Archive for the ‘Structural Crisis’ Category
Profits are definitely up. In fact, as Doug Henwood reports in a post on his Left Business Observer blog, corporations are “flush with cash”:
At last count, U.S. nonfinancial corporations had nearly $16 trillion in financial assets on their balance sheets, almost as much as they have in tangible assets. The gap between internal funds available for investment and actual capital expenditures—what’s called free cash flow—is very wide at around 2% of GDP. That’s down from the high of 3% set a couple of years ago, but sill higher than at any point before 2005.
So, what are corporations doing with all their cash? Well, definitely not investing in new plant or equipment.
Quoting Henwood again:
What matters for the accumulation of real capital is net investment—the gross amount invested every year less the depreciation of the existing capital stock. We’ve just gotten numbers for 2012, and they’re remarkably low. Private sector net nonresidential fixed investment (as a percent of net domestic product, or NDP) fell below 1% in 2009. It’s recovered some, to just over 2% last year, but that’s half the 1950-2000 average, and lower than any year between 1945 and 2009. We won’t have 2013 numbers until August of next year, but it looks like they’ll stay in this depressed neighborhood.
Instead of investing, “corporations are shoveling cash out to their shareholders. Through takeovers, buybacks, and traditional dividends, nonfinancial corporations are transferring an amount equal to 5% of GDP to their shareholders these days—again, down some from recent highs, but very high by historical standards.”
These trends help explain how the top 1% of income earners were able to capture 95% of all the income gains over the period 2009 to 2012. They also help explain why continued stagnation appears the most likely outcome for the years ahead.
Despite the declining rate of unemployment—-it fell to 7.4% in July, the lowest level since December 2008—it is clear that economic trends, especially the rate and nature of job creation, are far from desirable.
As the Wall Street Journal explains:
The U.S. labor market’s long, slow recovery slowed further in July—and many of the jobs that were created were in low-wage industries.
Employers added a seasonally adjusted 162,000 jobs in July, the fewest since March, the Labor Department said Friday, and hiring was also weaker in May and June than initially reported. Moreover, more than half the job gains were in the restaurant and retail sectors, both of which pay well under $20 an hour on average. . . .
The falling jobless rate reflects to some degree a pace of hiring that, though slow, has remained steady over the past year even as the broader economy has grown in fits and starts. The U.S. has added an average of 192,000 nonfarm jobs per month so far this year, hardly a robust pace but more than enough to keep up with population growth.
But the drop in the unemployment rate is also the result of a job market that remains too weak to draw back workers who have dropped out of the labor force. Some 6.6 million workers say they want a job but don’t count as unemployed because they aren’t actively looking, a number that has barely budged in the past year. The number of Americans working or looking for work fell by 37,000 in July; as a share of the population, the labor force remains near a three-decade low. . . .
President Barack Obama has stressed the need for good jobs, including during a visit this past week to an Amazon.com Inc. facility in Chattanooga, Tenn., where he called for “a better bargain for the middle class.”
The day before the president’s visit, the Internet retail giant said it was adding more than 5,000 full-time jobs in its distribution centers across the country. Many of the jobs pay $11 an hour or less, although the company said workers will qualify for health insurance and other benefits, including stock grants and tuition subsidies.
“In our viewpoint these are great jobs,” Amazon spokeswoman Kelly Cheeseman said.
But the proliferation of low-wage jobs is leading to anemic growth in incomes. Average hourly wages were up by less than 2% in July from a year earlier, continuing a pattern of weak wage growth in the recovery. A broader measure of income released by the Commerce Department on Friday showed that inflation-adjusted incomes actually fell slightly in June.
The following chart, from a Washington Post article, helps highlight the problematic nature of U.S. job growth. By far the greatest number of jobs lost during the recession were mid-wage jobs. And by far the greatest number of jobs created during the recovery have been low-wage jobs.
