fiscal policy

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Ryan Republican Rubbish

The three “R”‘s: Reading, ‘riting, ‘rithmetic. Or as of today: Ryan’s Republican Rubbish.

The budget proposal unveiled with great fanfare by the Republican leadership is a farce. The numbers are so other worldly it takes a great deal of effort to keep a straight face. I still harbor doubts about its intent. I wonder whether it isn’t some silly sophomoric joke being played on the media. After all the right-of-center media has pronounced that the earth moved and, at last, someone has made a serious attempt to deal with the deficit “crisis”. That someone being the heroic and evidently stupendously stupid Paul Ryan.

Let’s see now.

Real estate construction is going to boom. Not just recover from its bubble induced disaster, but boom. Despite the evidence that prices are beginning to fall again, and construction is at all time lows.

Unemployment is going to drop to 2.5%. It’s a miracle! Yes 2.5%. The last time that happened in the US? Don’t bother looking it up. Try never. At least in an economy not influenced by war. Yes, we had unemployment that low just after World War II. Since then? Nope.

Then discretionary spending, which is the dribs and drabs of the budget outside of the big four – those being Social Security, Medicare, Offense, and Interest on Debt – is going to disappear almost entirely. It is going to drop from its current 12% of total spending to 3.5% of total spending in 2050. How? Who knows? There is no information in the plan. None. This line item includes education, justice, foreign aid, and so on. Presumably in the Ryan nirvana we don’t need those things. Please don’t ask where these cuts are coming from. It’s a mystery. That, I suppose, makes it all the more inscrutable. And fun. These are, apparently, good qualities in economic policy making.

The list of insane assumptions goes on. That anyone could possibly take this plan seriously is truly odd. Only a committed right winger hoping for the GOP to get real about the evils of big government or the assumed debt crisis could read beyond the first page. The rest of us give up somewhere around the second line. It is that bad.

No. It is beyond that bad.

Set aside the obvious ideological arguments about whether there is a debt crisis – I say no – and let’s accept that we need to do some cutting. So we begin in Republican territory as we discuss what to do about this supposed problem. I would have thought that they would then have produced a serious plan. One that was attached somehow to planet earth. This one isn’t. In no way can we take this so-called plan as a blueprint for policy. Not a single piece of it is tenable.

That Ryan is already ordained as the new face of sensible, grown up, economic policy discussion is a testimony to the combination of gullibility and flat out ignorance of our media when it comes to anything remotely economic. They haven’t a clue. Not one whit of one. If they accept this garbage at face value they are … well words fail me.

Oh. And I didn’t tell you that the conjuring tricks Ryan pulls include more tax cuts for the wealthy. Is that a rabbit I see in that hat. I believe it is.

But here we are. Discussing it. That alone should tell us all we need to know about the state of our discourse.

From my point of view the logical process for discussion should include, up front, a debate about whether there is a true fiscal crisis. We should then identify the causes of whatever problem we think exists. Only then should we articulate responses.

Ryan has swept through the first two steps. The Republicans take it as established fact that there is a crisis. They then produce this fantasy solution. The entire debate is truncated, and focused on getting more tax cuts for the wealthy paid for by trashing all services provided by the government. This simple minded and politically motivated attack would destabilize the middle class, create a permanent poverty ridden underclass, and reduce business by draining demand from the economy. It seems to be built upon the utopian and puerile ideas of libertarianism coupled with the equally infantile dreamscapes of right wing economics. That’s exponential stupidity. It is bizarre.

I can understand a right wing argument based upon truly grown up analysis and thought. I don’t agree, but I recognize that sensible people can, and do, hold those views. Ryan’s plan, however, falls short of any reasonable standard of adult argument. The country needs to go through a cathartic debate about the cause and effect of various economic policies. A sensible right wing contribution to such a debate would be very valuable. It would act as a terrific counterpoint to a left of center description of the accumulated errors of the Reagan/Bush doctrine that produced the Great Recession. But we cannot have a critique of that doctrine if its defenders are incapable of coming up with ideas based here on earth.

