Wednesday, June 22, 2011

Alan Blinder's Latest Attempt To Revive Keynesian Economics

I know Princeton economics professor and former Fed member Alan Blinder is a liberal Keynesian economist. But in yesterday's Wall Street Journal editorial, he displayed an ability to play fast and loose with contexts, as well as so narrowly define terms and situations as to make his points irrelevant.

He began by writing,

"Right now, I'm worried about the damage that might be done by one particularly wrong-headed idea: the notion that, in stark contrast to Keynes's teaching, government spending destroys jobs.

No, that's not a typo. House Speaker John Boehner and other Republicans regularly rail against "job-killing government spending." Think about that for a minute. The claim is that employment actually declines when federal spending rises. Using the same illogic, employment should soar if we made massive cuts in public spending—as some are advocating right now.

Acting on such a belief would imperil a still-shaky economy that is not generating nearly enough jobs. So let's ask: How, exactly, could more government spending "kill jobs"? "

Blinder is engaging in incredibly literal interpretation of a statement that isn't meant to convey what he chooses to draw from it.

To begin with, empirically, Alan Reynolds has done research, about which he wrote in a Journal editorial, which has effectively dismissed the contention that government intervention in recessions helps economies. I mention this because later in his editorial, Blinder appeals to empirical evidence, or the lack of it.

Regarding 'job killing government spending,' it's not meant to be a direct and simple logical proposition as implied by Blinder's semantics. Rather, in the current context, with pre-existing uncertainty regarding government extra-legal intervention in business sectors (health care, autos, finance, insurance), aggressive regulatory actions (energy, autos, finance, health care), combined with record government debt and deficits, further deficits or higher taxes to finance more spending is seen as driving businesses to refrain from domestic expansion and/or new hiring. Additionally, the increasing deficits are expected to lead to higher rates on government borrowing demanded by investors, which will raise the deficit, which will eventually require, combined with the other economy-retarding government policies, higher taxes.

These are nuances points, but Blinder's not interested in the reality of nuances as he continues,

"The generic conservative view that government is "too big" in some abstract sense leads to a strong predisposition against spending. OK. But the question remains: How can the government destroy jobs by either hiring people directly or buying things from private companies? For example, how is it that public purchases of computers destroy jobs but private purchases of computers create them?

One possible answer is that the taxes necessary to pay for the government spending destroy more jobs than the spending creates. That's a logical possibility, although it would require extremely inept choices of how to spend the money and how to raise the revenue. But tax-financed spending is not what's at issue today. The current debate is about deficit spending: raising spending without raising taxes."

Blinder is wrong on both points. It's precisely government's ill-advised spending that is at issue. Such as bailing out GM, rather than letting it be reorganized through conventional bankruptcy. Plus, such government spending inevitably invites cronyism, e.g., Jeff Immelt's GE and its curious ties with the current administration and benefits from all manner of environmentally-related government-procured favors.

Further, "tax-financed spending" is indeed part of what's at issue today. In order to avoid further borrowing, the current administration is using the debt limit crisis to try to force higher tax rates and new taxes.

Blinder continues to write,

"For example, the large fiscal stimulus enacted in 2009 was not "paid for." Yet it has been claimed that it created essentially no jobs. Really? With spending under the Recovery Act exceeding $600 billion (and tax cuts exceeding $200 billion), that would be quite a trick. How in the world could all that spending, accompanied by tax cuts, fail to raise employment? In fact, according to Congressional Budget Office estimates, the stimulus's effect on employment in 2010 was at least 1.3 million net new jobs, and perhaps as many as 3.3 million."

Well, as Blinder would know if he read the business press of the past few years, most of that so-called stimulus was used to fund transfer payments to state and local governments. It didn't create jobs, but it may have maintained some. Blinder evades the question of whether simply leaving the governments to resolve their own longer term fiscal situations wouldn't be better for the nation in the first place.

Oh, those pesky details that fall outside of economics.

