The Dangers of Deficit Reduction
NEW YORK - A wave of fiscal austerity is rushing over Europe and America. The magnitude of budget deficits -- like the magnitude of the downturn -- has taken many by surprise. But despite protests by yesterday's proponents of deregulation, who would like the government to remain passive, most economists believe that government spending has made a difference, helping to avert another Great Depression.
Most economists also agree that it is a mistake to look at only one side of a balance sheet (whether for the public or private sector). One has to look not only at what a country or firm owes, but also at its assets. This should help answer those financial-sector hawks who are raising alarms about government spending. After all, even deficit hawks acknowledge that we should be focusing not on today's deficit, but on the long-term national debt. Spending, especially on investments in education, technology and infrastructure, can actually lead to lower long-term deficits.
Faster growth and returns on public investment yield higher tax revenues, and a 5 to 6 percent return is more than enough to offset temporary increases in the national debt. A social cost-benefit analysis (taking into account impacts other than on the budget) makes such expenditures, even when debt-financed, even more attractive.
Finally, most economists agree that, apart from these considerations, the appropriate size of a deficit depends in part on the state of the economy. A weaker economy calls for a larger deficit, and the appropriate size of the deficit in the face of a recession depends on the precise circumstances.
It is here that economists disagree. Forecasting is always difficult, but especially so in troubled times. What has happened is (fortunately) not an everyday occurrence; it would be foolish to look at past recoveries to predict this one.
In America, for instance, bad debt and foreclosures are at levels not seen for three-quarters of a century; the decline in credit in 2009 was the largest since 1942. Comparisons to the Great Depression are also deceptive, because the economy today is so different in so many ways.
Yet, even with large deficits, economic growth in the U.S. and Europe is anemic, and forecasts of private-sector growth suggest that in the absence of continued government support, there is risk of continued stagnation -- of growth too weak to return unemployment to normal levels anytime soon.
The risks are asymmetric: If these forecasts are wrong, and there is a more robust recovery, then, of course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a premature "exit" from deficit spending risks pushing the economy back into recession.
As the global economy returns to growth, governments should, of course, have plans on the drawing board to raise taxes and cut expenditures. The right balance will inevitably be a subject of dispute. Principles like "it is better to tax bad things than good things" might suggest imposing environmental taxes.
The financial sector has imposed huge externalities on the rest of society. America's financial industry polluted the world with toxic mortgages, and, in line with the well established "polluter pays" principle, taxes should be imposed on it. Besides, well-designed taxes on the financial sector might help alleviate problems caused by excessive leverage and banks that are too big to fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their key societal role of providing credit.
Over the longer term, most economists agree that governments, especially in advanced industrial countries with aging populations, should be concerned about the sustainability of their policies. But we must be wary of deficit fetishism. Deficits to finance wars or giveaways to the financial sector (as happened on a massive scale in the U.S.) lead to liabilities without corresponding assets, imposing a burden on future generations. But high-return public investments that more than pay for themselves can actually improve the well-being of future generations, and it would be doubly foolish to burden them with debts from unproductive spending and then cut back on productive investments.
These are questions for a later day -- at least in many countries, prospects of a robust recovery are, at best, a year or two away. For now, the economics is clear: Reducing government spending is a risk not worth taking.
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Inside Alan Greenspan's Nightmare
News that wages are rising in China is greeted with dread by those who share Greenspan's unwarranted fear of rising inflation
by Mark Weisbrot
Alan Greenspan had a dream, or rather a nightmare. Greenspan seems to have woken up in a cold sweat one morning in fear that the period of "disinflationary pressures" that had kept inflation low since the 1990s was about to end. This was 2007, when he published his autobiographical economic treatise, The Age of Turbulence. Despite his well-known love for economic data, and poring over the latest reports from every statistical agency, he did not realise that he was sitting on a housing bubble of epic proportions. Not seeing the bubble (he also missed the prior stock market bubble that accumulated and burst on his watch, causing the 2001 downturn), he could not know that it would soon collapse and cause a very ugly recession, in which inflation would be irrelevant.
