Anatomy of the Global Economy
A Free Lunch for America
J. Bradford DeLong
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BERKELEY – Former US Treasury Secretary Lawrence Summers had a good line at the International Monetary Fund meetings this year: governments, he said, are trying to treat a broken ankle when the patient is facing organ failure. Summers was criticizing Europe’s focus on the second-order issue of Greece while far graver imbalances – between the EU’s north and south, and between reckless banks’ creditors and governments that failed to regulate properly – worsen with each passing day.
But, on the other side of the Atlantic, Americans have no reason to feel smug. Summers could have used the same metaphor to criticize the United States, where the continued focus on the long-run funding dilemmas of social insurance is sucking all of the oxygen out of efforts to deal with America’s macroeconomic and unemployment crisis.
The US government can currently borrow for 30 years at a real (inflation-adjusted) interest rate of 1% per year. Suppose that the US government were to borrow an extra $500 billion over the next two years and spend it on infrastructure – even unproductively, on projects for which the social rate of return is a measly 25% per year. Suppose that – as seems to be the case – the simple Keynesian government-expenditure multiplier on this spending is only two.
In that case, the $500 billion of extra federal infrastructure spending over the next two years would produce $1 trillion of extra output of goods and services, generate approximately seven million person-years of extra employment, and push down the unemployment rate by two percentage points in each of those years. And, with tighter labor-force attachment on the part of those who have jobs, the unemployment rate thereafter would likely be about 0.1 percentage points lower in the indefinite future.
The impressive gains don’t stop there. Better infrastructure would mean an extra $20 billion a year of income and social welfare. A lower unemployment rate into the future would mean another $20 billion a year in higher production. And half of the extra $1 trillion of goods and services would show up as consumption goods and services for American households.
In sum, on the benefits side of the equation: more jobs now, $500 billion of additional consumption of goods and services over the next two years, and then a $40 billion a year flow of higher incomes and production each year thereafter. So, what are the likely costs of an extra $500 billion in infrastructure spending over the next two years?
For starters, the $500 billion of extra government spending would likely be offset by $300 billion of increased tax collections from higher economic activity. So the net result would be a $200 billion increase in the national debt. American taxpayers would then have to pay $2 billion a year in real interest on that extra national debt over the next 30 years, and then pay off or roll over the entire $200 billion.
The $40 billion a year of higher economic activity would, however, generate roughly $10 billion a year in additional tax revenue. Using some of it to pay the real interest on the debt and saving the rest would mean that when the bill comes due, the tax-financed reserves generated by the healthier economy would be more than enough to pay off the additional national debt.
In other words, taxpayers win, because the benefits from the healthier economy would more than compensate for the costs of servicing the higher national debt, enabling the government to provide more services without raising tax rates. Households win, too, because they get to buy more and nicer things with their incomes. Companies win, because goods and workers get to use the improved infrastructure. The unemployed win, because some of them get jobs. And even bond investors win, because they get their money back, with the interest for which they contracted.
So what is not to like? Nothing.
How, you might ask, can I say this? I am an economist – a professor of the Dismal Science, in which there are no free lunches, in which benefits are always balanced by costs, and in which stories that sound too good to be true almost inevitably are.
But there are two things different about today. First, the US labor market is failing so badly that expanded government spending carries no resource cost to society as a whole. Second, bond investors are being really stupid. In a world in which the S&P 500 has a 7% annual earnings yield, nobody should be happy holding a US government 30-year inflation-adjusted bond that yields 1% per year. That six-percentage-point difference in anticipated real yield is a measure of bond investors’ extraordinary and irrational panic. They are willing to pay 6% per year for “safety.”
Right now, however, the US government can manufacture “safety” out of thin air merely by printing bonds. The government, too, would then win by pocketing that 6% per year of value – though 30 years from now, bondholders who feel like winners now would most likely look at their portfolios’ extraordinarily poor performance of over 2011-2041 and rue their strategy.
J. Bradford DeLong, a former assistant secretary of the US Treasury, is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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RalphMus 05:52 30 Sep 11
Nice article by Brad de Long except . . . .what in Heaven’s name is the point of borrowing money (even at 1%) when you can print the stuff at no cost? Of course the knee jerk reaction of economic illiterates to the phrase “print money” is “inflation”. But as David Hume pointed out over two hundred years ago, money supply increases are not inflationary except to the extent that they are spent: except to the extent that they increase demand for labour. Thus creating jobs for X people as a result of printing will be no more inflationary than creating jobs for X people as a result of borrowing.
Second, infrastructure projects get trotted out every time there’s a recession – Pericles advocated the idea in ancient Greece two and a half thousand years ago. Now why does the optimum mix of infrastructure and other forms of public and private spending change just because GDP expands a bit slower than normal? It doesn’t! In short, an ALL ROUND increase in spending, public and private, is preferable to the bizarre collect of pet projects that politicians, economists, greens, etc etc come up with every time there’s a recession.
gamesmith94134 06:51 30 Sep 11
Gamesmith94134: Dr. Doom Warns Wall Street and Washington---- Heed Karl Marx's Warning!
Mr. Gert van Vugt,
You make the best description on the theory on the economical growth Paradigm that the economic change seems like Malthusian’s diminishing return, and I agree. However, Mr. Roubini makes his point on the social disruption reverse itself through the diminishing demand. If we can put away the elements like the Ponzi scheme and benefactors in social caused deficiency or defects to growth. Corruption by capitalism and the dependency by socialism among societies both caused failure in the economical and societal development.
