Archive for October, 2012
A big debate is underway about fiscal multipliers. Sounds esoteric but it is not—it reveals that economics is far from an exact science and the outcome appears to confirm what most working people thought, which is that government spending can help an economy grow.
A fiscal multiplier is an estimate of the economic impact of a change in government spending. The debate was triggered, surprisingly enough, by a small box in the International Monetary Fund’s annual publication, World Economic Outlook. There, the International Monetary Fund (IMF) admitted that its previous estimates of fiscal multipliers were too low.
Here is what the IMF chief economist Olivier Blanchard wrote:
The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.
As part of the attack on the role of government in the economy, many economists, prior to the Great Recession, argued that fiscal multipliers were roughly equal to 1. That meant a 1% reduction in government spending would likely cause a 1% decline in GDP, and a 1% increase in government spending would likely generate a 1% increase in GDP.
As the Great Recession got under way, many economists, including those at the IMF, began arguing for substantially lower multipliers, on the order of 0.5%. On the basis of this reduced value, many forecasters argued for the benefits of austerity. Debt was seen as a major problem and if fiscal multipliers were only 0.5%, a $1 cut in government spending would reduce debt by $1 but GDP by only 50 cents.
Well, after watching how austerity policies collapsed many economies around the world, especially in Europe, the IMF acknowledged that it had badly misjudged the size of the fiscal multiplier. As Cornel Ban explains:
In contrast [to its previous low estimates], the October 2012 WEO found that in fact [fiscal multipliers] ranged between .9 to 1.7 (the Eurozone periphery is closer to the higher end of the range), an error that explained the IMF’s extremely optimistic growth projections for countries who front-loaded fiscal consolidation. Assuming the multiplier was 1.5, a fiscal adjustment of 3 percent of GDP-as much as Spain has to do next year- would lead to a GDP contraction of 4.5 percent. It was momentous finding and those who had been skeptical of the virtues of austerity felt vindicated.
Barry Eichengreen and Kevin H O’Rourke provide additional evidence for large fiscal multipliers, in fact for larger multipliers than those proposed by the IMF. According to them:
The problem is that standard theory doesn’t tell us much about the precise magnitude of the multiplier under [current] conditions. The IMF’s analysis, moreover, relies on observations for only a handful of national experiences. It is limited to the post-2009 period. And it has been criticized for its sensitivity to the inclusion of influential outliers.
Fortunately, history provides more evidence on the relevant magnitudes. In a paper written together with Miguel Almunia, Agustin Bénétrix and Gisela Rua, we considered the experience of 27 countries in the 1930s, the last time when interest rates were at or near the zero lower bound, and when post-2009-like monetary conditions therefore applied (Almunia et al. 2010).
Our results depart from the earlier historical literature. Generalizing from the experience of the US it is frequently said, echoing E Cary Brown, that fiscal policy didn’t work in the 1930s because it wasn’t tried. In fact it was tried, in Japan, Italy, and Germany, for rearmament- and military-related reasons, and even in the US, where a Veterans’ Bonus amounting to 2% of GDP was paid out in 1936. Fiscal policy could have been used more actively, as Keynes was later to lament, but there was at least enough variation across countries and over time to permit systematic quantitative analysis of its effects.
We analyze the size of fiscal multipliers in several ways. First, we estimate panel vector regressions, relying on recursive ordering to identify shocks and using defense spending as our fiscal policy variable. The idea is that levels of defense spending are typically chosen for reasons unrelated to the current state of the economy, so defense spending can thus be placed before output in the recursive ordering. We also let interest rates and government revenues respond to output fluctuations. We find defense-spending multipliers in this 1930s setting as large as 2.5 on impact and 1.2 after the initial year.
Second, we estimate the response of output to government spending using a panel of annual data and defense spending as an instrument for the fiscal stance.
Here too we control for the level of interest rates, although these were low virtually everywhere, reflecting the prevalence of economic slack and ongoing deflation. Using this approach, our estimate of the multiplier is 1.6 when evaluated at the median values of the independent variables.
