Let’s Roll — Time for Tax Cuts And More Stimulus

“The movers and shakers of our society seem…oblivious to the terrible destruction wrought by the economic storm that has roared through America.” Thus writes the New York Times’ Bob Herbert, who notes in a weekend column that “nearly 44 million people were living in poverty last year, which is more than 14 percent of the population. That is an increase of 4 million over the previous year, the highest percentage in 15 years.”

And as for the middle-class, Herbert observes, they have “hobbled for years with the stagnant incomes that accompany extreme employment insecurity” and are now in retreat. The economic fear stalking America goes far to explain the severe fall in popularity of President Obama and the rise of the Tea Party.

For all of my fears of the social conservatism that is veined through the Tea party movement, the public focus for most Tea Partiers is on the economy. But their answer is not the right one to deal.

Understandably, they blame government. It was government that gave us the runaway juggernauts of Fannie Mae and Freddie Mac; it was home-ownership encouragement from both sides of the Washington DC political aisle that gave us sub-prime; and it was the administration of George W. Bush that believed “deficits don’t matter” and presided over the greatest splurge of public spending since Lyndon Johnson.

So, why trust government now? For the Tea Partiers it is time to get back to basics – to the U.S. Constitution, to balanced budgets, to limited government. All noble aims. For many of them, though, read “no government” when they say limited government. But this isn’t the time to say “no government” — we need it to sort out the mess it co-authored.

Unfortunately, in the same way that Tea Partiers are going back to basics and mistaking the sky-rocketing deficit as the problem, so various policy-making elites are returning to unsophisticated positions. Free market advocates are becoming more uncompromising; Keynesians more Keynesian. All are over-focused on ideology.

In this fevered political environment the administration is more timid than it should be. The U.S. needs another financial stimulus. Yes, this would add to the federal deficit but when you have cancer, to survive you need to take some poisons as therapy. Convalescence can come later.

For Republicans – and the Tea Partiers – that is heresy. For them “big government” explains the economy’s weakness, and high unemployment is evidence that the President’s fiscal stimulus failed. But this is wrong. As the Economist magazine notes, “the notion that high joblessness ‘proves’ that (the) stimulus failed is simply wrong. The mechanics of a financial bust suggest that without a fiscal boost the recession would have been much worse.”

There has been growing confidence that America will escape a double-dip recession but that is far from certain. The jobs market remains in a slump, recovery is anemic, property prices continue to fall, a further wave of home foreclosures is on the cards.

In 1937-38, fiscal and monetary contraction killed dead a recovery, sending the economy back into a prolonged slump that didn’t end until World War II.  And as Arthur Laffer argued in a Wall Street Journal op-ed earlier this year tax hikes had much to do with the problem. “The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity.”

That lesson seems belatedly to have been absorbed by Obama aides, who are now supporting the idea of extending the Bush tax cuts, except for the top 2 percent of earners.

But this crisis is not a normal cyclical one. There are serious structural aspects to it, as the PIMCO chief executive Mohamed El-Erian has been maintaining. His point?  Policymakers must implement a “structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.”

El-Erian’s recommendations include “pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.”

Yes, in short, a stimulus from tax cuts that can help encourage consumption and unleash animal spirits AND more public spending to get things moving more.

For the Democrats tax cuts – especially for the wealthy – are anathema. But the U.S. needs to grow its way back into prosperity. For Republicans and Tea Partiers, more government spending is just an excuse for “big government.” Of course, federal deficits will need to be curbed in the long run – preferably starting within a couple of years.

Let’s go back to El-Erian’s point about there being a structural part to this crisis and observe the labor market.

According to the GOP Nevada Senate candidate Sharron Angle, people who receive unemployment assistance are “spoiled.” In short, they should just get a job. Easier said than done. Americans have been used to employment snapping back after recessions. But there is clear evidence now that it isn’t just weak demand that’s responsible for stubborn unemployment but something more structural.

For example, unemployment has not fallen in the way it should have with increases in job openings. Many jobseekers do not have the skills needed by employers. This is nothing to do with being “spoiled.” Half of the eight million jobs lost in the recession were in construction and manufacturing. Many of those workers are unable to slot into jobs in education, say, or health services. Add to that the difficulty workers have now in re-locating because they owe more on mortgages than their homes are worth.

Looser monetary policy will not alleviate this problem. Libertarians  argue that government should have no role in trying to sort this out. But the free market will be too slow.