Even worse, almost all the jobs created over the last six months have been part-time. According to a McClatchy report:
The unemployment rate is measured by the separate Household Survey, and it fell two-tenths of a percentage point to 7.4 percent, its lowest level since December 2008. That’s due in part to slow growth in the labor force. The jobless rate is based on a sample of self-reporting from ordinary people across the nation, and it’s the Labor Department measure that shows a very troubling trend in hiring.
“Over the last six months, of the net job creation, 97 percent of that is part-time work,” said Keith Hall, a senior researcher at George Mason University’s Mercatus Center. “That is really remarkable.”
Hall is no ordinary academic. He ran the Bureau of Labor Statistics, the agency that puts out the monthly jobs report, from 2008 to 2012. Over the past six months, he said, the Household Survey shows 963,000 more people reporting that they were employed, and 936,000 of them reported they’re in part-time jobs.
“That is a really high number for a six-month period,” Hall said. “I’m not sure that has ever happened over six months before.”
No wonder workers are struggling to make ends meet—job creation is weak and most of the jobs being created are low paying and part time. But it is not like corporations don’t care. For example, McDonald’s Corporation teamed with Visa to offer its workers a helping hand: a web page with advice about how to budget better. This must be a great help to workers that earn on average about $8.25 an hour.
The McDonald’s working budget, shown below, is a bit hard to interpret. What is clear however is that the company expects workers to have two jobs, pay $20 a month for health care, nothing for heat, $600 a month for rent, and . . .
For insight into what it is like to live on a McDonald’s wage, check out the Bloomberg story on Tyree Johnson, a 20 year employee still making minimum wage. Corporations like McDonalds don’t pay these low wages because they are hurting but rather because they help their bottom line, as the following graphic from the Bloomberg story shows.
Corporate apologists often argue that these jobs are just “starter” jobs for high school students seeking to earn money for some extra like a smart phone. But as the New York Times notes, only 14% of those earning between the minimum wage and $10 an hour are less than 20 years old.
As Steven Greenhouse reports, fast food and other low wage workers have begun organizing and striking to improve their working conditions; they are demanding a $15 hourly wage:
In recent weeks, workers from McDonald’s, Taco Bell and other fast-food restaurants — many of them part-time employees — have staged one-day walkouts in New York, Chicago, Detroit and Seattle to protest their earnings, typically just $150 to $350 a week, often too little to support themselves and their families. More walkouts are expected at fast-food restaurants in seven cities on Monday. Earlier this month hundreds of low-wage employees working for federal contractors in Washington walked out and picketed along Pennsylvania Avenue to urge President Obama to press their employers to raise wages.
These workers are taking real risks and if successful their gains would likely boost living and working conditions for most U.S. workers. They deserve our strong support.
Any improvement in living and working conditions in the United States is going to require far more than tinkering at the margins. The fact is that U.S. economic dynamics have undergone a major transformation.
As Figure 1, taken from a Dollars and Sense article by Gerald Friedman, shows, profits and investment are no longer positively related. Since the early 2000s, profits have soared as a percent of GDP and net private investment has plummeted. Even during the 1990s, when high-technology was celebrated as the engine of never-ending growth, net investment as a share of GDP remained below 1970s and 1980s highs.
Our leading companies, the ones that shape government policy, are now able to make healthy profits without spending on plant and equipment much beyond replacement. Their profits are now largely secured by globalizing manufacturing production, financialization, intensification of work, wage suppression, and government tax-breaks and subsidies. Of course, that means that their quest for profits will continue to lead to policies likely to undermine progress in reversing negative trends in majority living and working conditions.
A case in point is their aggressive push, supported by the Obama administration, for new free trade agreements—the Trans-Pacific Partnership Free Trade Agreement and the Trans-Atlantic Free Trade Agreement. President Obama took the lead in securing passage of the Korea-U.S. Free Trade Agreement, arguing that it would improve our trade balance with Korea and by extension U.S. jobs. Well, the returns are in, and in line with the record of past agreements, the outcome is the exact opposite.
The Eyes on Trade blog offers the following summary:
April  was another record-breaking month for U.S. trade with Korea under the U.S.-Korea Free Trade Agreement (FTA). The monthly U.S. trade deficit with Korea soared to its highest point in history, topping $2.5 billion for the month of April alone.