These estimates based on 1930s data are at the higher end of those in the literature, consistent with the idea that the multiplier will be greater when interest rates do not respond to the fiscal impulse, whether because they are at the lower bound or for other reasons. The 1930s experience thus suggests that the IMF’s new estimates are, if anything, on the conservative side.
Some economists remain unconvinced—in fact, some actually argue that government spending is incapable of creating jobs. The economist Robert J. Samuelson was so upset to read a New York Times editorial which claimed that government spending creates jobs that he had to respond:
In 35 years, I can’t recall ever writing a column refuting an editorial. But this one warrants special treatment because the Times’ argument is so simplistic, the subject is so important and the Times is such an influential institution.
Here is the nub of his argument:
it’s true that, legally, government does expand employment. But economically, it doesn’t — and that’s what people usually mean when they say “government doesn’t create jobs.”
What the Times omits is the money to support all these government jobs. It must come from somewhere — generally, taxes or loans (bonds, bills). But if the people whose money is taken via taxation or borrowing had kept the money, they would have spent most or all of it on something — and that spending would have boosted employment.
In other words, because the government relies on the private sector for the money it spends, the jobs created by its spending cannot be a net addition to the economy. Said differently, jobs supported by public spending are not real jobs. There is a lot that can be said, but here is Dean Baker’s response:
Samuelson tells us that if the government didn’t tax or borrow or the money to pay its workers (he makes a recession exception later in the piece) people “would have spent most or all of it on something — and that spending would have boosted employment.”
Again, this is true, but how does it differ from the private sector? If the new iPhone wasn’t released last month people would have spent most or all of that money on something — and that spending would have boosted employment. Does this mean that workers at Apple don’t have real jobs either?
The confusion gets even greater when we start to consider the range of services that can be provided by either the public or private sector. In Robert Samuelson’s world we know that public school teachers don’t have real jobs, but what about teachers at private schools? Presumably the jobs held by professors at major public universities, like Berkeley or the University of Michigan are not real, but the jobs held at for-profit universities, like Phoenix or the Washington Post’s own Kaplan Inc., are real.
How about health care? Currently the vast majority of workers in the health care industry are employed by the private sector. Presumably these are real jobs according to Samuelson. Suppose that we replace our private health care system with a national health care service like the one they have in the U.K. Would the jobs in the health care no longer be real? . . .
How about when the government finances an industry by granting it a state sanctioned monopoly as when it grants patent monopolies on prescription drugs. Do the researchers at Pfizer have real jobs even though their income is dependent on a government granted monopoly? Would they have real jobs if the government instead paid for research out of tax revenue and let drugs be sold in a free market, saving consumers $250 billion a year?
Robert Samuelson obviously thinks there is something very important about the difference between working for the government and working in the private sector. Unfortunately his column does not do a very good job of explaining why. It would probably be best if he waited another 35 years before again attacking a newspaper editorial.
If people are confused about how our economy works, or doesn’t work, it is no wonder.
Market advocates have had their way for years now—one of the consequences has been the growing dominance of industry after industry by a select few powerful corporations. In short, unchecked competition can and does produce its opposite.
As John Bellamy Foster, Robert W. McChesney, and R. Jamil Jonna explain:
This [development] is anything but an academic concern. The economic defense of capitalism is premised on the ubiquity of competitive markets, providing for the rational allocation of scarce resources and justifying the existing distribution of incomes. The political defense of capitalism is that economic power is diffuse and cannot be aggregated in such a manner as to have undue influence over the democratic state. Both of these core claims for capitalism are demolished if monopoly, rather than competition, is the rule.
The chart below highlights the rise, especially since the 1980s, in both the number and percentage of U.S. manufacturing industries in which four firms account for more than 50% of sales.
Number and Percentage of U.S. Manufacturing Industries in which Largest Four Companies Accounted for at Least 50 Percent of Shipment Value in Their Industries, 1947-2007
As the table below shows, the concentration of market power is not confined to manufacturing.