Perhaps, we focus on the circuitry on the accumulation of wealth and consumable wealth that runs the economy. It seems both the capitalism and socialism ran short and proven wrong in the economical model or social model that became self-destructive; eventually, the economy runs from diminishing demand to diminishing return, or vice versa. So, if we use the living standard as the equilibrium position to the supply line of the circuitry of wealth balanced by both of the diminishing return and diminishing demand.
How about I call my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth, which contains;
The base line as the diminishing return where the societies kept peace with its populace that consumable wealth that cause economical displacement like with its negative growth or no growth; it provides entitlement or social programs with non-productive individual citizens for example, 27% of its population on welfare with add-on with subsidies to sustain a standard of living.The top line as the diminishing demand that ended with accumulated wealth favors of concentrated wealth owned by individuals that ended with profitless, 1% holds 27% of the global or national wealth, plus those with extra wealth is not in production yields to no growth.And the diagonal line that connected to both ends is the support of the price and value in the middle is the standard of living which contains the most of the productive individuals who is moving up and down the ladder of growth.
If more of the wealth accumulated than the wealth consumed, then it causes saturation of the wealth. The diminishing demand under the standard of living agreement made the demand idle because of the shortage of consumption. In the process, the standard of living will go down to meet its demand after the deflationary measure to make it consumable. In reverse, the wealth consumed is over the wealth accumulated, as it is less profitable. Then, it triggers the inflationary measures to aggregate demand to accumulate more wealth in its diminishing return mode; eventually it will balance itself again with the agreement of the standard living with a viable growth.
It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB.
I am certain I am not being introspective; I may twist the theory a little; but the proof of the lower living standard in Europe made it plausible.
May the Buddha bless you?
Gamesmith94134: US economy----a big fat zero
In explaining the big fat zero, I took the evaluation of the circuitry of wealth in motion seriously. “It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB. “ that regardless how much more is being pumped into our economy now.
This is proof of the lesser achievement of the QE that the unachievable nominal living standard in American has became the tourniquet that put the dead lock on the process of deleveraging in the equity value and the shift of additional cost of living is added to the middle class like tuition of its children, DMV license fee, and more property tax or utility fees etc. They cannot simultaneously move up or down the nominal standard of living; they have save more to handle the coming months by cutting consumption. And the corporation cut more expansion to adapt the changes, or more accept A&M to set off the liquidity trap. More will be out crowded by the Acquisition and Merger to be unemployed. Then, the accumulated wealth eliminates the consumed wealth; and the support of the price and value unchanged----anemic growth; since deflation or inflation did not force the motion of living standard to change. Therefore, there is no aggregated demand and the high cost of living remains unsustainable to balance the accumulated and the consumed.
How does out economy can the simultaneity to adjust with the ladder of growth? The only solution is to make it affordable through deflation or change its nominal standard of living. If more of the quantitative easing or more social program applies; it only kicks the can down the road with more deficits till the end of the supply of more cash flow. So, deleveraging is essential to push the nominal living standard down till all is affordable with the cut on principle on the foreclosed housing and raise the interest rate as a catalyst to saddle on the falling equity price on housing and currency. Marketwise, the supply and demand will make it affordable. Seller must cut it price to pivot on its sale and buyer must be able to repay to buy. Once, this momentum of cutting price on the equity market is started, it would push the cost of living to fall; it can release the tourniquet that locked on the nominal standard of living that too many has became the underclass of it. If the failing prices of equity and currency make things affordable, aggregated demand will rise; then, the economy will be free to move the population simultaneously with the growth or doom.
I am not sure the recent litigation of equity dispute can make any ease on banking or the Freddie; since there is no other successful transfers of equity can make housing affordable. Bankrupt another bank would make the worst scenario to our failing economy. Only, Cutting the price on the foreclosed and devalue the ones on the market can turn the tide. Finally, Pumping cash flow into the economy would cause inflation and lesser affordable, either the Congress or the FED must find the way to approve the bank successfully write off the foreclosed; or the FED must raise the interest rate to assure the proper owner is found with appreciated dollars.
“Make it affordable” is the key to release the tourniquet to turn the economy around and not the other way around.
May the Buddha bless you?
MuhdBahaa 07:27 30 Sep 11
شكرا للكاتب وشكرا للمترجم
AndyC 01:52 05 Oct 11
Instead of 500 billion why not make it 5 trillion or even 50 trillion?
That way we could multiply all these good numbers and properity by a factor fo 10 to 100 times.
Makes sense, no?
pdemetriades 03:54 05 Oct 11
This is a great idea and I have written an article in Greek exploring whether it can also be adopted in Europe, as Germany can borrow at similar rates. A Marshall plan for the eurozone, financed by Germany, could be a free lunch for Europe. It could also be a free lunch for Germany itself, as it will benefit more than most from the recovery of its biggest export market.
I should also add that the 25% long run rate of return for infrastructure investment is consistent with my own estimates for 12 OECD countries, published in the Economic Journal.
Panicos O. Demetriades
Professor of Financial Economics
University of Leicester
johansbstn 03:02 09 Nov 11
1% sounds like a great deal . . . unless we have a deflation rate of 5%. Can it happen? Of course not, and Macbeth will "never vanquish'd be until / Great Birnam Wood to high Dunsinane Hill / shall come against him".
MSM 10:18 29 Sep 11
Professor DeLong,
Yes, your scenario and others for vigorous fiscal policy measures, including some I have worked through, have a clear positive return over about a decade or longer time scale.
Have you worked through what policies might maximize the return, or have you seen such work? For example, does doubling or tripling your suggested $500B in your model to $1T or $1.5T, increase the benefits increase commensurately?
(The rough optimal numbers I get keep coming in around $1T per year for 3 years.)
A sensible optimum could make for an attractive policy target, I think.