According to a ratio used by the Obama administration, the unprecedented deficit surge implies 13,500 U.S. jobs lost to trade with Korea in just thirty days. April’s trade deficit with Korea was 30% higher than in April 2012 — the first full month of FTA implementation — and 90% higher than in April 2011, before the FTA took effect.
The deficit increase owes largely to a dramatic drop in U.S. exports to Korea since enactment of the FTA. U.S. exports to Korea in April once again fell below the levels seen in any given month in the year before the FTA took effect. The sorry track record defies the promise (FTA = more exports) that the Obama administration used to pass the FTA. Undeterred by the facts, today the administration is using the same worn-out promise to sell the Trans-Pacific Partnership.
Unwilling to pursue policies that directly threaten corporate interests, the Obama administration has relied on monetary policy, or more specifically lower interest rates, to boost investment and employment. As Figure 2 from the Dollars and Sense article makes clear, while lower rates generally boost investment, data points for 2009, 2010, and 2011 strongly suggest that monetary policy has lost its effectiveness.
President Obama can talk all he wants about the need for more investment and better jobs, but unless he is pushed to pursue dramatically different policies, it is hard to see any real gains for working people over the next decades.
Media and policy-makers seem anxious to convince us that the economy is in strong recovery mode. Therefore no further significant policy interventions are needed.
Their optimism appears to rest heavily on the recent acceleration in consumer spending. After all, there are strong reasons for concern with the other major sources of growth: government spending on all levels is being cut, exports face a weakening world economy, and business investment remains largely stagnate.
But there are also strong reasons to challenge this optimistic view of consumer spending as a growth engine. The charts below, from a Wall Street Journal article, highlight some of the most important.
As we see below, while consumption spending is indeed accelerating, after tax personal income is falling. In other words, there appears little reason to believe that there is a solid foundation for sustaining this trend.
Additionally, after four years of recovery we still have 2.4 million fewer jobs than we had at the start of the recession. Moreover, as we see below, there has been no real wage growth. In fact, real average wages have fallen for most of the so-called expansionary period.
Yes, housing values are finally starting to rise and household debt payments as a share of after-tax income are declining. But to a large extent the new burst in consumption spending has more to do with renewed borrowing than solid gains in job creation and income.
Unfortunately, there is little reason for us to have confidence that the economy is gathering strength in ways that will be sustainable or benefit the great majority of working people.
While newspapers give a lot of ink to arguments about whether reducing the budget deficit will boost or reduce growth, they seem to have little interest in the related issue of whether economic growth really benefits the great majority.
David Cay Johnston, the Pulitzer Prize winning financial journalist, recently addressed this issue drawing on the work of economists Emmanuel Saez and Thomas Piketty:
In 2011 entry into the top 10 percent . . . required an adjusted gross income of at least $110,651. The top 1 percent started at $366,623.
The top 1 percent enjoyed 81 percent of all the increased income since 2009. Just over half of the gains went to the top one-tenth of 1 percent, and 39 percent of the gains went to the top 1 percent of the top 1 percent.
Ponder that last fact for a moment — the top 1 percent of the top 1 percent, those making at least $7.97 million in 2011, enjoyed 39 percent of all the income gains in America.
So, 81 percent of all the new income generated from 2009 to 2011 was captured by the top 1 percent income earners, where income is defined as adjusted gross income, which refers to income minus deductions or taxable income. In other words growth, even accelerated growth, is not going to do the majority much good if the economic structure remains the same.
Johnston highlights the problem with our existing economic model with perhaps an even more shocking example. He compares the average income growth of the bottom 90 percent with the average income growth of the top 10 percent, 1 percent, and top 1 percent of the top 1 percent over the period 1966 to 2011.
It turns out that the average income of the bottom 90 percent rose by a miniscule $59 over the period (as measured in 2011 dollars). By comparison, the average income of the top 10 percent rose by $116,071, the average income of the top 1 percent rose by $628,817, and the average income of the top 1 percent of the top 1 percent increased by a whopping $18,362,740. In short, growth alone means little if the great majority of people are structurally excluded from the benefits.
