Zombie Hoover vs. The World

by Eric Martin

This David Leonhard piece (via Matt Y) on the global trend in austerity measures implemented despite the deep recession and severe unemployment crisis is quite appropos of recent conversations on this Site.  As such, here is an extended excerpt:

The world’s rich countries are now conducting a dangerous experiment. They are repeating an economic policy out of the 1930s — starting to cut spending and raise taxes before a recovery is assured — and hoping today’s situation is different enough to assure a different outcome.

In effect, policy makers are betting that the private sector can make up for the withdrawal of stimulus over the next couple of years. If they’re right, they will have made a head start on closing their enormous budget deficits. If they’re wrong, they may set off a vicious new cycle, in which public spending cuts weaken the world economy and beget new private spending cuts.

On Tuesday, pessimism seemed the better bet. Stocks fell around the world, over worries about economic growth.

Longer term, though, it’s still impossible to know which prediction will turn out to be right. You can find good evidence to support either one.

The private sector in many rich countries has continued to grow at a fairly good clip in recent months. In the United States, wages, total hours worked, industrial production and corporate profits have all risen significantly. And unlike in the 1930s, developing countries are now big enough that their growth can lift other countries’ economies.

On the other hand, the most recent economic numbers have offered some reason for worry, and the coming fiscal tightening in this country won’t be much smaller than the 1930s version. From 1936 to 1938, when the Roosevelt administration believed that the Great Depression was largely over, tax increases and spending declines combined to equal 5 percent of gross domestic product.

Back then, however, European governments were raising their spending in the run-up to World War II. This time, almost the entire world will be withdrawing its stimulus at once. From 2009 to 2011, the tightening in the United States will equal 4.6 percent of G.D.P., according to the International Monetary Fund. In Britain, even before taking into account the recently announced budget cuts, it was set to equal 2.5 percent. Worldwide, it will equal a little more than 2 percent of total output.

Today, no wealthy country is an obvious candidate to be the world’s growth engine, and the simultaneous moves have the potential to unnerve consumers, businesses and investors, says Adam Posen, an American expert on financial crises now working for the Bank of England. “The world may be making a mistake, and it may turn out to make things worse rather than better,” Mr. Posen said. [...]

The policy mistakes of the 1930s stemmed mostly from ignorance. John Maynard Keynes was still a practicing economist in those days, and his central insight about depressions — that governments need to spend when the private sector isn’t — was not widely understood. In the 1932 presidential campaign, Franklin D. Roosevelt vowed to outdo Herbert Hoover by balancing the budget. Much of Europe was also tightening at the time.

If anything, the initial stages of our own recent crisis were more severe than the Great Depression. Global trade, industrial production and stocks all dropped more in 2008-9 than in 1929-30, as a study by Barry Eichengreen and Kevin H. O’Rourke found.

In 2008, though, policy makers in most countries knew to act aggressively. The Federal Reserve and other central banks flooded the world with cheap money. The United States, China, Japan and, to a lesser extent, Europe, increased spending and cut taxes.

It worked. By early last year, within six months of the collapse of Lehman Brothers, economies were starting to recover.  [...]

As is often the case after a financial crisis, this recovery is turning out to be a choppy one. Companies kept increasing pay and hours last month, for example, but did little new hiring. On Tuesday, the Conference Board reported that consumer confidence fell sharply this month.

And just as households and businesses are becoming skittish, governments are getting ready to let stimulus programs expire, the equivalent of cutting spending and raising taxes. The Senate has so far refused to pass a bill that would extend unemployment insurance or send aid to ailing state governments. Goldman Sachs economists this week described the Senate’s inaction as “an increasingly important risk to growth.”

The parallels to 1937 are not reassuring. From 1933 to 1937, the United States economy expanded more than 40 percent, even surpassing its 1929 high. But the recovery was still not durable enough to survive Roosevelt’s spending cuts and new Social Security tax. In 1938, the economy shrank 3.4 percent, and unemployment spiked.

Given this history, why would policy makers want to put on another fiscal hair shirt today?

The reasons vary by country. Greece has no choice. It is out of money, and the markets will not lend to it at a reasonable rate. Several other countries are worried — not ludicrously — that financial markets may turn on them, too, if they delay deficit reduction. Spain falls into this category, and even Britain may.

Then there are the countries that still have the cash or borrowing ability to push for more growth, like the United States, Germany and China, which happen to be three of the world’s biggest economies. Yet they are also reluctant.