So far no single growth engine has emerged to pull the U.S. towards strong recovery. Consumer spending and business investment have been too weak. President Obama’s hope that the country can export its way to strong recovery looks forlorn. For that to happen, America’s trading partners need to be buying American goods. They aren’t. China and India are eager to head off inflation and are tightening. The PIGS economies in Southern European are cutting spending and raising taxes. So are some of the more robust EU economies, notably Britain. But unlike the European countries the U.S. has some leeway to increase public spending — the yield on 10-year Treasury bonds remains below 4%, well down from the 8% of 1990 and inflation remains weak.

So government has to seek to accelerate growth – by tax cuts, payroll tax holidays and further government spending. The debt can be focused on down the road when growth increases along with tax revenues.

Two Economists, Two Different Views

Two different economists and two different views are out there in today’s New York Times and Washington Post. Economists disagreeing with each other! Well, that will shock no one, of course. What is more noteworthy is the simplicity of one argument and the sophistication of the other. And the best argument doesn’t come from the Nobel Prize winner.

Paul Krugman’s stance in the NYT is again all about the need for another Fed stimulus. But over at the Post Mohamed El-Erian, the CEO of Pimco, the investment management company, has a far greater grasp, I think, that the crisis we are in is as much a structural one as cyclical.

Nobel Prize winner Krugman places most of the political blame for the non-recovery recovery on Republican obstructionism and Democratic timidity. El-Erian sees the political dimension of the crisis in less partisan terms – the whole political elite is failing to understand what is happening, is his take.

Here’s El-Erian: “What is critical to keep in mind is that this situation is part of a broad, multiyear process driven by national and global realignments. It’s a secular phenomenon that needs to be better understood and navigated — by recognizing its structural dimensions and by urgently broadening the excessively cyclical policy mindsets that abound…

Policymakers must break this active inertia by implementing a structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.

Specific measures would include pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.”

And Krugman? “The Fed has a number of options. It can buy more long-term and private debt; it can push down long-term interest rates by announcing its intention to keep short-term rates low; it can raise its medium-term target for inflation, making it less attractive for businesses to simply sit on their cash. Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer.” Although for Krugman a stimulus would be the thing. Damn those Republicans!

El-Erian, it strikes me, is right.

Green Shoots of Recovery — Wishful Thinking

The stock market is up. Goldman Sachs has announced a profit.  All of a sudden the chatter on the evening cable shows is of the green shoots of recovery, with declarations being made that we have turned the corner on what only a few months ago was being described as the worst recession since the Second World War…no, the worst slump since the Depression. 

 

On the Lou Dobbs show on CNN tonight, Cato Senior Fellow Alan Reynolds talked of us coming out of the recession by the third quarter. I know Alan, and like him, but I think he is way off the mark and so too with the other upbeat commentators. The huge response by governments and central banks across the globe – a response Alan criticized – has no doubt slowed the pace of the slump but there remains plenty to worry about.

 The latest economic report from the OECD makes for grim reading. “Economic activity is expected to plummet by an average 4.3 percent in the OECD area in 2009 while by the end of 2010 unemployment rates in many countries will reach double figures for the first time since the early 1990s,” says the OECD’s Economic Outlook Interim Report.

It continues: “Amid the deepest and most widespread recession for more than 50 years, international trade is forecast to fall by more than 13 percent in 2009 and world economic activity to shrink by 2.7 percent. The big emerging economies will also suffer abrupt slowdowns in growth.”

 Several underlying problems remain. Banks are still not lending and investors remain skeptical about investing in banks for good reason: the policies introduced in Britain and the US aimed at cleaning up banks’ toxic debts are too limited.

And the threat of contagion is still there, with the Austrian, Swiss, Swedish and Germans banks highly vulnerable weighed down as they are by loans they made to the credit and investment-thirsty countries of Central Europe.

A second problem rests with what kind of recovery we can expect. The scale of the global recession will have undermined the productive potential of the US and other Western economies with investments not having been made in future efficient production and with the skills base weakened by job losses. All of that means that when the recovery does come – the OECD thinks next year at the earliest – we can only expect it to be very insipid.

Higher taxes needed to pay down the massive debt the governments of the US, Britain and some other Western states are taking on, such as Ireland, will further undermine recovery.

Lastly, nothing is being done about the huge trade and borrowing imbalances that brought us to where we are: in the States, the administration is focusing on stimulating demand (by borrowing, again) and in China the leadership is investing in productive infrastructure to produce the goods Americans will buy with the money they will borrow from China.