I was going to write about last week’s ECB decision to purchase unlimited volumes of government debt which means that any private bond trader that tries to take a counter-position against any Eurozone government will lose. It means that the central bank can set yields at wherever it wants including zero. It means that all the mainstream economists are wrong if they claim that deficits drive up interest rates to the point that governments become insolvent because the private bond markets will refuse to purchase their debt. I will write about that tomorrow as I have some number crunching to do. But today – a related story – the myth that there is such a thing as a “good” budget deficit reduction when private spending is insufficient to maintain full employment. That should occupy us for a few thousand words.
In her New York Times article (September 8, 2012) – Cutting the Deficit, With Compassion – the former economics advisor to the Obama Administration Christina Romer attempts to outline a Democratic plan for “dealing with the deficit” which she says should be “front and center” and allow the Democrats to move beyond the defensive position of “criticizing the Romney-Ryan approach”.
To which any sensible person who understands these matters will ask – why should the Democrats want to “deal with the deficit” anyway? What exactly is there to deal with?
Well, Dr Romer thinks that the Democrats should be developing:
… compassionate deficit reduction. The essence is to cut the deficit in a way that does as little harm as possible to people, jobs and economic opportunity.
In other words, she is advocating that the Democrats should hold out to the American people a policy position that will undermine economic growth, condemn millions of them to entrenched unemployment, and reduce the future opportunities for American children to achieve to their potential.
Since when has that been a core Democrat principle in the US?
This article is an example of the latest ploy by those who want to maintain their membership of the “progressive club” but who also consider that the neo-liberal agenda about “fiscal consolidation” is the main game they want to be part of. The problem is that the two aims are not commensurate – in fact, they are diametric.
In my view, anyone who falls for the neo-liberal narrative about the need to cut budget deficits at a time when private spending is clearly inadequate to maintain full capacity growth voids their membership of the progressive club.
Dr Romer claims that the principle of “compassionate deficit reduction” is the centrepiece of the Obama policy agenda to retain office at the coming US Presidential election.
She wants the Democrats to embrace “it more explicitly …. and make it easier to explain to voters”.
Without considering how bad the alternative is in the US at present (Romney-Ryan), the fact that Mr Obama and his team are trapped in this sort of narrative and seek to refine it should disqualify him from retaining office. Governments are only worth electing if they can advance public purpose and help citizens improve their life outcomes.
A government that deliberately undermines those aspiration – and uses macroeconomic policy to impose constraints on individuals which mean they can never escape disadvantage does not deserve to remain in office.
It is a devil’s choice (the devil and the deep blue sea) – the rock or the hard place. But when the political process can only promote a degenerating convergence to an economic policy framework that is obviously destructive – then the citizens should find a new way of engaging with political parties and that requires them to reject both if they are simultaneously arguing for essentially the same thing.
Dr Romer thinks the US has some time to engage in deficit reduction because:
Investors are willing to lend to the United States at the lowest interest rates in our history. That gives us the ability to cut the deficit on our own timetable. We should pass a comprehensive, aggressive deficit reduction plan as soon as possible, but the actual spending cuts and tax increases should be phased in as the economy recovers.
Why even invoke the notion that bond markets have the power to determine the course of fiscal policy? That is one of the starting point neo-liberal myths. The bond markets are more like mendicants seeking their handout of risk-free annuity income.
Even the ECB has demonstrated that the currency issuer runs the show whenever they choose to exercise that unique capacity. There is no imperative to reduce deficits in the fear that the private “investors” will impose some toll by refusing to buy the debt.
Please read my blog – Who is in charge? – for more discussion on this point.
Which means that a “comprehensive, aggressive deficit reduction plan” would only be indicated for the US government if the following circumstances were coincident:
1. All labour and capital resources were being full utilised.
2. The economy was thus producing at potential.
3. That demand-pull inflation (nominal spending outstripping the real capacity to produce) was rising rapidly.
If those conditions are absent then there is a need for a deficit expansion plan rather than the alternative which Dr Romer is advocating.
She knows that “immediate, extreme austerity would plunge … [the US] … back into recession” and that that is is obvious that a:
… fiscal contraction … would cause a rapid rise in unemployment. Well, duh.