China, until recently at least, has been worried about its housing market overheating. Germany has long been afraid of stimulus, because of inflation’s role in the Nazis’ political rise. In responding to the recent financial crisis, Europe, led by Germany, was much more timid than the United States, which is one reason the European economy is in worse shape today.

The reasons for the new American austerity are subtler, but not shocking. Our economy remains in rough shape, by any measure. So it’s easy to confuse its condition (bad) with its direction (better) and to lose sight of how much worse it could be. The unyielding criticism from those who opposed stimulus from the get-go — laissez-faire economists, Congressional Republicans, German leaders — plays a role, too. They’re able to shout louder than the data.

Finally, the idea that the world’s rich countries need to cut spending and raise taxes has a lot of truth to it. The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change.

In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases. But not a single big country has figured out, politically, how to do that.

I've got a couple of ideas to address long term spending cuts: pare down our insanely large military budget, disengage from wasteful and counterproductive foreign wars, create a smarter, less wasteful legal regimen for dealing with drug use and reassess our country's handling of exceedingly expensive end of life care, in which over-prescribed procedures generate results of dubious value, and can be as unwanted as they are likely to result in pain and discomfort without upside.

Comments

[Sebastian]

I'm going to look closely at the Dartmouth end of life study. I've been waiting more than a decade for a good view of that problem. I hope it is good.

[Eric Martin]

Sounds like a good idea for a post.

[cleek]

I've got a couple of ideas to address long term spending cuts: pare down our insanely large military budget, disengage from wasteful and counterproductive foreign wars, create a smarter, less wasteful legal regimen for dealing with drug use and reassess our country's handling of exceedingly expensive end of life care

i'm working on a device to translate English to GOPeese. let's see how it works:

I've got a couple of ideas to address long term spending cuts: weaken the US, surrender to our enemies, encourage moral decay, and create death panels.

success!

[hairshirthedonist]

Given this history, why would policy makers want to put on another fiscal hair shirt today?

Why am I just now finding this out?

[John Thullen]

"Longer term, though, it's still impossible to know which prediction will turn out to be true."

Well, Keynes said in the long term we're all dead.

"our country's handling of exceedingly expensive end of life care,"

Amended Keynes: In the long term, plus six months, we're all dead.

Maybe folks have been sticking around at exorbitant expense so they could read the Dartmouth Study, and now that it's published, they can check it out, and then check out.

By the way, let me be the first to call both Eric and Sebastian, in a rare instance of kidding bi-partisanship and to save Erick Erickson, Sarah Palin, and the Catholic Church their goat-breath, a couple of Nazi, Stalinist, granny-snuffing, Kervorkian death panelists.

Good luck being on that side of the debate in the rancid rhetorical atmosphere of 21st-century America.

If I make it alive through my coming unemployment and either lack of health insurance, or exorbitant health insurance with no income, I'm going to love the debate about whether I should be snuffed out by the public sector or the private sector.

[Eric Martin]

that was funny.

actually, cleek and hsh get gold stars today.

[Eric Martin]

OK, Thullen too.

God I'm such a liberal.

[Thoreau]

I've got a couple of ideas to address long term spending cuts: pare down our insanely large military budget, disengage from wasteful and counterproductive foreign wars, create a smarter, less wasteful legal regimen for dealing with drug use and reassess our country's handling of exceedingly expensive end of life care,

All of these things are goals that I agree with, and if these spending cuts are enacted they would certainly help reduce deficits. However, these measures still reduce total government spending in a time of recession. If you're going to argue for fiscal stimulus and against deficit reduction, then you have to argue for reallocating the money for these programs rather than simply cutting these programs. What would you like to spend it on instead? Or do you just want to cut these programs without reallocating?

[Eric Martin]

T, baby, why such a stranger around these parts?

Otherwise, I would note that my prescription was for "long term spending cuts" - meaning, outside of the recession.

This, in response to the close of the article that read:

"In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases."

So, short term we should increase spending, not cut it (though I'd be willing to reallocate starting now - infrastructure is rotting, ie) and cut taxes or leave them alone.

Long term, we need to cut more spending (AND allocate better) and get them taxes back up to a more realistic level given the services/quality of living Americans have come to expect (not to mention that our crumbling infrastructure will be a serious liability that can cause a nasty downward spiral as time goes by).

[bobbyp]

Yep. Things look bleak. Ask the Irish (see recent NYT article). Ask some Latvians. They have willingly swallowed the bitter pill of economic contraction and deflation, and stood by helplessly while prices plummet and people are thrown out of work. But the IMF is pleased as punch.

And STILL the bond markets are not happy. Spain is now in their sights.

