Economics

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Back to the Budget

One of the least remarked upon aspects of the President’s State of the Union address last week was that it made no reference to the federal budget or to the deficit. Nor, for that matter did any of the seven – yes seven! – official or quasi-official Republican rebuttals.

Why has the budget become a non-issue?

Well, because the deficit has shrunk at a rapid rate. This is what it looks like expressed as a percentage of the economy as a whole:

 

Fed Deficit

In terms of dollars the deficit was $483 billion in 2014 and is expected to shrink slightly to $467 billion in 2016. As a percentage of GDP the deficit is now down to 2.8% in 2014, which compares with an average of 2.7% for the past fifty years. So after its extraordinary run-up because of the crisis of 2007/2008 the Federal deficit is pretty much back to normal.

A couple of days ago the Congressional Budget Office released its latest long range forecast for the Federal budget, and announced that the red ink will begin to swell again in the not too distant future, with deficits inching back up towards between 3% and 4% of GDP over the next decade.

A consequence of this is that the amount of Federal debt owned by the public will also start to rise again, from its current level of about 74% of GDP towards close to 80% by 2025. Just for reference that ratio was around 37% before the crisis began.

Why is this worthy of comment right now?

Because the President will submit his annual budget to Congress next week and rumor has it that he looking for an increase in spending somewhere in the range of $70 billion. This will undoubtedly bring the deficit back into focus, and will cause the usual rumpus from the GOP.

So as we set the stage for the next round of budget battles we ought to reflect on a few significant points:

First, let me remind you of the famous comment by Dick Cheney: “deficits don’t matter”. This was standard Republican thinking back in the 1980’s when Reagan tax and spending policies caused outlays to grow much faster than revenues. You can see this effect clearly in the cart above, where the 1980’s are a decade of large deficits – much larger than anything seen since those of the wartime economy of the 1940’s. It is always fun to poke Cheney’s line at any Republican who now claims that it is Democratic policy making that created the deficits.

Second, as the chart also shows, apart from the recent post-crisis years the only period of consistent reduction in the deficit was during the Clinton era. I don’t count the Bush administration for the simple reason that the reduction in later years was from a larger deficit that was a deliberate consequence of profligate tax policy at the onset of the Bush era. I realize that some Bush apologists will claim that deficit increase of 2001/2002 was in reaction to the recession around that time, but I don’t buy it: the Bush administration’s early policy was built around reducing revenues, and the infamous tax cuts of that era reflect, not a Keynesian style stimulus, but a Grover Norquist driven attempt to “starve the beast”. Those of us enamored with Clinton, however, would do well to remind ourselves that the deficit reduction during the 1990’s and more to do with the dot-com bubble than it did with intentional policy.

Third, a significant factor in driving the recent reduction in the deficit has been the notorious sequester of 2011 [aka: The Budget Control Act].  This legislation imposed strict spending guidelines on Congress, which, after a so-called Super-Committee failed to find any common ground for cuts, kicked in with full force in 2013. So sequester is still driving budget policy and the two sides in Congress both tear their hair out over the damage being done to pet projects – the defense budget is now down to about 3.3% of GDP and is expected to fall further to about 2.8% over the next couple of years. The effect of the sequester will be to drive discretionary spending – i.e. that part of spending not mandated by specific legislation – down to levels unheard of since records were first established for such spending in 1940. We are already back to levels not seen since 1962. Obviously this untenable: it leaves no room at all for increases in infrastructure spending, which has been moribund for years now.

Fourth, this all leaves the field open for continued war over the mandatory part of the budget which largely consists of Social Security, Medicare, and Medicaid. These programs together comprise a large majority of total Federal spending and are due to increase gradually over the next decade as the baby boom generation ages and retires. According to the CBO, Social Security spending will rise to about 5.7% of GDP by 2025 [from around 4.9% in 2015 and 4.2% in 1990], while spending on the various health care programs will rise to about 6.2% of GDP [from around 5.1% in 2015 and 2.3% in 1990]. Only a couple of weeks into the new Congress and the groundwork has been set for the next battle over Social Security: the House GOP leadership changed the rules covering the way in which internal transfers between the two Social Security accounts are agreed to by Congress. The account covering the disability portion of the program was set up at a different time from the main account, and is expected to need replenishment in 2016. In that past votes to authorize such a replenishing move were pro-forma and perfunctory. Now the new rule allows a single member of Congress to veto them. So instead of being routine, as they have been in the past, they will become hostage to right wing attack.