If the “rule of thumb is that every $100 billion of deficit reduction will cost close to a million jobs in the near term” is true (and certainly the direction of the relationship is correct if not the quantum) then any deficit reduction will undermine employment – in the short-run.
So you would only consider a deficit reduction if there was credible evidence that there were substitutes in the wings ready to fill the gap.
Dr Romer provides no evidence that personal consumption, private investment and/or net exports will be able to not only offset the lost public contribution to aggregate demand caused by the deficit reduction but also significantly add to overall spending so the economy can reach full capacity in the near future.
It is almost as if she operates in some sort of parallel universe – Yes, deficit reduction is damaging. But, we can do it nicely – is the message she wants to provide. But there is nothing nice about deliberately causing unemployment.
Consistent with these sort of articles that essentially advocate deficit reduction but claim that it can be done nicely, Dr Romer argues that a change in the composition of the budget can help reduce the damage.
She wants the US government to:
… pair serious long-run deficit reduction measures with equally serious, near-term jobs measures — like a sizable short-run infrastructure program and a one-year continuation of the payroll tax cut for working families first passed in 2010 … Even better would be to give businesses increasing employment a tax credit so large they couldn’t help but notice it, and state and local governments a round of aid generous enough to finally stop the hemorrhaging of teacher jobs and essential government services.
A second feature of compassionate deficit reduction is well-designed tax reform that raises at least some additional revenue.
The message gets confusing. Overall, a change in the composition of the Budget spending initiatives might be warranted to ensure that public spending is jobs-rich and promotes equity. At any point in the business cycle these concerns should be monitored to make sure public spending is actually advancing desirable outcomes in addition to ensuring there is “enough” aggregate spending.
But the composition of the budget is one thing and the overall impact on aggregate spending is another. The macroeconomics imperative is to ensure that the economy is moving towards and achieving full employment.
Changing the composition of spending at the same time as cutting overall net public spending may redistribute the spatial and personal costs in desirable ways but the strategy will still cause unemployment and lost national income and undermine future capacity.
The question that Dr Romer avoids is whether now is the time to be cutting net spending. All she asserts (more than once) is that the the US “budget problems are so large” – but never articulates what the actual problems are.
By avoiding a discussion of the basic premise she falls prey to the neo-liberal line, which is really about reducing the size and spread of the government sector rather than about any intrinsic reality that the US government is in danger of becoming insolvent. They claim the latter but really just want the former.
Dr Romer falls into that narrative trap and, in doing so, undermines the credibility of her “progressive” position and makes it easier for the neo-liberals to maintain the dominant position in the public debate.
Dr Romer also focuses on the question of “inefficiency” of public spending. Again there is a conflation here between composition and level. Modern Monetary Theory (MMT) does not advocating “wasting” public spending – by which I mean using public spending to command access to real resources and then using more real resources than are necessary to accomplish the particular task in question.
She says that it is fortunate for Democrats that:
… there is much inefficiency in the current system, so it should be possible to cut costs without lowering benefits. But if we can’t save enough money by reducing waste and finding better ways to provide care, we might have to consider more painful choices.
But while the spending might be considered “wasteful” from a microeconomic (resource usage) perspective, the fact is that the spending goes into the expenditure system and drives firms to provide output and employ people. It might be that some firm or another is supplying more output than is strictly necessary to fulfill a particular real aim.
But if you cut that spending and get better micro efficiency, you still have the macroeconomic problem to address – which is to ensure that total spending is commensurate with the level necessary to absorb all the workers that wish to work at the current wage levels.
Cutting spending to improve resource usage in the health system, for example, while desirable if there is waste, will mean firms will lay off workers in that are of activity. That means that spending elsewhere is required to ensure those workers are redeployed into other uses.
Deficit reduction prevents that sort of redeployment. The government might achieve a “leaner” economy with higher micro efficiency but it will be at the expense of increased macroeconomic inefficiency courtesy of the rise in mass unemployment.
The latter imposes massive costs on an economy (which are disproportionately borne by the weak and low-skilled) which dwarf the known and estimated costs of so-called microeconomic inefficiencies. A focus on the latter should never be pursued at the expense of the former.