Then again, right wing economics has been in fantasyland for the best part of seventy years, if not more if we go all the way back to its Walrasian roots in 1870. So I suppose it was inevitable that right wing politics would feel comfortable joining it.

My fear is that we will not have the debate we needed in order to correct course and avoid further decline. No one can debate with lunacy like this. Perhaps that was the intention. If so it is deeply disturbing that one of our two major political parties has decided that a comedy routine can substitute for policy discussion.

As for the other party … don’t get me started. Their ineptitude is what opened the door for Ryan to display his imbecility. I imagine Obama is already searching for ways to embrace the central message of the Republicans. It is when outrageous and plainly made up stuff masquerades as serious policy proposals that nations decline. The well of innovative or clever though has clearly run dry. We now reach the denouement where the clowns entertain us as we sink below the waves.

Is America that sick? The next few months will reveal all.

One thing we do know: the Ryan plan is not worth discussing. But we are. That’s not a good start.

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Debt Conundrum

What I am about to say is not novel, but nor is it trite: if the austerians – the word we now use to describe those who advocate cutting public spending and debt – really believe that a reduction in public spending can spur, without doubt, economic growth, then the gap opened up by that reduction must be more than filled by something else.

So what is that something else?

Well, a sudden shift in trade could do the trick. That means a sudden expansion of US exports so that the US trade balance zooms from a sea of red ink towards being securely in the black. Canada managed this solution when it had budgetary difficulties. As did Sweden. Somehow I see this as unlikely here. Our appetite for oil sets a fairly high threshold for us to jump over, and the dollar would need to drop some more. With world oil prices moving higher, and not lower, the degree of difficulty is increased. At least near term.

And where would these exports go?

The data suggests there are only three viable trade partners to absorb enough US goods: Europe, Japan, and China. The Euro zone as we know is not in too good a shape, and has already reduced its trade imbalance with the US. The other two are more problematic. Japan is in all sorts of difficulties as result of the recent disaster, its economy is weakened in the short term, and any recovery there may not support a boom in US trade. That leaves China which continues to resist strong currency adjustment and thus blunts the possibility of a US trade surge.

So, even though the world economy is growing at a decent clip, it is not at all clear US exports are about to take off sufficiently to plug the gap opened up by reduced government spending.

So that throws the spotlight onto the private sector.

There we have two possibilities: investment and consumption.

I have berated big business enough times for you all to realize that I am highly skeptical about the probability of investment suddenly rising to the task of leading an economic charge. Business is awash with cash; profits are at very high levels – last year’s profit growth was the best since 1950 – and still investment is more of a dribble than anything else. Indeed the latest numbers suggest companies have reached a plateau in most forms of investment, and are now sitting around waiting to see if demand picks up enough to justify a second installment. The recent durable goods data shows a definite flattening out of growth in investment. There doesn’t seem to much else on the horizon.

So despite all that idle cash waiting to be deployed into productive activity, business investment is much too slow to offset the imminent reduction in the economy planned by the austerians. Every day that pile of cash goes unused the more the opportunity lost costs money. Since I don’t believe business willingly leaves profits on the table uncontested, there must be something preventing action. Clearly the business world is nervous about something.

And that something is the shape of household demand.

Which gets us to the center of our dilemma.

The current outlook for households is not exactly rosy. Wages are flat, indeed when the impact of inflation is accounted for they are going in the wrong direction. The job market still casts a pall across the economy, and causes enough anxiety to restrict much free spending. Home prices have dropped and caused a perceived need to replace that loss on household balance sheets with other assets. That means savings need to rise at least temporarily. That implies a decline, or at least a flattening out, of consumption. So little growth is likely from this quarter.

We have reached an impasse: none of the potential sources of replacement activity seem likely to play that role. Thus, a decline in public spending inevitably will lead to a smaller economy. GDP will decline from its current path. Whether that decline will be large enough to push us into recession I doubt. But it will be enough to throw us into a potentially endless sideways movement with constant high unemployment, and ugly performance in most important categories of activity. Stagnation beckons.

Unless.

Unless we go through a great boom in private debt.

Yes. That’s right. The only way the austerian project is viable is if household debt levels grow sufficiently to provide the spending power needed to offset the lost government spending.

