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The Case Against Everything
There is no more important question when evaluating our personal beliefs, public policy, or science than, “What evidence would cause me to change my opinion?” If you can’t answer that question you are being, by definition, unreasonable.
Will Wilkinson on the Democracy in America blog at The Economist plays the game with some hot-button political issues in response to Charles Murray’s argument that says,
Data can bear on policy issues, but many of our opinions about policy are grounded on premises about the nature of human life and human society that are beyond the reach of data. Try to think of any new data that would change your position on abortion, the death penalty, legalization of marijuana, same-sex marriage or the inheritance tax. If you cannot, you are not necessarily being unreasonable.
That’s as clear-cut of an admission of irrationality as I’ve seen.
I largely agree with Wilkinson so I won’t cover the topics above, but I think it’d be entertaining to go through some others:
Uncertain Examples
In my Quixotic quest to find evidence for “policy uncertainty” holding back our recovery, the closest thing I’ve heard to a reasonable and measurable indicator is low “US fixed capital investment.” Alan Greenspan has been trumpeting this metric for at least over a year now. He also uses this example to question the wisdom of the stimulus package. But looking at fixed investment, it’s not apparent that it’s being held back by any change in regulation or fear of future taxes as Greenspan argues.
It’s obvious that investment levels aren’t back to pre-recession heights, yet the trend is clearly recovering from the depths of the recession. In contrast, we have this chart from Jared Bernstein that shows that the stimulus package certainly wasn’t inconsistent with economic growth.
Notice that as fiscal and monetary stimulus begin to run down close to the present we see weaker growth. This correlation isn’t proof, but I’m still waiting on a believable counter-explanation for this data.
Broken Window Fallacy Fallacy
So lately I’ve been hearing Bastiat’s broken window fallacy repeated in order to retort some liberals’ thoughts that the Japanese crisis may help the economy. It was also a common argument – for some reason – against the stimulus.
In the Daily Caller, Ryan Young explains why [the Keynesian argument] makes no sense. Sure, Japanese workers will have no choice but to rebuild, and people will have to spend their savings to rebuild their houses or replace possessions destroyed in the quake. That spending will be captured in GDP measurements and it will look like Japan’s economy is boosted. However, Ryan notes:
. . . if the tsunami had never happened, people would still have all the buildings and cars that they had in the first place. They would be able to spend their money on other, additional goods that they want.
And those new construction jobs the tsunami will create? Every last one of those workers could be making something else instead. They could be producing computers, televisions, almost anything.
As not to let the great Bastiat be used so crassly, allow me to point out that, yes, fixing a broken window or a destroyed city won’t make more wealth than we originally started with. It will only get us back to where we previously were. Now let me just clear this up to the anti-stimulus crowd: Bastiat wasn’t arguing to stop fixing broken windows. We had a recession – the economy shrunk. Japan is going through a catastrophic disaster. It helps the economy to fix things.
So when de Rugy says the GDP measurements make it “look like” a boosted economy, what she fails to notice is that it looks like GDP is growing because it is growing. Ryan Young stumbles on the whole reason why we need stimulus when he writes, “those workers could be making something else.” The problem during a recession and our currently weak economy is precisely that lots of idle workers are not making anything. De Rugy smugly wonders why stimulus advocates don’t “recommend that we send our military to destroy New York, and some bridges and roads along the way” in order to improve the economy. Well, Veronique, doing that would commit the broken window fallacy. Thinking that we shouldn’t pay jobless construction workers to fix our naturally crumbling infrastructure is the broken window fallacy fallacy.
Breaking Commitments
I’m about as big a fan of markets you will find from someone on the center-left (a very imprecise designation). I prefer the government allow free interaction between people as much as possible unless the negative externalities outweigh the positive consequences of the exchange. But certain recessions seem to call out for intervention.