In an effort to highlight this extreme disparity in adjusted income growth rates, Johnston suggests plotting the numbers on a chart, with $59, the amount gained by the bottom 90 percent, represented by a bar one inch high. As the chart below shows, the bar representing average gains for the top 10 percent would be 163 feet high, that for the top 1 percent would be 884 feet high, and that for the top 1 percent of the top 1 percent would be 4.9 miles high.
In sum, the real challenge facing the great majority of Americans is not figuring out how to make the economy growth faster. Rather, it is figuring out how to create space for a real debate about how to transform our economy so that growth will actually satisfy majority needs.
The following two charts taken from a Center for Economic Policy and Research Center study by John Schmitt and Janelle Jones highlight the distressed nature of the U.S. labor market and the need for raising the minimum wage and strengthening union organizing.
Schmitt and Jones define low wage work as that work paying $10.00 an hour or less in 2011 dollars. As the charts show, low wage workers are far more educated and older in 2011 than in 1979. Said differently, education and experience are not sufficient to ensure a living wage.
Not surprisingly, growing numbers of low wage workers at Walmart and at chain fast food restaurants have begun engaging in direct action for higher wages and better working conditions. They deserve our support.
With the election over, the news is now focused, somewhat hysterically, on the threat of the fiscal cliff.
The fiscal cliff refers to the fact that at the end of this calendar year several temporary tax cuts are scheduled to expire (including those that lowered rates on income and capital gains as well as payroll taxes) and early in the next year spending cuts are scheduled for military and non-military federal programs. See here for details on the taxes and programs.
Most analysts agree that if tax rates rise and federal spending is cut the result will be a significant contraction in aggregate demand, pushing the U.S. economy into recession in 2013.
The U.S. economy is already losing steam. GDP growth in the second half of 2009, which marked the start of the recovery, averaged 2.7% on an annualized basis. GDP growth in 2010 was a lower 2.4%. GDP growth in 2011 averaged a still lower 2.0%. And growth in the first half of this year declined again, to an annualized rate of 1.8%.
With banks unwilling to loan, businesses unwilling to invest or hire, and government spending already on the decline, there can be little doubt that a further fiscal tightening will indeed mean recession.
So, assuming we don’t want to go over the fiscal cliff, what are our choices?
Both Republicans and Democrats face this moment in agreement that our national deficits and debt are out of control and must be reduced regardless of the consequences for overall economic activity. What they disagree on is how best to achieve the reduction. Most Republicans argue that we should renew the existing tax cuts and protect the military budget. Deficit reduction should come from slashing the non-military discretionary portion of the budget, which, as Ethan Pollack explains, includes:
safety net programs like housing vouchers and nutrition assistance for women and infants; most of the funding for the enforcement of consumer protection, environmental protection, and financial regulation; and practically all of the federal government’s civilian public investments, such as infrastructure, education, training, and research and development.
The table below shows the various programs/budgets that make up the non-security discretionary budget and their relative size. The chart that follows shows how spending on this part of the budget is already under attack by both Democrats and Republicans.
Unfortunately, the Democrat’s response to the fiscal cliff is only marginally better than that of the Republicans. President Obama also wants to shrink the deficit and national debt, but in “a more balanced way.” He wants both tax increases and spending cuts. He is on record seeking $4 trillion in deficit reduction over a ten year period, with a ratio of $2.50 in spending cuts for every $1 in new revenue.
The additional revenue in his plan will come from allowing tax cuts for the wealthy to expire, raising the tax rate on the top income tax bracket, and limiting the value of tax deductions. While an important improvement, President Obama is also committed to significant cuts in non-military discretionary spending. Although his cuts would not be as great as those advocated by the Republicans, reducing spending on most of the targeted programs makes little social or economic sense given current economic conditions.
So, how do we scale the fiscal cliff in a responsible way?