This is truly perverse.

After berating us all for reckless borrowing and the damage it did to our economic stability, the austerity police are now relying on us plunging more deeply into debt so that they can cut public debt without cutting the economy. They just don’t want to admit it. Their entire plan relies on pumping private debt up beyond where it is currently. This does not mean that those folks who went into debt too deeply before have to return there. It means that others, people with healthy balance sheets, people who don’t normally borrow, and people who have cash anyway, all have to fill the void. As the crisis abates and the cleaning up of the bad debts accumulated back in the bubble are worked off, the austerians assume there is a pool of new borrowers waiting to jump in and provide the boost we need.

Some of this borrowing could come, I suppose, from businesses tapping into the banks and credit markets. But, as I said, business is awash with cash. Business doesn’t need to borrow. Besides they don’t seem keen to spend.

No. This increase in debt has to come from households. Especially those who sat out the last boom in debt.

Is this likely?

You answer that one.

I don’t think it is.

That means the austerity programs being shoved into place can have only one impact: they will contract the economy. Demand will fall. It isn’t too large a government budget that scares business into hoarding its cash. It is too small a government. Every dollar cut from government spending is a dollar less flowing through the pockets of business, both large and small. That means fewer jobs, not just because we fired a bunch of teachers or firefighters, but because we drained demand from the private sector and thus reduced the need to hire workers.

Expectations play a key role in the economy. As long as the austerians scream panic and cut, those expectations will tend towards being negative. This is the exact opposite of what the orthodox economists would preach. But they’re wrong anyway.

We have a debt conundrum: the fiscal conservatives are advocating fiscal recklessness. They just don’t want to say so. Then again, these are the same folks who brought us the Reagan and Bush deficits. So we should not be surprised. Not surprised at all.

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Growth, But Not Enough

Solid is one of those words none of us wants to hear as a description of our abilities. Solid is not exciting. Solid is very middling. There is no va-va-voom in solid. But then again neither is it bad. No, solid is just dull. Very dull.

Our economy is solid.

Ugh.

Today’s reports on GDP for the fourth quarter 2010 has growth at an annualized 3.1% rate. That’s good. It just is not good enough. If you recall, the previous estimate was for growth at 2.8%, so evidently the later data has been on the plus side. The biggest contributors to the increase appear to have been a revised inventory number, which was less of a downward drag than previously thought; and a stronger business investment figure. Neither of these was the prime motor for growth, however, since the main boost came from a combination of higher personal consumption and a better trade balance. Since this is the third and final report of the fourth quarter this is the one that goes into the books. It also brings to a close the revising of the overall 2010 performance which is now settled at 2.9%, compared with the drop of 2.6% in 2009.

While that turn around appears terrific I must warn you that it is nowhere near good enough. A more typical recovery would have seen much faster growth in the first full year after a recession. Then again, the economy has gone through significant changes over the last three decades, one consequence of which is the the days of very fast recoveries seem to be over. The trajectory in the last three recessions has been for much less rapid recovery from a much longer decline. My view is that this change stems, at least in part, from the reduced emphasis on manufacturing in the overall economy. In the earlier post-war recessions, the cycle was dominated by sudden shifts in factory employment. The adjustments were quick and dramatic. But as finance, and other services, grew in importance those dramatic shifts have given way to much longer and more difficult adjustment periods. Those famous V shaped recessions have given way to elongated U’s. And the Great Recession was so deep, and so shocking, that we are still lingering near the bottom and are nowhere near climbing back to where we would have been had there been no downturn.

That, I think, is what most people overlook.

Had we avoided the downturn we would have had an economy chugging along between 2.5% and 3.0% a year. OK, but not great. Solid in fact. But we blew a great hole in that history so the long term trend line now shows a big downward dip. If we plot our actual performance against the trend line we would all notice that we are not back to where we would have been. That means we still have lost momentum to recover. And don’t forget: to the extent we wallow about beneath the long term trend line we are forgoing wealth that we will never recover. Not, that is, unless we accelerate to growth rates well above the trend line.

And therein lies our problem.

GDP growth in 2010 was insufficient to recoup our lost wealth. So that loss is permanent. In effect we have recovered in name only. The deeper reality is that we have an impoverished economy more limping than running along.