Percentage of Sales for Four Largest Firms in Selected U.S. Retail Industries
|Industry (NAICS code)||1992||1997||2002||2007|
|Food & beverage stores (445)||15.4||18.3||28.2||27.7|
|Health & personal care stores (446)||24.7||39.1||45.7||54.4|
|General merchandise stores (452)||47.3||55.9||65.6||73.2|
|Book stores (451211)||41.3||54.1||65.6||71.0|
|Computer & software stores (443120)||26.2||34.9||52.5||73.1|
As impressive as these concentration trends may be, they actually understate the market power exercised by leading U.S. firms. The reason is that many of these firms are conglomerates and active in more than one industry. The next chart provides some flavor for overall concentration trends by showing the growing share of total business revenue captured by the top two hundred U.S. corporations. Notice the sharp rise since the 1990s.
These are general trends. Here, thanks to Zocalo (which draws on the work of Barry Lynn), we get a picture of the market dominance of just one corporation–Procter and Gamble. This corporation controls:
• More than 75 percent of men’s razors
• About 60 percent of laundry detergent
• Nearly 60 percent of dishwasher detergent
• More than 50 percent of feminine pads
• About 50 percent of toothbrushes
• Nearly 50 percent of batteries
• Nearly 45 percent of paper towels, just through the Bounty brand
• Nearly 40 percent of toothpaste
• Nearly 40 percent of over-the-counter heartburn medicines
• Nearly 40 percent of diapers.
• About 33 percent of shampoo, coffee, and toilet paper
A recent Huffington Post blog post, which includes the following infographic from the Frence blog Convergence Alimentaire, makes clear that Procter and Gamble, as big as it is, is just one member of a small but powerful group of multinationals that dominate many consumer markets. The blog post states: “A ginormous number of brands are controlled by just 10 multinationals . . . Now we can see just how many products are owned by Kraft, Coca-Cola, General Mills, Kellogg’s, Mars, Unilever, Johnson & Johnson, P&G and Nestlé. ” See here for a bigger version of the infographic.
And, it is not just the consumer goods industry that’s highly concentrated. As the Huffington Post also noted: “Ninety percent of the media is now controlled by just six companies, down from 50 in 1983 . . . Likewise, 37 banks merged to become JPMorgan Chase, Bank of America, Wells Fargo and CitiGroup in a little over two decades, as seen in this 2010 graphic from Mother Jones.”
Not surprisingly, there are complex interactions and struggles between these dominant companies. Unfortunately, most end up strengthening monopoly power at the public expense. For example, as Zocalo reports, Wal-Mart, Target, and other major retailers have adopted a new control strategy in which:
these retailers name a single supplier to serve as a category captain. This supplier is expected to manage all the shelving and marketing decisions for an entire family of products, such as dental care.
The retailer then requires all the other producers of this class of products — these days, usually no more than one or two other firms — to cooperate with the captain. The consciously intended result of this tight cartelization is a growing specialization of production and pricing among the few big suppliers who are still in business. . . .
It’s not that Wal-Mart and category copycats like Target cede all control over shelving and hence production decisions to these captains. The trading firms use the process mainly to gain more insight into the operations of the manufacturers and hence more leverage over them, their suppliers, and even their other clients. . . . Wal-Mart, for instance, has told Coca-Cola what artificial sweetener to use in a diet soda, it has told Disney what scenes to cut from a DVD, it has told Levi’s what grade of cotton to use in its jeans, and it has told lawn mower makers what grade of steel to buy.
And don’t think that such consolidation within the Wal-Mart system makes it easier for new small manufacturers and retailers to rise up and compete. The exact opposite tends to be true. . . . This [system] boils down to presenting the owners of midsized and smaller companies, like Oakley or Tom’s of Maine, with the “option” of selling their business to the monopolist in exchange for a “reasonable” sum determined by the monopolist.
This was the message delivered to many of the companies that in recent decades managed to develop big businesses seemingly outside the reach of the Procter & Gambles, Krafts, and Gillettes of the world. Consider the following:
• Ben & Jerry’s, the Vermont ice cream company that reshaped the industry, was swallowed by Unilever in 2000.
• Cascadian Farm, one of the most successful organic food companies, sold out to General Mills and was promptly transformed into what its founder calls a “PR farm.”
• Stonyfield Farm and Brown Cow, organic dairy companies from New Hampshire and California, respectively, separately sold con-trol to the French food giant Groupe Danone in February 2003 and were blended into a single operation.
