need money and that means contributions. And the best of all words are contributions from groups living in their own district.
The alternative isn’t, as the stimulus scaremongers suggest, to turn our backs to the downturn. We do have mechanisms in place to deal with economic distress. Public aid for the indigent has been modernized and expanded to provide a range of unemployment and income-maintenance schemes. Bankruptcy courts and laws give individuals another chance and facilitate the orderly reorganization or liquidation of troubled businesses. The FDIC has been dealing with bank failures for more than 70 years, and the Federal Reserve has been empowered to provide liquidity in the face of financial panics for even longer.
Quite right, the “do nothing” approach isn’t really doing nothing as these institutions will come into play. The Federal Reserve has already injected trillions into the economy and worked to keep various financial institutions from failing. The FDIC has taken over banks and guaranteed deposits and the amount that is covered has been increased as well. There are potential problems in that some acounts do have very large sums in them, but even here I think it could be possible to guarantee those deposits as well. Maybe this isn’t enough by some people’s measure but it isn’t doing nothing.
If the current crisis is indeed unprecedented, why not increase the funding and resources to battle-tested measures? When earthquakes or tsunamis strike, we rush in more doctors and supplies. We don’t use untested medical procedures or set up new relief agencies on the fly.
Here I think the counter argument could be that the “battle-tested” measures may not be sufficient. Still, if the current crisis is unprecedented why not do some things that prior to this crisis were “politically infeasible”? For example, Greg Mankiw favors reducing the payroll tax immediately and phasing in a gasoline tax to replace the revenue. This strikes me as having a number of good selling points,
- it puts money in people’s hands immediately and does so every pay check,
- it puts money in the hands of those most likely to spend it–i.e. those at the lower end of the income distribution,
- it actually would reduce emissions far more effectively–i.e. for those who really think global warming is a serious problem this is a damn good first step,/li>
- any reduction in our demand for gasoline would reduce revenues flowing to the Middle East, and from there into the hands of terrorists.
Of course the draw back is that it is a new tax, but it merely replaces one that we had before. Further, it is one people can try to avoid by driving more fuel efficient cars. And to the extent that the rich drive larger less fuel efficient cars this is a tax on the rich. Do we see anythink like this in the stimulus bill during this unprecedented economic crisis? No.