The slowness of growth last year is very worrying because there are many signs pointing to weakness at the moment. Real estate is stuck so deep in a hole that no one can credibly suggest it returns to be the boost it was during the 2000’s. Which is probably good in view of the damage it wrought. Exports are our best shot at getting medium term growth, but for that to come to fruition we need a further devaluation of the dollar and some cooperative adjustments in our trading partners to deal with their own imbalances. In particular, the Chinese, Japanese, and Germans all need to reduce their export reliance by boosting their domestic consumption. Their economies are built around excessive employment in exporting businesses which deprives us of jobs and their own people of consumer goods. Unless there is a willingness to deal with these imbalances, I doubt that our trade position will provide the boost to our GDP growth I would like to see.

So what else could?

Not much.

Business investment could be one area of extra growth, but there is little sign of a boom there. Companies are sitting on piles of cash and are not deploying it productively at the moment. This is with historically low interest rates which implies very low investment hurdle rates. If business can’t find profitable opportunities at these rates I doubt they will suddenly burst into activity any time soon.

Consumption would be another possibility for higher growth, but that too looks set for drift rather than acceleration. Households are still grappling with rebuilding their balance sheets to compensate for lost home values While the stock market has recovered, and thus boosted some family portfolios, housing was always a bigger wealth provider for the majority of people. So as long as home prices remain weak, and they have just begun to decline again, most households will look to save more than before to create a cushion against uncertainty. This, obviously, shifts a portion of income from spending to savings and thus slows GDP down. The possible offset to this slowdown would be if those savings found their way into an expansion of investment, but as I just said, there is no evidence of much growth in that sector.

The last possible area for growth would be government spending, but as we are all painfully aware the current emphasis is on reducing not increasing government activity. So, far from being a net boost, I expect the cost cutting mania now sweeping the nation to become a net drag on growth. Yes, this is dumb. And, no, it won’t change. We appear hell bent on slowing growth down.

All of this means that the outlook for GDP is not too terrific. The economy is out of the deepest parts of the hole it fell into, but it is not yet healthy enough for us to breath easily. The ugly truth is that we appear set for drift. There is no appetite for fiscal policy remedies, which leaves us reliant on the Fed’s loose monetary policy. With interest rates at practically zero we have no room to maneuver. Not that this worries policy makers. They have all moved on to the deficit and debt as their problems to solve. The fact that the best solution would have been a rapidly expanding economy eludes them.

Oh. And one more thing. Buried on today’s report is data on corporate profits. Guess what? Despite all the moaning about the administration’s supposedly anti-business attitude, and despite the gloom and doom we hear constantly from the Chamber of Commerce, profits soared. And I mean soared. Before tax corporate profits grew 36.8% in 2010. Read that agin and digest it fully. Profits boomed. Last year was the best year for profits since 1950 which was an odd year itself as business boomed after the post war recession. No wonder stock prices rose. Couple this with the news that GE is getting a tax rebate of over $3 billion on gross profits of over $14.2 billion – of which $5.1 billion was in the US – and it easy to understand why workers might be perplexed by the idea that they need to give back more in order to solve our supposed “debt crisis”.

These are boom times for capitalists. Just not for the rest of us.Today’s report simply confirms this.

Until we restore a more equable balance the economy will remain merely solid. That’s not good enough.

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Small Government Dreaming

Sometimes you set out to do something and then notice that whatever it is you did causes more grief elsewhere. So you end up with a different and often larger problem. America is in such a mode right now. Our leadership, such as it is, has fallen prey to the outsourcing game. Only when a government outsources it’s called “privatization”. The explanation is normally that by offloading a service – firefighting for instance – to a private organization the government doing the privatizing will save money. Taxes can go down. Local deficits can be cut. And no one will notice because the service still is provided. The taxpayers get something for nothing. Wow. Why didn’t we think of this before?

Because it’s a sham.

The New York Times has a good story about this exact circumstance in a Californian location called Costa Mesa.

I don’t want to repeat that story. What I want us to focus on is the inherent destabilization it implies.