• Glaceau, the company behind the brightly colored Vitamin Water and one of the last independent success stories, sold out to Coca-Cola in 2007.
The practical result is a hierarchy of power in which a few immense trading companies — in control of and to some degree in cahoots with a few dominant supply conglomerates — govern almost all the industrial activities on which we depend, and they back their efforts with what amounts to police power. This tiny confederation of private corporate governments determines who wins and who loses in this country, at least within our consumer economy.
Of course the growing concentration nationally is matched by a growing concentration of power globally, with large transnational corporations from different nations battling each other and, in many cases, uniting through mergers and acquisitions. We cannot hope to understand and overcome our current problems and the structural pressures limiting our responses to them without first acknowledging the extent of corporate dominance over our economic lives.
Presidential candidate Mitt Romney’s low federal tax rate—14.1%—has called attention to the fact that our tax code favors people who make their money from investments rather than labor. According to the conventional wisdom, this is as it should be. It encourages people, like our job creators, to invest their money, thereby boosting growth and the well-being of all working people. Sounds plausible but the facts don’t support the policy.
BusinessWeek lays out the background and political context for our current low taxation rates on investment income as follows:
Since 1950 capital gains have generally been taxed at a lower rate than income, to spur investment. The rate under President George W. Bush went from 20 percent to 15—the lowest ever—and was billed as a way to stimulate the economy. (If nothing’s done by Jan. 1 to change tax and budget provisions already passed by Congress, the rate will snap back to 20 percent, a scenario both parties hope to avoid.) Mitt Romney wants to ditch capital gains tax altogether for people earning less than $250,000. President Barack Obama, in his Affordable Care Act, increased the rate by 3.8 percent for high earners beginning in 2013, and has proposed the so-called Buffett Rule, which would among other things end an accounting interpretation that allows private equity and hedge fund managers (and Romney) to save money by paying tax on their earnings at the capital gains rate. Neither candidate, though, contests the Bush administration’s basic logic: that a lower capital gains rate encourages investment, which creates jobs and helps the economy grow. That doesn’t mean they’re right.
Leonard E. Burman, a tax expert, took on this issue in recent testimony before the House Committee on Ways and Means and the Senate Committee on Finance. A good place to start is with who benefits from lower capital gains taxes.
Not surprisingly, as the figure below (which is taken from Burman’s testimony) shows, the benefits are extremely concentrated. As Burman noted:
In 2010, the highest-income 20 percent realized more than 90 percent of long-term capital gains according to the TaxPolicyCenter. The top 1 percent realized almost 70 percent of gains and the richest 1 in 1,000 households accrued about 47 percent. It is hard to think of another form of income that is more concentrated by income.
Moreover, as the next figure shows, the concentration of capital gains has grown over time. Given that the rich fund political campaigns, this certainly helps to explain why both political parties are so determined to keep the rate low.
But, to the main question—do lower capital gains taxes actually boost growth? This is what Burman had to say in his testimony:
The heated rhetoric notwithstanding, there is no obvious relationship between tax rates on capital gains and economic growth. Figure 4 [below] shows top tax rates on long-term capital gains and real economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, we’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series. The correlation is 0.12, the opposite sign from what capital gains tax cut advocates would expect, and not statistically different from zero. Although not shown, I’ve tried lags up to five years and using moving averages, but there is never a larger or statistically significant relationship.
Burman notes that he posted this figure on his blog and offered the data to anyone interested, challenging readers to find support for lower rates. “A half dozen or so people, including at least one outspoken critic of taxing capital gains, took me up on the offer, but nobody to my knowledge has been able to tease a meaningful relationship between capital gains tax rates and the GDP out of the data.”
As reported in a previous post, Thomes L. Hungerford, writing for the Congressional Research Service, came to the same conclusion about the lack of any relationship between the capital gains tax and GDP. In fact, he concluded raising the top income and capital gains tax rates would likely reduce income inequality without causing harm to the economy.
So, if we are really concerned with the budget deficit, rather than slashing spending on social programs lets raise the top tax rates. Wonder if this will come up during our presidential debates?