So I have a serious question for all readers that favor government inaction during strong recessions and high unemployment. Let’s abstract away from our current economic predicament. Paul Krugman in an interview with Rachel Maddow discussed our current unemployment mess, but regardless of if you think his analysis of the current economy is accurate try to grapple with this chain of logic:
We don’t have jobs because businesses aren’t hiring. Businesses aren’t hiring because they don’t have sales. Businesses don’t have sales because people don’t have money. People don’t have money because they don’t have jobs.
He believes in these situations the government needs to step in to break that cycle by boosting aggregate demand and putting people to work. For those who don’t favor fiscal or monetary stimulus, what is supposed to break that cycle? Falling prices don’t seem to do it. First deflationary cycles can happen and those are very dangerous. Also “sticky wages” won’t allow businesses to cut nominal wages enough for the market to easily self adjust. Economists George Akerlof and Robert Shiller in Animal Spirits discuss the topic.
Yale’s Truman Bewley gives qualitative evidence on money wage stickiness. He conducted an intensive interview study of New Englanders involved in the wage setting process. He asked why money wages had not declined in the New England recession of 1991-92. With the high unemployment of the time, any worker who might quit in response to a wage cut could have been replaced easily and rapidly. But Bewley found that employers were loath to reduce wages during the recession. In the employers’ opinion workers would view such wage cuts as unfair. They would reduce their commitment to their jobs. Furthermore, when the economy revived they would still be angry and thus more likely to quit. Bewley found a few firms that made such cuts, but only after considerable agonizing and also after continued losses. In those rare instances workers accepted wage cuts as fair. They were a last resort, necessary to save their jobs.
It might be an irrational feature of human nature that causes that but it exists and can’t be wished away to fit an ideological commitment to free markets. I suppose one could argue that after the economy completely crashes with prolonged periods of high unemployment which causes huge amounts of human suffering, economic loss, and lost opportunity the economy might eventually self-correct. That might be a necessary evil if it prevented all future recessions, but it obviously wouldn’t.
What is supposed to break that cycle? Are you conceding that a devastating depression is necessary for the market to realign? If so, why is your commitment to markets stronger than it is to people?
Where’s the Rise of Big Government We’ve Been Hearing About? ctd
Again, where and when did the switch to socialism happen? I can’t seem to find it in the data… Hmmm…. Also, where was the massive increase in spending for stimulus?
Total Government Spending (all levels of government):
The only way you see a massive increase in government is if you only look at short term federal government spending AND ignore the fact that GDP collapsed because of the recession. Yes, taxes coming in are much less because of cuts and because of the recession – that’s what’s really causing the short term deficit.
We’re not going bankrupt because we’re spending too much on infrastructure or any such nonsense. It appears we’re still short about $2 Trillion for infrastructure (well, according to some reports anyway). Entitlements need to be reformed, the tax base increased, and we need to find a way to increase economic growth. Maybe the Fed actually intends to try something new now.
(graph via Krugman)
No More Uncertainty: It’s Demand
Catherine Rampell, of the Economix blog at the New York Times, shows what “the biggest single problem facing America’s small businesses” is right now.
Much of the debate about how to spur growth and encourage hiring has focused on making the tax picture temporarily more business-friendly. But as you can see, the portion of small businesses citing taxes as their superlative problem has remained about the same — mostly in the 17-22 percent range, say — for about a decade. (my emphasis)
It’s clear that “poor sales” is what has changed (look from Sep ’07 on) and why employers aren’t hiring right now. That’s not to say that taxes aren’t a concern – of course they are a concern – but if you’re trying to argue that small businesses aren’t hiring now because of the increased weight of Obama’s Marxist regulations (dark orange), new crushing tax increases, the recent Nazi-like health insurance scheme (light orange), or because evil unions are keeping wages artificially high (light blue) you might reexamine those views in light of the, you know, evidence.
Note to policymakers: craft policies that best increase aggregate demand.
Moreover this demonstrates the continued lack of evidence for the argument from uncertainty (i.e. policy uncertainty is causing businesses not to hire) (see: here, here). Yglesias also asks proponents of that argument to justify their argument from history.