Fifth, the CBO’s forecasts of a renewed deterioration in the budget in the years beyond 2020, are heavily affected by interest rates. The CBO expects interest rates to return to ‘normal’ levels quite quickly. This will, inevitably, raise the cost of the accumulated debt, so that it gets back to about 3% of GDP by 2025 up from around 1.3% now. This is, however roughly what interest costs were in the early 1990’s before the Clinton era reduction in debt.

Overall lamentable tax policy over the past thirty years – and especially under Reagan and Bush –  has seen Federal revenues drop to only 17.5% of GDP. Whilst this is around the average for the past fifty years it is well below the level of spending, which, at around 20% of GDP, is also right at its fifty year average. In other words we have arrived, accidentally rather than deliberately, at a budget whose income and expense components reflect long term attitudes. The net result being a return also to the long term amount of deficit.

What throws this into the political battleground is that spending on social programs is mandated to increase simply because of the aging of the population. We are thus confronted with a dilemma: do we fund that increase? Or do we cut into spending – essentially reneging on the deal we made with future retirees when they were working and contributing to the programs?

So, although the budget wars might seem to have faded from view, they will assuredly pop right back up. Perhaps as early as next week’s Presidential budget proposal.

Stay tuned.

 

 

 

 

 

 

 

 

 

 

 

 

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The Greek Experiment

Let me congratulate the Greeks for taking the first, but only the first, step towards a more civilized economic policy. I am intrigued by the prospect of Yanis Varoufakis as economic minister deep in argument with any of the large number of radicals that infest European economic posts. And, yes, they are the radicals. The notion that aggressive austerity measures can engender growth and can be mostly benign with respect to employment, wages, and other immediate aspects of economic life is a radical, almost extreme, idea honed most recently to protect wealthy elites from having to engage with the rest of the societies inside which they exist. Against this form of radicalism people like Varoufakis, despite being smeared as radicals themselves, are more orthodox than not. At least they realize that economies are not mere models to manipulate, but are collections of people whose futures and dignity are surely worthy of consideration alongside such abstractions as markets or efficiency.

Any economy that is suffering 28% unemployment and which has experienced a drop of about 25% in GDP is a candidate for a shift in economic policy because it is evident that the existing policy – the one that produced those levels of unemployment – is not working. The experiment of imposing extreme austerity in order to protect the Greek banking system, which is what the Greek crisis resolves to, is an absurd and inhuman failure.

The austerity imposed on Greece in return for financial support was supposed to achieve a twofold result: Greek debts were targeted to decline as the government’s budget was brought into balance; and the Greek economy’s competitiveness was expected to recover making it possible to eliminate Greece’s chronic trade account deficits.

While it is true that Greek competitiveness has recovered somewhat – the trade balance now has a modest positive balance – the recovery is an illusion: it is more a function of the collapse of Greek demand for imported goods than it is a sudden recovery for Greek exports.

What about that collapse of an appetite for imports?

When your economy sheds nearly one million jobs in the space of a few years, demand is bound to plummet.

And when you deliberately create such an implosion all sorts of other bad things happen. Such as the pernicious decline in prices called deflation. Whilst the notion that prices are declining may seem attractive to those of us still living with memories of 1970’s double digit inflation, they are, in fact, a very bad phenomenon. The most obvious nasty outcome being that it makes the repayment of debt more difficult: since, under deflation, the real purchasing power of wages has risen [you can buy more goods with the same amount of cash], and since the debt is denominated as a fixed quantity at the moment it is created, the implication is that the inflation adjusted value of debt also rises. The result being that someone has to forgo more goods in future to pay down the same amount of debt as in the past. Not only this but cashflows for businesses diminish – they are selling the same number of things but at lower prices – this forces employers to reduce wages and/or employment, which, in turn reduces the purchasing power within the economy and hence demand.

It is easy to think through why deflation is so harmful potentially.

Yet those who seek to impose austerity blithely ignore the deflationary threat. Indeed they often imagine that they are fending off the precise opposite. The delusion is extraordinary.