This by itself should be enough to question the wisdom of central bankers, since the evidence for both of these world-historic asset bubbles was blindingly obvious once they had reached a certain size. But Greenspan's nightmare is scary for other reasons, some of which will become increasingly relevant as the world economy recovers.
As Greenspan details in his book, the reason for his nightmare is that the world was depleting its stock of hundreds of millions of unemployed people, including those of the former Soviet Union and also in rural China. In other words, "too many" of them had become employed, and this was allowing for wages of factory workers in China to rise. So long as China had a huge mass of unemployed, wages were held in check, and - according to Greenspan - competition from low-wage production there held down wages in the rest of the world, including even rich countries like the United States. All good! Until the nightmare started.
Is there something wrong with this picture, that one of the world's most powerful economic decision makers (at the time), dreads the decline of mass unemployment and rising wages among people making 80 cents an hour? What, then, is the purpose of economic development, if not to raise living standards for poor people? Some may dismiss Greenspan's values as unrepresentative - he was, after all, a devotee of the extreme libertarian writer Ayn Rand. And his autobiographical narrative is rather unusual: although we learn about his love of baseball, music (he attended the Julliard School), and how he became interested in economics, there is something missing. Most public figures of his stature, and even most economists, would have offered at least a perfunctory paragraph about how his economic thinking was aimed at helping those at the bottom of the social ladder - whether true or not. Greenspan didn't bother.
But unfortunately Greenspan is not an outlier but a moderate among central bankers. What is worse, their perverse world view has a hugely disproportionate influence on reporting and discussion of economic issues. As the press has recently reported, wages in China are again rising, due to the additive effect of the global economic recovery and the world's most effective economic stimulus programme, which enabled China to plough right through the world recession with 8.7% growth in 2009. The reports are somewhat less negative than they were a few years ago, but Greenspan's nightmare is everywhere: a dreaded "labour shortage" is forcing Chinese wages up and this will add to inflation. It is not clear what is wrong with a "labour shortage" being resolved in the way that markets resolve other shortages: ie the price of labour goes up until quantity supplied matches quantity demanded.
"China has drained its once vast reserves of unemployed workers in rural areas and is running out of fresh labourers for its factories," reports the New York Times. "Personnel managers here say they are also abandoning the informal tradition of not hiring anyone over 35 - they say they are now hiring workers up to 40 years old, and sometimes older, despite concerns about whether they can keep up week after week with the rapid pace of Chinese assembly lines."
"Managers can no longer simply provide eight-to-a-room dorms and expect labourers to toil 12 hours a day, seven days a week," says Business Week.
There is more, but we wouldn't want to give Alan Greenspan a heart attack.
To its credit, the Times recognises the positive aspect of rising wages for Chinese workers and also notes that the Obama administration, which has complained about the Chinese yuan being undervalued, should welcome this development. An increase in Chinese wages, to the extent that it raises the price of the country's exports, has the same impact as an appreciation of the yuan.
But the reality is that the Obama administration, as well as Congressional leaders, are not really serious about a more competitive dollar. If they were, they could push down the value of the dollar worldwide, rather than trying to blame the Chinese for our overvalued currency. But they don't do that because the Greenspan/Wall Street view prevails: anything that lowers inflation is good, whether it's an overvalued dollar, cheap imports from repressed overseas labour, or US workers' wages stagnating, as they have, for decades.
All this despite the fact that the non-partisan Congressional Budget Office projects inflation over the next 10 years averaging less than 1.7% annually - lower than any decade for more than half a century. Imaginary threats of inflation could turn out to be one of the more real threats to the United States' economic recovery.
Mark Weisbrot is Co-Director of the Center for Economic and Policy Research (CEPR), in Washington, DC.
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