I’d be fascinated to hear Otellini describe to me the past era in which firms knew exactly what their health care, energy, and tax costs were going to be. This was a time in which the future trajectory of oil prices was entirely predictable, and it was clear that congress would never again alter the tax code. A time when general macroeconomic conditions were not subject to any vagaries of fortune. A magical time.
The biggest uncertainty to businesses right now is whether their sales will grow. They don’t see consumers demanding more goods so if they think sales will stay low they won’t hire new workers to supply for that demand. Welcome to Econ 101.
[update 09/18]: I got in a little debate on this topic over at Rick MacDonald’s blog. I’ll crosspost it here but I encourage readers to check out the original post and following discussion at the source. Enjoy. I threw in a couple more links and a graph so readers have an easier time following what I’m referring to.
Dan: I’m sympathetic to the argument that we should make tax policy simple, clear, and as least burdensome as possible for the engines of economic growth – businesses. But I have to say I’m completely unpersuaded that the primary trouble for our businesses right now is taxes or policy uncertainty. There just doesn’t seem to be much of any evidence that demonstrates that either of these are unique or major problems to our current economic climate. It seems you’re a proponent of this view and I’ve tried to find some evidence to support those positions (especially the latter). I was wondering if you could respond to my questions regarding this theory. It seems to me that the real problem for small businesses is lack of aggregate demand manifesting in poor sales.
Rick: I’ve provided interviews with Donald Trump, Jim Rogers, T. J. Rodgers and Steve Wynn…if the direct statements of billionaires can’t convince you about the importance of unpredictability and their view that the uncertainty of markets, tax policy and government intervention are inhibitors; it would seem that you are content to remain unconvinced. The consensus as stated by these gentlemen is the consensus on Wall Street among the majority who are holding onto their capital reserves and only betting on the short term.
Dan: It’s not that I’m content to remain unconvinced, it seems you’ve mistaken some anecdotes for data. In the link I provided survey evidence (close to 4,000 businesses were surveyed) from respected National Federation of Small Businesses, and policy uncertainty doesn’t show up – or at the least isn’t nearly as big a concern as other issues. Poor sales seems to be the overriding concern. Also, I linked to a graph of recent major legislation paired with the stock market and the passing of the bills never seems to greatly affect the stock market in a negative way. Even with healthcare where you’d suppose the most uncertainty resides, that industry has seen the most job growth out of the major sectors of our economy. Furthermore, it’s not clear that if uncertainty is a problem that it’s a major problem (I’m not saying that it’s not a problem AT ALL, even slightly) or that it’s uncertainty with policy rather than run of the mill economic uncertainty. Consider that quote from Matthew Yglesias I referenced, where he makes the point (I made it to you before myself in a previous exchange) that there is no time in history where there is complete economic certainty. Therefore, how can anyone say now that it is a special problem?
So in light of all this (survey data from thousands of small businesses, stock market/legislation comparative analysis, the case of the healthcare industry, and the general historical perspective) what can you point to that demonstrates that uncertainty is a MAJOR problem? A few businessmen just saying so isn’t especially persuasive – if a few other extremely rich businessmen said the opposite would you find that convincing of my case? If all this doesn’t make you question your case, maybe it is you who “are content to remain unconvinced.” Notice I am just merely asking you to provide some evidence to support your position aside from a few anecdotal statements you have already quoted. I didn’t think it was absurd to ask you to justify your claims or respond to my counter-evidence.
Rick: It’s my view that you are content to remain unconvinced. The “anecdotes” come from 4 major investors and holders of wealth in the form of fixed capital.
As to statistics; many on the left claim that we are not suffering inflation. If you’ve been shopping on your own for a while, you will notice that prices (especially food prices) have been steadily rising even though interest rates remain low. Jobs are still disappearing at over 400,000 a week, wages are beginning to fall as well and credit is tighter than ever in spite of the government spending the wealth of 2-3 generations or more. As I’ve said before, I have too much to do to debate on line via a blog.