It is also easier for an economy to transition from states of micro inefficiency. which require structural reforms, when it is in a state of high employment rather than when it is entrenched in a state of high and persistent unemployment and governments are running pro-cyclical fiscal austerity strategies – no matter how compassionate the deficit reduction is.
How close is the US to the three circumstances I outlined above? Answer: not very close at all.
The most recent data available from the US Congressional Budget Office – Deficit or Surplus With and Without Automatic Stabilizers – (January 31, 2012) estimates the extent of the macroeconomic inefficiency in the US at present.
The CBO define potential GDP as “the quantity of output that corresponds to a high rate of use of labor and capital” and the GDP gap “equals GDP minus potential GDP”, which is the quantity of output that corresponds to a high rate of use of labor and capital”
The “unemployment gap equals the rate of unemployment minus the natural rate of unemployment, which is the rate of unemployment arising from all sources except fluctuations in aggregate demand”.
The following graph shows the GDP and unemployment gaps (which are by dint of the way they are constructed near-mirror images of each other). The values for 2011 and 2012 are “Projected using CBO’s baseline assumptions”.
I caution readers who seek to use this data. As I explain in this blog – Structural deficits and automatic stabilisers – the estimates of the GDP and unemployment gaps provided by the CBO are likely to be an understatement of the true gaps.
The techniques that organisations such as the IMF, OECD and CBO use to estimate both potential GDP and the “natural rate of unemployment” are biased towards under-estimating potential GDP and over-estimating the “full employment” unemployment rate – which they call the natural rate as a reflection of their ideological adherence to the mainstream macroeconomic liturgy.
But even if we accept the CBO estimates of each gap – each macroeconomic inefficiency – for the sake of comparison, the average real GDP gap (even with the earlier and sometimes severe recessions included) for the period 1962 to 2007 was -0.3 per cent – that is, relatively small. By comparison the gap between 2008 and 2011 averaged 6.2 per cent – that is, relatively huge.
CBO currently estimate the real GDP gap to be around 5.3 per cent and the unemployment gap to be around 3.3 per cent.
The daily loss of income that is occurring in the US as a result of these gaps is enormous. This lost income will never be regained. It is lost forever.
I also note that inflation is hardly an issue in the US at present.
So why would any progressive want to buy into the neo-liberal deficit reduction narrative?
Further, growth is now slowing which will mean these CBO estimates of the GDP and unemployment gaps will be conservative (quite apart from the technical points noted above about bias).
The latest US national accounts data for the second quarter 2012 was published by the US Bureau of Economic Analysis – on September 4, 2012.
It shows that the US economy slowed from 2.0 per cent in the March quarter to 1.7 per cent in the second-quarter 2012. These estimates – the so-called “second estimates” are based on more comprehensive data and revised the growth estimate for the June quarter up from 1.5 per cent.
The following graph shows Real GDP growth (per cent per annum) and the respective contributions to that growth from the main expenditure components (percentage points annualised) for the March-quarter and June-quarter 2012.
You can see that the contribution of government was negative in both quarters but less negative in the June quarter 2012.
The BEA say that:
The deceleration in real GDP in the second quarter primarily reflected decelerations in PCE, in nonresidential fixed investment, and in residential fixed investment that were partly offset by a smaller decrease in federal government spending, an acceleration in exports, and a smaller decrease in private inventory investment.
PCE is personal consumption expenditure.
My reading of the latest data from the US – both the labour force and national accounts data – is that the policy reality is the opposite to that held out by Dr Romer. She is making a political statement disguised as an economic imperative.
In my view, political leadership is about taking the economic imperative and ensuring the public understand the correct policy settings consistent with that imperative.
The economic imperative is clear. There is an urgent need for more discretionary net spending in the US which should certainly be targetted to ensuring it is jobs rich.
Growth is slowing and a public stimulus is required. There is no way under present circumstances that private spending (or net exports) will be sufficient to push the growth rate towards its full employment level while also compensating for the negative contribution from the government sector. To further strain demand by deliberate deficit reduction is equivalent to madness.