While it is correct that a private contractor can deliver services in such a contract for a lower cost in the short term, there are hidden longer term costs that society ends up paying that nullify the advantage. For, just as outsourcing by a private business ends up lowering the average wages of the people delivering that service, so too does government privatization.

There is no way around it.

The way a privatized service can cost the government less is because the service provider pays lower wages, gives out fewer benefits, or employs fewer people. So we get rid of higher cost public workers and employ fewer and worse paid private workers. The aggregate wages in society go down. So too do pensions. So too does society’s ability to buy things. That means many local small businesses get less traffic and start to suffer. Eventually the entire local economy shrinks to a lower level of activity more in accord with the reduced purchasing power circulating within it.

This is all inevitable.

Advocates of privatization either don’t care about these longer term trends, or try to argue that there are offsetting benefits. Those so-called benefits are usually in the form of the fired workers ending up doing something “more productive”, so the net social cost is either zero or even a positive. It’s called enhanced productivity. Or the allocation of resources from low value uses to higher value uses.

There is a reason why economics is called the dismal science. You cannot get something for nothing. But privatization makes it look as if you can.

Now, I am not saying we all should be happy paying public workers high wages. There is plenty of evidence suggesting that public workers are paid less than their private industry peer groups anyway. The point is more direct: we delude ourselves if we think privatization solves anything. All it does is mask a deeper social problem: the economy is sputtering enough that it looks as if we cannot afford some of those services anymore. The problem is not the cost of those services, nor the public budgets that appear under stress. It is that our economy has underperformed for decades now and is not growing the way it ought to.

The small government dream is thus a focus on the wrong problem. Government deficits are more symptom than a disease. We are looking in the wrong place fro solutions.

The problem with this is that it is the middle class who benefits disproportionately from government spending. The poor get some support, but they are far less likely to partake of the full gamut of government largesse. They are far less likely to drive along publicly funded roads. They spend less time in publicly funded schools. They are less likely to own a home and thus get tax credit for mortgage interest. And so on. So while it may appear from the headlines that the poor get a good deal from government programs, the middle class does even better.

What about the rich?

Well, they too get a good deal. They also use the system a fair bit. But they are also more likely to opt out and buy services privately – schools for instance – and the big difference is that they contribute more in tax dollars. So they pay more for the services.

No. Big government is a middle class benefit by and large.

Indeed I think that the modern middle class is largely a function of big government.

Think about it.

Without big government the middle class would be paying for all sorts of things from its current income. That implied subsidy from the rich would not be there, so the cost/benefit would shift negatively for the middle class wage earners. Of course the middle class could forgo the services, but that would imply a loss in standard of living. You don’t get anything for nothing after all.

I am not writing off the poor, or applauding the rich, I am simply pointing out the bind we are stuck in. And it is some bind.

All those small government efforts popping up around the world will impoverish the middle class. It is unavoidable. So if you are hell bent on austerity take a moment to figure out what you will end up without. Because you will, assuredly, end up without something.

The counter argument is an illusion.

As I said earlier it hinges on the notion that by cutting government we are freeing up resources that the private sector is more able to deploy productively. So the short term pain will be offset by long term gain.

No so much. Alternatively: if you believe that, I have a bridge here in New York I want to sell you.

Let’s take a look at the private sector record. First up: the dot-com bubble. Good allocation of resources there. Yes we ended up with some neat stuff, but there was an extraordinary amount of collateral damage along the way. Just how many of those ridiculous internet businesses can you remember? Not to mention just how many survived? Second: the real estate bubble. That worked out well. Now, I realize that there are a lot of revisionist free market types claiming that the entire crisis was the result of ill advised government attempts to force poor people to buy houses they couldn’t afford, but I don’t agree. Frankly I get a bit tired of the narrative that says it is always the government in cahoots with poor people that disturbs the serenity of the wealthy. Besides, I don’t get how perfect markets seem always to get discombobulated by the government. Aren’t markets supposed to be efficient? And wouldn’t that mean they can see through, and adjust for, the government ruse? Apparently not.

Anyway, we have two very bad recent episodes of private sector ineptitude. So shifting resources out of government does not always end up enhancing social welfare.