More to the point the entire construct of austerity fueled growth is an imaginary one that is both novel and bizarre. All the evidence suggests it being a total illusion, yet it has a grip on the minds of key policy makers, especially in Europe.

So the Greek experiment is not what Varoufakis might start to suggest as sound economic policy, but what has been enforced on Greece these past few years.

We are not entering a period of economic experimentation, we are exiting one.

It is a lesson we ought to learn here in the US where the experiment of extreme economics has, for the past thirty years, resulted in a whole host of bad outcomes for average American families. It is time to return to an economics that acknowledges the purpose of policy being to enhance the lives of those who comprise the economy, and not to treat those lives as just one variable in an elegant equation where the ultimate goal is efficiency and not dignity.

People will choose dignity over efficiency more often than orthodox economists want to believe. This does not mean people will avoid tough trade-offs, it means that people need to be assured that policy makers take them into account when prescribing policies that have life damaging outcomes.

In a nutshell: if we had more unemployed economists we might, possibly, have an economics more sensitive to the human condition than that which now dominates policy. Perhaps the Greeks can lead the way.

 

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Feel The Love – Davos Style

You will have seen or heard by now that our rich and beautiful are ensconced in their annual self-congratulatory power meet-up in Davos. This is where they all make what they consider to be important statements about the state of the world, where they have lots of important conversations, and make, or reinforce, lots of important contacts.

None of which matters a damn, except to them.

We can usually count on at least one pompous lunatic to emerge as front runner as idiot of the week. This year Jeff Greene has stormed to an early lead.

Why?

Because of his absurd thoughts on the state of the US economy:

“America’s lifestyle expectations are far too high and need to be adjusted so we have less things and a smaller, better existence …We need to reinvent our whole system of life.”

This in an interview in which he expressed concern that the US faces a jobs crisis sufficient to cause social unrest and political extremism.

So, naturally, he concludes that we ought to cut down on our expectations. We ought reduce our goals. We ought to slim down to fit into our more modest and impoverished fortunes. If the economy sucks, then all we can do is to live within those narrower boundaries and give up any silly notions of a brighter future. Grim is the new happy.

Don’t know who Jeff Greene is?

He’s a billionaire who made his money gambling in real estate and the money markets. He struck it lucky, although he would argue he was ultra smart. And because he’s ultra smart he can tell us what to do.

His lesson for us?

Live more modestly. Don’t get upset about the fading of the American Dream. Don’t break windows. And definitely don’t get into such a bad mood as to support populist pro-worker ‘radical’ politics. That would be uncivilized.

Oh. Jeff Greene flew his family and two nannies to Davos for the week on a private jet. So he knows all about how to fit within more modest means.

Plutocrats just don’t get it do they?

They are a problem we need to fix.

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Zero Shocker

What with the World Economic Forum folks wading in on inequality ahead of the annual Davos shindig for the great and beautiful, here’s what Oxfam has to say:

“Global wealth is increasingly being concentrated in the hands of a small wealthy elite … These wealthy individuals have generated and sustained their vast riches through their interests and activities in a few important economic sectors, including finance and pharmaceuticals/healthcare. Companies from these sectors spend millions of dollars every year on lobbying to create a policy environment that protects and enhances their interests further.”

Moreover Oxfam predicts that the top 1% will have more wealth than the bottom 99% by about 2016. Here’s their chart:

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There’s no shock, is there?

The odd thing is that even though people are talking endlessly about inequality, very little is being done. Is this because, as Oxfam tells us, that the rich and beautiful are able to stifle the debate? Is it ineptitude on the part of our leadership? Is it outright corruption? Whatever it is, it remains undeniable that inequality looms larger than ever as both an economic and a political issue.

More to the point, for me at least, the collective known as the economics profession is all over the lot on the inequality. Instead of staying with the meta theme that inequality is clearly an concern, economists, as is their wont, tend to dive into the weeds and study endless theoretic details, offer widely contradictory opinions, and engage in fruitless picayune discussions that move the debate not an inch forward. This great cloud of dust raised by economists is familiar to the profession, but can be deeply disappointing to outsiders. After all if the profession within whose remit inequality appears to reside best cannot present a coherent critique, who can?

No wonder the rich and beautiful continue along their merry way.

And no wonder that regular people remain frustrated with the ever greater distance between what they need economic policy to be and what it turns out as.

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Economics Is What?