If the GDP and employment gaps can be reduced and close back to the long-term average, then the revenue side of the US budget will increase dramatically (relative to now) and get back towards the 18 per cent of GDP mark. The deficit terrorists have been trying to argue that since 2000 the revenue side of the US budget has been “structurally weakened” by tax cuts. The average between 2000 and 2008 was 17.9 per cent of GDP, not that much below the long-term average. So the structural deterioration argument doesn’t hold.
Budget deficits are required whenever there is a non-government spending gap. That will always be the case if the non-government sector desires to save overall.
This MMT insight should be the basis of a progressive attack on the orthodoxy not half-baked feel-good notions of compassion deficit reductions which really amount to the deliberate creation of joblessness.
There is no inevitability that inflation will result if governments maintain high levels of demand and support private consumption. The trick is to understand that the deficits are also supporting net private saving (the other side of the consumption coin). Deficits beyond that support level do introduce inflation risk. But then who advocates that?
As an aside, after my talk in Brussels last week I received a fair share of “hate E-mails” and (deleted) comments on my blog from people purporting to be representing the “progressive left” – more or less accusing me of being some ill-formed C18th conservative Tory for advocating that the government should guarantee employment. Apparently, those who haven’t read any of my work on the topic think I am advocating a return to the poor houses – a form of institutionalised slavery.
Ignorance is bliss for these E-mail senders.
The point of the Job Guarantee is that is the base case safety net. It doesn’t aspire to cure all ills. It doesn’t replace the need for expanded government investment in public infrastructure (and the related skilled jobs that would accompany that) or the creation of adequate numbers of skilled public sector jobs in the service-delivery areas (education, health, environment, arts and recreation etc).
It just ensures that there is enough interesting work available at all times to anyone who cannot find work elsewhere (for whatever reason).
They claim that expansionary fiscal policy can always create full employment – which is correct. But it cannot always create full employment and price stability, which are the two key macroeconomic goals in a mixed economy.
Further, an economy that is enduring accelerating inflation will ultimately become unsustainable and governments will invoke contractionary policy and the full employment status will lapse.
The Job Guarantee approach – relying on employment buffer stocks – is the way to defeat that trade-off. It means that the most disadvantaged workers can always access work. Surveys show that the unemployed prefer to work than being marginalised on social security systems, which have increasingly become punitive.
Why the Job Guarantee proposal offends those who claim to be progressive is beyond me.
Yes, it is a palliative to the “capitalist hegemony” and doesn’t advocate a violent revolution to overthrow the filthy exploiting capitalist power brokers. When the time is right to abandon the capitalist system in favour of a more functional and equitable system that safeguards human potential and our natural environment then I will be one of the first to the barricades (although I suspect my knees will have given in long before that time arrives!).
But until that time I prefer to use my academic position (relatively well-paid and somewhat secure) to advocate policies that will make a real difference now. I prefer not to use my secure position to drink latte in cafes in an assembly of self-styled progressives and discuss how the revolution will pan out while ignoring the every day reality that people want work and do not have it and are poor and socially excluded as a consequence.
I prefer not to condemn the unemployed to years of this sort of macroeconomic tyranny while I wax lyrical about post-modern interpretations of what Marx said and how it relates to the struggle towards revolution.
When I receive E-mails (or comments on the blog) which attack the Job Guarantee as a fascist or Tory plot and the correspondents claim they represent the true progressive position and tell me that I am a progressive quisling – I think about the 1971 poem/song – The Revolution Will Not Be Televised – by Gil Scott-Heron. The lyrics contain the following refrain:
The revolution will not be televised, will not be televised,
will not be televised, will not be televised.
The revolution will be no re-run brothers;
The revolution will be live.
I also think about the more recent song from the – Brooklyn Funk Essentials – The Revolution was Postponed because of Rain. It is a very stark commentary on the so-called progressive side of the political struggle. You can see the full lyrics at this blog from 2010 – A new progressive agenda?.
I am currently in Maastricht (at the University) until the coming Thursday. Then I will be in London until next Monday (from Thursday afternoon). So the times that I publish my blog will remain atypical until then.
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.