Here in the US, banks and corporations are flush with cash and basically hoarding it (Krugman's 'lower bound').

We are about to repeat Japan's lost decade, I guess because we just can't bring ourselves to believe it can happen here.

Believe me, it can.

[bobbyp]

"Greece has no choice. It is out of money."

Greece is tied to the Euro, and therefore does not control its own currency. When the economic contraction sweeping the world hit them, their government spending went into deficit and they had to borrow from the bond markets. They have stepped up like good little children and adopted drastic austerity measures. This has only made things worse. Now the ECB is (reluctantly) trying to cover up the mess (go to Naked Capitalism for more).

[Tony P.]

Otherwise, I would note that my prescription was for "long term spending cuts" - meaning, outside of the recession.

You're an optimist, aren't you, Eric? I mean, we've learned to talk casually about the Long War; why not the Long Recession?

Can't raise taxes in a recession, you know. That would hurt The Economy. (Just like civil liberties would hurt The War.) "Long" is good, for some people.

--TP

[Brett Bellmore]

"John Maynard Keynes was still a practicing economist in those days, and his central insight about depressions — that governments need to spend when the private sector isn’t — was not widely understood."

And the flip side of that insight, that governments need to refrain from spending when the private sector IS spending, is STILL widely rejected by governments, hence the current problems. Let's stop pretending that stimulus all the time is an application of Keynesian policy.

"Well, Keynes said in the long term we're all dead."

It's better in the original French: "Après moi, le deluge."

[DecidedFenceSitter]

Brett, I don't think that here, on this site you'll get a lot of complaints, on the other recent thread, you had lots of folks bemoaning the fact that the gov't didn't raise taxes and lower spending in the good times to pay for the deficits raised in the bad times.

[Eric Martin]

What DFS said.

Brett, if you note in this post, I actually list long term spending cuts and tax increases for the recovery years.

So, no pretend Keynesiansim. I mean, who exactly on this site are you accusing of pretending?

[joel hanes]

Fred Clark at The Slacktivist asks The Economist for national financial guidance, and receives a Village centrist answer.

[Eric Martin]

nice one jh

[Brett Bellmore]

"Brett, if you note in this post, I actually list long term spending cuts and tax increases for the recovery years.

So, no pretend Keynesiansim. I mean, who exactly on this site are you accusing of pretending?"

Last time I checked, Keynesianism didn't call for lots of 'stimulus' in good times, and even more in bad times. It called for stimulus in bad times, and paying the debt off in good times. (And let's not have that myth about Clinton's 'surplus' again, I already debunked it.)

So, pretend Keynesianism? Yup.

[Brett Bellmore]

Check this out:

"http://thehill.com/homenews/house/106905-house-democrats-pass-budget-enforcement-resolution>It also sets a goal of cutting deficits to the point where revenues equal all spending except for interest payments on the debt."

IOW, the best goal they can imagine setting, (And they're not going to try, mind you, to achieve it, is perpetually expanding deficits. Where they'll pretend they've balanced the budget, by not counting interest payments as part of the budget.

Yeah, pretend Kenyesiansim is a complement for this sort of thing.

[Lewis Carroll]

"It also sets a goal of cutting deficits to the point where revenues equal all spending except for interest payments on the debt." BY 2015.

Fixed that for you, Brett.

Yes, how remarkable that they can only manage to try to balance the structural deficit in 4 1/2 years, but not at the same time come up with a plan for dealing with George W. Bush's $hit bed in that time frame as well. How disappointing.

http://dshort.com/charts/federal-debt-to-gdp.html?federal-debt-to-gdp-politics-update

[Brett Bellmore]

What "fixed"? They've set a pathetic goal which is totally meaningless. It's like a home owner saying, "By four years from now, I plan to have my budget balanced, except for my mortgage payments, which I will continue to finance with my credit cards." Only they're going to pretend that it's a meaningful goal.

Just like they're going to pretend that they're making efforts to achieve it. Hell, they wouldn't even pass a budget this year, because doing so would make it too obvious how badly the budget was out of balance! How lame is THAT?

[Lewis Carroll]

Right, Brett, except you forgot the part where it was the home owner's irresponsible spending beforehand partying, giving away gifts to his favorite friends and putting it up his nose that put him in debt in the first place, and the part where he purposely depressed his own income as well.

Now, when the bill comes due, and there's finally some adult supervision, you want those adults to wave a magic wand and make it all OK in short time. Got it.

Seems to me that based on past history, all we have to do is not elect presidents named Reagan or Bush, and we'll be OK.