The Keynesians say this and the Austrians say that…I tend to agree with the Austrian economists and see hope that Keynesian economics will soon be tossed aside as a failed system and buried in a grave alongside communism. I know, the video is all ancedotal, but it’s also true.
Rick: Opinions vary, and it’s not that I’m not interested; as I stated earlier, I have little time for long pedantic discussions via comments.
The Great Revision
In the past few days I’ve come across some common misunderstandings of what actually happened during the The Great Depression and what lessons it should provide us for monetary and fiscal policy today. One came from my uncle’s coworker and another from a fellow blogger. So readers here get a better sense of my thoughts on both with a risk of being slightly unfocused, I’ll just include some parts from my private email correspondences in with my response to “Rick.”
Oh Rick, I’m almost sorry to have to chip away at the icon you’ve placed a top the pedestal. Maybe your love of one-dimensional Randian characters explains it, but Amity Schlaes and The Forgotten Man are hard for most of us to sympathize with. You ask your readers to “compare the two statements against easy to find historic facts and decide for yourself whose opinion is the most accurate.” Well, I did. I can understand the appeal of a novel like Atlas Shrugged, but I can’t get behind any of Schlaes’ fiction.
I am not dogmatic on this issue. I am willing to look at evidence or analysis that recovery from the Great Depression would have been faster if spending had been cut to the level of revenues or even lower or whatever, but I have been unable to get any conservative critic of the New Deal to say that this is what they believe. They always change the subject to various other things Roosevelt did, much of which I agree was mistaken. I just want a simple answer from Amity Shlaes, Jim Powell, and Burt Folsom, all of whom have recent books critical of Roosevelt, to this question: Would recovery have been faster if spending had been cut and deficits had been smaller during the 1930s? If the answer is yes, please provide some logical and empirical evidence supporting this view. (my emphasis)
Suppose that wages across the US economy had been, say, 20 percent lower than they actually were. You might be tempted to say that this would make hiring workers more attractive. But to a first approximation, prices would also have been 20 percent lower — so the real wage would not have been reduced. So how would lower wages lead to higher demand for labor?
What Keynes realized by applying the concept of “sticky prices/wages” (which Shlaes largely ignores) is that the government needs to intervene and push aggregate demand rightward while expanding the real money supply.
Don’t forget too that Keynes wasn’t a marxist, he wanted to save capitalism. Here he is on Hayek’s Road to Serfdom:
I find myself moved, not for the first time, to remind contemporary economists that the classical teaching embodied some permanent truths of great significance, which we are liable today to overlook because we associate them with other doctrines which we cannot now accept without much qualification. There are in these matters deep undercurrents at work, natural forces, one can call them, or even the invisible hand, which are operating toward equilibrium. If it were not, we could not have got on even so well as we have for many decades past.
Another common criticism that keeps turning up is the “uncertainty” critique. It argues that businesses are uncertain what certain legislation and other government policies will result in so they won’t hire new workers, but will sit on their profits until they have a better idea of what is going to happen. Aside from not having much evidence (here, here) to support this claim, I’m also baffled that people somehow think the free market is more certain. The free-market does a lot of good things, but certainty isn’t really what defines it. Also, will sweeping reform that pulls the government out of huge portions of the economy really make things more certain? If you think it’d be better, than make that argument – just don’t tell me it’d make things less uncertain. Don’t trust Amity Schlaes and others that don’t seem to even understand the arguments for stimulus. Seek out actual economists on the left and the right for more useful arguments for and against stimulus; after reading “historian” Schlaes, it seems we should trust them more on history as well.
Krugman’s column.
Schlaes’ response.
First A Tragedy Then A Farce
Stimulus, Unemployment, and Austerity Roundup
Daniel Hamermesh wants to extend unemployment benefits.