This week’s Economist magazine includes an article designed to uplift the hearts of depressed economists everywhere. It devotes a whole page under the headline “Meet the market shapers”, to a catalog of what it regards as cutting edge examples of economists doing useful stuff at the ‘micro’ level. By micro in these cases the Economist means working inside or alongside a business firm.

All the cases in the article are about some clever folk doing some clever analysis that, so we are told, really and truly helps the firms in question do better. In particular a theme emerges that the work seems to help the firms match what they have to sell with people who are likely, though not certain, to buy.

Naturally, although the magazine doesn’t admit to any added value in this, all the firms cited are Silicon Valley start ups and the like. As we know all Silicon Valley firms are very, very smart – they disrupt the dullards who have only managed to survive a few decades by shooting into orbit and surviving [gasp] for months and even years. So to help firms that are already clever is a real feather in anyone’s cap.

All this cutting edge stuff has the Economist really excited. Not only does it give the story a full page, but it even devotes one of its editorial columns to explaining what micro-economists do:

“they hone in on a particular area, often a single type of market or firm, and try to find out how it works”

Then:

“Armed with vast data sets produced by tech firms, macroeconomists can produce startlingly good forecasts of human behavior.”

Call me skeptical.

I have a few of issues here I need to address.

First: there is nothing inherently economic about big data analysis. Anyone armed with the right technical and analytical background could do the work being described in the article. Indeed they have. Analysts in other disciplines were comfortable with large-scale analysis before economists were. While I have no doubt about the quality of the work, what I do doubt is that it has anything to do with economics. If all it takes to be called a micro-economist is to be working on market or firm level analysis, albeit using some fancy math, then there are droves of such people most of whom would never dream of calling themselves economists. The word ‘analyst’ seems to fit rather nicely. That the analysts happens to have a PhD in economics is merely an indicator of how economics has become a technical training and left behind being a science devoted to investigating economies. So quite why technical analysis can be claimed as a triumph for, or the exclusive territory of, economics is something I cannot fathom.

Second: while I have no doubt the results are of value to the firms where the economists work, if they are ‘startlingly good forecasts of human behavior’, then I have to assume that the analysis ignored anything taught in standard micro-economics classes. If there is one claim economics cannot make is that it has a deep and well grounded understanding of human behavior. It has gone out of its way to ignore human foible in order to compress behavior into a suitable shape for its own ends. For instance, the entire theory of rational choice is absurd on its face except to economists who wanted something they could base their imaginary economies on. No one can credibly claim that standard micro is a model of actual human behavior. All the work underway in behavioral economics is finally unmasking micro’s naivety. Besides anyone familiar with thinking outside of the tunnel vision of economics would be aware of the ghastly simplification and muddle that micro is when compared with the higher understanding that exists outside. No one looking in can avoid being stunned at the silliness embodied in what standard economics treats as basic knowledge. So, I repeat: for the work the Economist cites to be ‘startlingly good’ I have to assume it isn’t based on economics. Which, perhaps, is why the Economist is startled.

Yes there is a world out there. A real one. And a real world where there are analysts with a good grip on reality.

Thirdly: The entire premiss of the article, and the Economist’s breathless expose of the work, is a touching example of how standard economists are driven to take credit – for economics – for just about anything that sounds both clever and remotely accurate. After the economic crisis of 2007/2008 exposed the dismal shambles that occupies the once highly regarded intellectual space called economics, with its fragmented and contradictory explanations, overly formal methods, stale thinking, and ideological taint, of course economists want to rehabilitate their art. Instead of fixing its many and manifest errors they have taken the easy way out: they invade other spaces and re-brand their technical methods as being economics. In other words they no longer even worry about the economy, they are now content to be technicians-for-hire, and number-crunchers par excellence.

One last thing: the Economists bravely ends its article with this:

“While they are too busy to realize it such firms are also providing the best defense of economics against its critics. Far from being unrealistic and out of touch, the role of chief economist will design the way that the firm works.”

On the contrary. The message is almost the opposite. Because economics is unrealistic and out of touch, economists have had to look for work elsewhere – where their inability to understand the economy is not an impediment. As for designing how the firm works: I think there are plenty of other hands at work there, and if a young person is setting out to have such influence, there are many, many, shorter and cheaper avenues towards that goal. Most of which avoid micro-economics like the plague.

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