But it does seem to end up enhancing some people’s welfare. Which is why small government has so many ardent adherents. If you run the business that benefits from the privatizing, then you are a winner. If you are a worker in that business, then you win to the extent you have a job, but you probably lose because your wages and benefits will be lower than the displaced public worker.

Hang on. Didn’t I just say that public workers are paid less than private workers? So how can it be that wages go down in general after privatization? Simple. Its dynamics. In the current state public workers earn less than their peers. Then again there are exceptions to this – California prison guards for instance. But let’s stick with the general case. In order to justify a low cost bid and thus to win the privatized contract, a private business has to squeeze out costs. Otherwise there’d be no advantage to privatization. Not only does the privatized service need to be a replication of the public service, but it needs to turn a profit. So there’s overhead to add to the overall cost. So now the cash flow has to be divided between the workers and the capitalist owning the business. That’s easy: wages go down. Or benefits get cut.

I am sure we can all think of examples where this scenario didn’t play out. Waste is not just a public sector problem. The US defense budget is a classic example of things going hopelessly wrong. The Pentagon seems to have the entire argument backwards. They outsourced a ton of stuff and ended up paying more than if they had kept it all in-house.

That is not my point. I want to focus on the logic of the small government effort. It is an illusion. At the end of the day, small government inevitably leads to small service. And since the middle class gets the biggest return on those services, in an austerity program it is the victim, unwitting or not, of the cuts.

Which brings me to ask: why, then, is it the middle class agitating for austerity? The poor may be ticked off. And the rich may be indifferent. But the main body of support for bashing the public worker unions, and for cutting big government programs comes from middle class voters. Whenever asked voters want to retain the services, but cut the cost. They imagine that government is one huge pile of waste. If only that waste is eliminated they can get the magic of extra service at no extra cost.

Paper shuffling is not the exclusive domain of the public sector. Anyone who has worked in a bank knows that. Bureaucracy is endemic to modern society. So it is a fool’s game to imagine you can have small government without losing some service along the way, or without lowering aggregate wealth somehow.

Yes, productivity should offset the loss. And, no, recent history tells us productivity is not the engine driving wealth it once was for most of us. Until wages get more of a share in productivity growth, smaller government will remain a dream. It is a dream in which the middle class gives up stuff and gets nothing back. In other words it shrinks. So when we wake up from this dream America will be a smaller place.

I wonder if that’s what the voters want?

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GDP Revised Down

Watch this space.

One of the reasons we all should ignore the puffery in the markets about the nature of the recovery is that the economy is still subject to significant risks. We all know and talk about the high level of unemployment, almost accepting it now as part of our near term fate. What we should be worrying about also is how that problem is about to be made worse by the fiscal crises at the state and local government level of the economy.

This is the most immediate lesson we can draw from today’s release of the revised fourth quarter 2010 GDP figures.

Recall that the original release had growth at a 3.2% annual rate. That’s the sort to platform from which we could reasonably expect growth to accelerate as household and corporate imbalances are worked off. Once expectations about the future improve, consumption and investment both should take off and propel us to higher growth for a while before we settle back down at a more sustainable rate. Indeed we have seen signs of confidence increasing and investment rising, making this typical recovery narrative very plausible. Which is why we see it stated so often in the media.

But.

Today’s revision should wake us up to the damage being wrought by the state level fiscal crisis. Yes, the revision includes a downward move for consumption – from 4.4% to 4.1%, but the big hit to growth comes from state government spending cuts. The original estimate of growth included only a -0.9% decline in state government spending. This release makes that decline much larger, at -2.4%. Therein lies the danger ahead. We are all aware of the enormous head of steam now building to slash government spending. That sounds very antiseptic when expressed in accounting terms. And balanced budgets sound very virtuous. But a cut in spending mean a cut in jobs. It means cuts in purchases from business, which, in turn, implies downstream cuts in jobs as well. Given the current mood, and the zeal of those intent on cutting spending, I think we can expect more of these negative numbers going forward. We are running a serious risk of undoing the good work done by the stimulus.

Enough said.

We should all revise down our projections for 2011. The cost cutters are at work.

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