Friday, November 21, 2014

The Wages of Economic Ignorance

LONDON – Politicians are masters at “passing the buck.” Everything good that happens reflects their exceptional talents and efforts; everything bad is caused by someone or something else.

The economy is a classic field for this strategy. Three years after the global economy’s near-collapse, the feeble recovery has already petered out in most developed countries, whose economic inertia will drag down the rest. Pundits decry a “double-dip” recession, but in some countries the first dip never ended: Greek GDP has been dipping for three years.

When we ask politicians to explain these deplorable results, they reply in unison: “It’s not our fault.” Recovery, goes the refrain, has been “derailed” by the eurozone crisis. But this is to turn the matter on its head. The eurozone crisis did not derail recovery; it is the result of a lack of recovery. It is the natural, predictable, and (by many) predicted result of the main European countries’ deliberate policy of repressing aggregate demand.

That policy was destined to produce a financial crisis, because it was bound to leave governments and banks with depleted assets and larger debts. Despite austerity, the forecast of this year’s UK structural deficit has increased from 6.5% to 8% – requiring an extra £22 billion ($34.6 billion) in cuts a year. Prime Minister David Cameron and Chancellor George Osborne blame the eurozone crisis; in fact, their own economic illiteracy is to blame.

Unfortunately for all of us, the explanation bears repeating nowadays. Depressions, recessions, contractions – call them what you will – occur because the private-sector spends less than it did previously. This means that its income falls, because spending by one firm or household is income for another.

In this situation, government deficits rise naturally, as tax revenues decline and spending on unemployment insurance and other benefits rises. These “automatic stabilizers” plug part of the private-sector spending gap.

But if the government starts reducing its own deficit before private-sector spending recovers, the net result will be a further decline in total spending, and hence in total income, causing the government’s deficit to widen, rather than narrow. True, if governments stop spending altogether, deficits will eventually fall to zero. People will starve to death in the interim, but the budget will be balanced.

That is the crazy logic of current economic policy in much of Europe (and elsewhere). Of course, it will not be carried through to the bitter end. Too much will crack along the way – the banks, the monetary system, social cohesion, the legitimacy of the political regime. Our leaders may be intellectually challenged, but they are not suicidal. Deficit reduction eventually will be put into cold storage, either openly, as I would prefer, or surreptitiously, as is politicians’ way. In the United Kingdom, there is already talk of Plan A +.

Those who see the need for such a growth strategy, but who also want to help their friends, like the idea of tax cuts – especially for the rich. This knocks a hole in current deficit-reduction plans, but, provided government continues to cut spending, it has the benefit (from a conservative’s point of view) of shrinking the state’s role over time.

Apart from questions of fairness, cutting top tax rates is an inferior way to increase spending, because the rich have a higher propensity to save. Tax reductions should be targeted specifically at the poor if one wants the money to be spent to stimulate the economy.

In fact, the best option of all is for the government to spend the money itself. Governments can do this consistently with a medium-term deficit-reduction plan by making a crucial distinction between their budgets’ current and capital accounts. The current account covers spending on services and perishable goods that produce no assets. The capital account is for buying or building durable assets that give a prospective future return. The first is a charge on taxation; the second is not.

If today’s accounting rules are too insensitive to make this distinction, a separate entity could do the investing. A national investment bank would be capitalized by the government, borrow from the private sector, and invest in infrastructure, housing, and “greening” the economy. This would simultaneously plug a hole in demand and improve the economy’s long-term growth prospects. There are signs that officials in the UK and the United States are starting to move in this direction.

If nothing works, it will be time to sprinkle the country with what Milton Friedman called “helicopter money” – that is, put purchasing power directly into people’s pockets, by giving every household a spending voucher with an expiration date. This would at least keep the economy afloat pending the development of the longer-term investment program.

It would be better if such schemes could be agreed upon by all by G-20 countries, as was briefly the case in the coordinated stimulus of April 2009. If not, groups of countries should pursue them on their own.

The European Union desperately needs a growth strategy. Its current bailout schemes only help countries like Greece and Italy to borrow money cheaply in the face of prohibitively high market interest rates, while the schemes’ insistence on more budget-deficit reduction in these countries will reduce European purchasing power further. The recipient governments will have to cut their spending; the banks will have to take large losses.

In the long run, the eurozone must be recognized as a failed experiment. It should be reconstituted with far fewer members, including only countries that do not run persistent current-account deficits. Everything else that has been proposed to save the eurozone in its current form – a central treasury, a monetary authority that does more than target inflation, fiscal harmonization, a new treaty – is a political pipe dream.

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    1. CommentedParrain Boursorama

      The best model for expanding Alternative Energies and Environmental Protection globally is through using market equilibrium, whereas governmental subsidies and fiscal stimulus to be just supplementary

    2. CommentedNathan Coppedge

      Pragmatics should be known to the government as just that policy you mention: that essential services are the only tax burden. I took it for granted years ago that the U.S. government would skimp on many policies and services. Obviously the time to do that was the Bush era, if not before. It is surprising that there is not a legal mandate for reducing expenditures, when clearly the nation has at least an outward financial crisis. The solution doesn't seem to lie in adopting fictions, even though some of those fictions are beginning to look very real. Whenever debt of any kind---fiscal or roll-over---is greater than GDP, there should be an automatic policy to pay off more debt than is incurred, without cease until 100 percent of the debt is paid, and military expenditures should be cut, and taxes should be raised. If there is an exception to this rule, it looks more like socialism than capitalism to me. The government should account for its own interest.

      If there is an exception to this rule, it falls at the point where people realize that skyscrapers can be built by printing money. But if that fiction can exist, so can a host of others---why not live a fantasy life? Just bad people? Is there a threshold beyond which everyone is "living a lie"? Or is it just optimal to struggle no matter who you are and where you're from? Maybe that is a psychological rather than an economic or political theory. What I have observed is that people with normal brain chemistry are more willing to incur debt. Does this mean abnormal people (some would say, the poor) have to live a double nightmare of fictional economics combined with an assumed failure of conscience? Perhaps there is potential, as I have noted elsewhere in Esther Dyson's columns, to grow the qualia aspects of life by networking good intentions, however meager and however superficial seeming, for the benefit of the social idiom and the ideotropes, the so-called information society of the future.

      Many of these observations about practical concerns for politicians make me angry. Once it seems like they hear the same words I hear, it looks like a big problem someone should have dealt with a long time ago. Incompetence? Don't people worship information? Sometimes it shouldn't look different to a politician. In that sense I agree with the article, not that anyone should need my agreement. Why not treat citizens as their own fictional economies, if the uber-structure of everything doesn't actually depend on individuals? Perhaps the economy of the future will incorporate several concepts of reality, with the effect that citizenship will be capable of prioritizing multiple levels of personal economics, not as someone said Macro or Micro economics, but instead Meso- or Meta-. Which as I've said in the article on that subject, is not metaphysical as much as it is a matter of multiple types of value, and the citizen-function effecting problems which are not vertical.