The original, and I believe continuing, purpose of unemployment insurance is to maintain consumption of the unemployed—to prevent hardship. With 45 percent of the unemployed out of work more than 26 weeks, by far the highest percentage since the 1930s, consumption maintenance seems to argue even more strongly than usual for the wisdom of re-extending benefits.
Daniel Wilson for the Federal Reserve Bank of San Francisco estimates the effect of state allocations from the federal stimulus package.
The estimated jobs multiplier for total nonfarm employment is large and statistically significant for ARRA spending through March 2010, but falls considerably and becomes insignificant in April and May. The implied number of jobs created or saved by the spending is about 2.0 million as of March, but drops to 0.8 million as of May. Across sectors, the estimated impact of ARRA spending on construction employment is especially large, implying a 18.4% increase in employment (as of May 2010) relative to what it would have been without the ARRA. Lastly, I find that spending on infrastructure and other general purposes has a large positive impact, while spending on safety-net programs such as unemployment insurance and Medicaid reduces employment.
Brad DeLong argues for bigger budget deficits.
The Federal Reserve has pushed interest rates to the floor and wishes it could drive them into the basement—to –5 percent per year or so. Thus the multiplier on the government’s spending is not 0.4 but more like 1.5. We do not get $40 billion of additional production and employment for $100 billion; we get something closer to $150 billion. And there is no crowding out of private investment; on the contrary, there is likely to be crowding in.
[...]
The increased cash flows to businesses boost future private-sector incomes by $1 billion a year. The costs of amortization reduce them by $1.07 billion a year. The net cost? $70 million per year. So to gain $150 billion of increased production and incomes this year we incur a $70 million a year cost going forward. That means that using expansionary fiscal policy to boost output today is an investment worth doing at any interest rate greater than 0.05 percent per year.
Ezra Klein questions the logic of the austerity crowd.
[E]ven as a matter of simple logic, I really don’t understand the case for why a business would begin spending if the government announces major cuts this year. So the government says, “I’m going to take demand out of the market, end tax cuts that are helping people spend, throw a large number of public employees out of work, and reduce the spending power of the unemployed.” And it’s in that context that, say, a manufacturer of picture frames, or a local coffee chain, decides to hire more people? Where is the promise of further demand?
Krugman faults the Obama administration for not trying to get a bigger stimulus through the first time.
So all policy needed to do was meliorate the worst, while we waited for the economy to recover spontaneously. From the Lizza article:
Summers did not include Romer’s $1.2-trillion projection. The memo argued that the stimulus should not be used to fill the entire output gap; rather, it was “an insurance package against catastrophic failure.”
I don’t know why Summers etc. believed this. Even before the severity of the financial crisis was fully apparent, the recent history of recessions suggested that the jobs picture would continue to worsen long after the recession was technically over. And by the winter of 2008-2009, it was obvious that this was the Big One — which, if the aftermath of previous major crises was any guide, would be followed by multiple years of high unemployment.
But where is Barack Obama’s leadership when you need it? The White House is letting Republicans win the argument by refusing to address the long-term issue. The president set up a fiscal commission to make recommendations – a classic stalling device. He and his party, if they believe in anything, believe in bigger government. Yet he has tied his own hands on revenues by promising no tax increases for most Americans. He has pushed through an unpopular healthcare reform that only he and his most besotted allies believe will cut costs.
Is it surprising that the country thinks fiscal policy is out of control, even to the point of looking warily at extended jobless benefits? To get its way on short-term stimulus, the White House needs to talk seriously about long-term budget policy. The silence is deafening.
What would a radically centrist “Jobs Now, Deficits Soon” package look like?
Start with the tax side, where we should accelerate the kind of sensible tax reform that’s overdue. That means cutting payroll and corporate taxes now — and offsetting this with phased-in tax hikes on dirty energy and consumption, to take effect only once jobs and growth are back on track.
[...]