We need to start with the understanding that we do not face a serious national deficit or debt problem. As Jamie Galbraith notes:
. . . is there a looming crisis of debt or deficits, such that sacrifices in general are necessary? No, there is not. Not in the short run – as almost everyone agrees. But also: not in the long run. What we have are computer projections, based on arbitrary – and in fact capricious – assumptions. But even the computer projections no longer show much of a crisis. CBO has adjusted its interest rate forecast, and even under its “alternative fiscal scenario” the debt/GDP ratio now stabilizes after a few years.
Actually, as the chart below shows, the deficit is already rapidly falling. In fact, the decline in government spending over the last few years is likely one of the reasons why our economic growth is slowing so dramatically.
As Jed Graham points out:
From fiscal 2009 to fiscal 2012, the deficit shrank 3.1 percentage points, from 10.1% to 7.0% of GDP. That’s just a bit faster than the 3.0 percentage point deficit improvement from 1995 to ’98, but at that point, the economy had everything going for it.
Other occasions when the federal deficit contracted by much more than 1 percentage point a year have coincided with recession. Some examples include 1937, 1960 and 1969.
In short, we do not face a serious problem of growing government deficits. Rather the problem is one of too fast a reduction in the deficit in light of our slowing economy.
As to the challenge of the fiscal cliff—here we have to recognize, as Josh Bivens and Andrew Fieldhouse explain, that:
the budget impact and the economic impact are not necessarily the same. Some policies that are expensive in budgetary terms have only modest economic impacts (for example, the 2001 and 2003 tax cuts aimed at high-income households are costly but do not have much economic impact). Conversely, other policies with small budgetary costs have big economic impacts (for example, extended unemployment insurance benefits).
In other words, we should indeed allow the temporary tax rate deductions for the wealthy to expire, on both income and capital gains taxes. These deductions cost us dearly on the budget side without adding much on the economic side. As shown here and here, the evidence is strong that the only thing produced by lowering taxes on the wealthy is greater income inequality.
Letting existing tax rates rise for individuals making over $200,000 and families making over $250,000 a year, raising the top income tax bracket for both couples and singles that make more than $388,350, and limiting tax deductions will generate close to $1.5 trillion dollars over ten years as highlighted below in a Wall Street Journal graphic .
However, in contrast to President Obama’s proposal, we should also support the planned $500 billion in cuts to the military budget. We don’t need the new weapons and studies are clear that spending on the military (as well as tax cuts) is a poor way to generate jobs. For example, the table below shows the employment effects of spending $1 billion on the military versus spending the same amount on education, health care, clean energy, or tax cuts.
And, we should also oppose any cuts in our non-security discretionary budget. Instead, we should take at least half the savings from the higher tax revenues and military spending cuts–that would be a minimum of $1 trillion–and spend it on programs designed to boost our physical and social infrastructure. Here I have in mind retrofitting buildings, improving our mass transit systems, increasing our development and use of safe and renewable energy sources like wind and solar, and expanding and strengthening our social services, including education, health care, libraries, and the like.
Our goal should be a strong and accountable public sector, good jobs for all, and healthy communities, not debt reduction. The above policy begins to move us in the right direction.
One of the biggest obstacles to improving economic conditions has been majority belief that our current economic system is capable of delivering steady improvements in living and working conditions. Because of that belief, it has been easy for economic and political elites to convince large numbers of people that current economic problems must be the result of too much government spending, or immigrants, or unions, or taxes or . . . . In other words anything but capitalism itself.
However, there are now signs that the times may be changing.
A New York Times blog post by Thomas B. Edsall discusses some recent polling data which suggests that growing numbers of Americans, what many analysts are calling the rising American electorate–unmarried women, young people, Hispanics, and African Americans–are open to serious economic change.
For example, Edsall summarizes the results of one poll as follows:
When voters were asked whether cutting taxes or investing in education and infrastructure is the better policy to promote economic growth, the constituencies of the new liberal electorate consistently chose education and infrastructure by margins ranging from 2-1 to 3-2 — African Americans by 62-33, Hispanics by 61-37, never-married men by 56-38, never-married women by 64-30, voters under 30 by 63-34, and those with post-graduate education by 60-33.