Toss in some progressive trims to Social Security and Medicare benefits beginning a few years out. And wrap it all up (as I’ve argued elsewhere) with a new law requiring a supermajority vote in Congress to run deficits higher than 3 percent of GDP whenever unemployment is below 6 percent. Along with the new taxes and entitlement trims, this will convince bond markets we’re serious and underscore that we’re only running outsized deficits to fight today’s output and jobs gaps.
Fareed Zakaria interviews British Chancellor of the Exchequer George Osborne. Osborne recently unveiled a massive austerity budget with large spending cuts and tax increases.
Greg Mankiw counters Krugman’s claim that stimulus skeptics are logically incoherent.
A coherent objection to this line of argument might be the following: If the government borrowed the money to spend, it would need to eventually pay the money back. That means higher future taxes, on top of the future tax increases that President Obama already will need to impose to finance his spending plans. Higher future taxes reduce demand today for at least a couple reasons. First, there are Ricardian effects to the extent that consumers take future taxes into account when calculating their permanent income. Second, those future taxes are not likely to be lump-sum but will be distortionary; it is plausible that at least some of those future tax distortions may adversely affect the incentive to invest today.
That is, businesses may be reluctant to invest in an economy that they expect to be distorted by historically unprecedented levels of taxation in the future. The more the government borrows, the higher taxes will need to go, the more distorted the future economy will be, and the less attractive is investment today.
Brad DeLong retorts @Mankiw.
For these parameter values, a $1 boost to infrastructure spending crowds-out $0.01 of private investment spending and $0.05 of private consumption spending, leaving $0.94 of stimulus.
To claim that the excess burden of taxation is not $0.50 on the dollar but $20 on the dollar, or that a 1% fall in productivity produces not a 1.5% fall but a 30% fall in the desired capital stock can be called many things.
“Coherent” is not one of them.
More Stimulus Needed?
I’ve defended the stimulus and criticized some of its design; well I still feel similarly, but as Matthew Yglesias points out (via Mark Thoma) fiscal stimulus on net hasn’t happened. Read his whole short post – but here’s the relevant quote from Thoma:
But it’s important to remember that the proper measure for fiscal stimulus is not spending by the federal government; it is spending by all levels of government. And when you look at the contributions to US GDP growth (Table 1.1.2 at the BEA site), total government spending has been a drag on growth over the past two quarters. The increases at the federal level have not been enough to compensate for the spending cuts at the local and state levels.
It is also important to realize that a $787 billion stimulus package over 3 years seems large, but compared to the size of the US economy as a whole (14.2 trillion in 2009) it is easy to see why it might not have been large enough. According to the IMF, “U.S.’s planned stimulus amounts to 2 percent of output in 2009 and 1.8 percent” in 2010. Krugman most frequently made this point before the Recovery Act passed and argues it now to push for further stimulus.
Consider the long-run budget implications for the United States of spending $1 trillion on stimulus at a time when the economy is suffering from severe unemployment.
That sounds like a lot of money. But the US Treasury can currently issue long-term inflation-protected securities at an interest rate of 1.75%. So the long-term cost of servicing an extra trillion dollars of borrowing is $17.5 billion, or around 0.13 percent of GDP.
And bear in mind that additional stimulus would lead to at least a somewhat stronger economy, and hence higher revenues. Almost surely, the true budget cost of $1 trillion in stimulus would be less than one-tenth of one percent of GDP – not much cost to pay for generating jobs when they’re badly needed and avoiding disastrous cuts in government services.
Federal fiscal expenditure stimulus has mostly compensated for the negative state and local stimulus associated with the collapsing tax revenue and the limited borrowing capacity of the states. While this is a significant accomplishment, the net effect is that the consolidated fiscal expenditure stimulus is small, at a time when the private sector’s deleveraging has reduced private consumption. Thus, the fiscal expenditure stimulus did not manage to provide a viable cushion for the negative stimulus associated with private sector’s declining demand.
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