Conservative constituencies generally chose lowering taxes by strong margins — whites by 52-42, married men by 59-34, married women by 51-44, all men by 52-41; older voters between the ages of 50 and 65 by 54-42.
The constituencies that make up the rising American electorate are firmly in favor of government action to reduce the gap between rich and poor, by 85-15 among blacks, 74-26 for Hispanics; 70-30 never-married men; 83-15 never-married women; and 76-24 among voters under 30. Conservative groups range from lukewarm to opposed: 53-47 for men; 53-47 among voters 50-65; 46-54 among married men; 52-47 among all whites.
One of the clearest divides between the rising American electorate and the rest of the country is in responses to the statement “Government is providing too many social services that should be left to religious groups and private charities. Black disagree 67-32; Hispanics disagree 57-40; never-married women 70-27; never-married men, 59-41; young voters, 66-34; and post-grad, 65-34. Conversely, whites agree with the statement 54-45; married men agree, 60-39; married women, 55-44; all men, 55-43.
Edsall also cites a 2011 Pew Research Center Poll that is even more suggestive of support for fundamental change. Although it is impossible to know what people mean by the terms capitalism and socialism, the table below, taken from the poll, suggests that opposition to capitalism is at significant levels among many of the groups that comprise the rising American electorate.
Polling data is not the same as political action of course. But the negative views of capitalism and surprisingly strong support for socialism among many in the population must be worrisome to those who continue to benefit from existing economic relations.
One can only imagine that far more people will come to hold these views if government leaders succeed in using the artificially created “fiscal cliff” to further cut key social programs. People want action on jobs, not cuts in government spending, regardless of whether those cuts are accompanied by tax increases on the wealthy.
There is growing talk that the economy is finally on its way to recovery—“A Steady, Slo-Mo Recovery”—in the words of Businessweek.
Here is how Peter Coy, writing in Businessweek, explains the growing consensus:
Job growth is poised to continue increasing tax revenue, which will make it easier to shrink the budget deficit while keeping taxes low and preserving essential spending. All this will occur without any magic emanating from the Oval Office. It would have occurred if Mitt Romney had been elected president. “The economy’s operating well below potential, and there’s a lot of room for growth” regardless of who’s in office, says Mark Zandi, chief economist of forecaster Moody’s Analytics.
Something could still go wrong, but the median prediction of 37 economists surveyed by Blue Chip Economic Indicators is that during the next four years, economic growth will gather momentum as jobless people go back to work and unused machinery is put back into service. “The self-correcting forces in the economy will prevail,” predicts Ben Herzon, senior economist at Macroeconomic Advisers, a forecasting firm in St. Louis.
Before we get lulled to sleep, we need some perspective about the challenges ahead. How about this: we face a 9 million jobs gap, and this doesn’t even address the low quality of the jobs being created.
The chart below, taken from an Economic Policy Institute blog post, illustrates the gap.
As Heidi Shierholz, the author of the post, explains:
The labor market has added nearly 5 million jobs since the post-Great Recession low in Feb. 2010. Because of the historic job loss of the Great Recession, however, the labor market still has 3.8 million fewer jobs than it had before the recession began in Dec. 2007. Furthermore, because the potential labor force grows as the population expands, in the nearly five years since the recession started we should have added 5.2 million jobs just to keep the unemployment rate stable. Putting these numbers together means the current gap in the labor market is 9.0 million jobs. To put that number in context: filling the 9 million jobs gap in three years—by fall 2015—while still keeping up with the growth in the potential labor force, would require adding around 330,000 jobs every single month between now and then.
Unfortunately, our “job creators” only created 171,000 net jobs in October. And that was considered a relatively good month. The chart below, from the Center on Budget and Policy Priorities, gives a sense of what we are up against.
Of course, weak job growth in the past doesn’t mean that we cannot have strong job growth in the future. On the other hand, such a change would require consensus on radically different policies than those currently being discussed and debated by those in power.
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.