Then Blinder turns to the fabled "crowding out" effect,

"A second job-destroying mechanism operates through higher interest rates. When the government borrows to finance spending, that pushes interest rates up, which dissuades some businesses from investing. Thus falling private investment destroys jobs just as rising government spending is creating them.

There are times when this "crowding-out" argument is relevant. But not today. The Federal Reserve has been holding interest rates at ultra-low levels for several years, and will continue to do so. If interest rates don't rise, you don't get crowding out."

I don't believe it's quite that simple just now. Rather than crowd out private investment via higher rates, perversely, private lending is stalled because everyone knows current rates don't cover risk. Especially when we just suffered through a residential housing-initiated financial crisis triggered by the Fed's low-rate policies.

Did you really forget that already, Alan?

Plus, the crowding out now occurring is businesses expecting higher taxes at some point to pay for all the deficit spending. That's implicitly crowding out domestic investment as businesses wait for the uncertain other government fiscal shoes to drop in the form of new taxes or higher tax rates.

Blinder then offers this,

"In sum, you may view any particular public-spending program as wasteful, inefficient, leading to "big government" or objectionable on some other grounds. But if it's not financed with higher taxes, and if it doesn't drive up interest rates, it's hard to see how it can destroy jobs."

He simply ignores the transmission effect I noted in my earlier comments, i.e., deficit spending means higher future taxes, in part due to the US government's debt becoming objectionably large to global investors. How Blinder can ignore this is a mystery to me, unless it's because he is an economist, not a financier.

Blinder then appeals to his liberal colleague Paul Krugman's argument,

"Let's try one final argument that is making the rounds today. Large deficits, it is claimed, are creating huge uncertainties (e.g., over what will eventually be done to reduce them) and those uncertainties are depressing business investment. The corollary is a variant of what my Princeton colleague Paul Krugman calls the Confidence Fairy: If you cut spending sharply, confidence will soar, spurring employment and investment.

As a matter of pure logic, that could be true. But is there evidence? Yes, clear evidence—that points in the opposite direction. Business investment in equipment and software has been booming, not sagging. Specifically, while real gross domestic product grew a paltry 2.3% over the last four quarters, business spending on equipment and software skyrocketed 14.7%. No doubt, there is lots of uncertainty. But investment is soaring anyway."

I suppose this is where economists show their ignorance of actual business operations. Business spending by US corporations doesn't mean that spending occurs in the US, or employs more workers in the US. Much of the growth of the S&P500 corporations recently has been overseas, not in the US. Blinder and Krugman fail to distinguish between domestic and foreign investment, spending and hiring by US multi-nationals.

Finally, Blinder closes with,

"Despite all this evidence and logic, some people still claim that fiscal stimulus won't create jobs. Spending cuts, they insist, are the route to higher employment. And ideas have consequences. One possibly frightening consequence is that our limping economy might have one of its two crutches—fiscal policy—kicked out from under it in an orgy of premature expenditure cutting. Given the current jobs emergency, that would be tragic.

Yet it is undeniable that we have a tremendous long-run deficit problem to deal with—and the sooner, the better. So it appears we're caught in a dilemma: We need both more spending (or lower taxes) to create jobs and less spending (or higher taxes) to tame the deficit monster. Can we square the circle?

Actually, yes. Suppose we enacted a modest fiscal stimulus program specifically designed for maximum job creation. My personal favorite is a tax credit for firms that add to their payrolls, but there are other options. And suppose we combined that with a serious plan for reducing future deficits—and enacted the whole package now. Then we could, in a sense, have our cake and eat it, too."

I disagree with Blinder's contention that "we need ..... more spending." Blinder seems unwilling, Keynesian that he is, to simply accept the conclusions of Reynolds' empirical work on the ineffectiveness of government fiscal expansionary policies, and let the US economy endure the natural cycles that private savings, spending and investment will cause.

Many observers, myself included, feel that government spending is the wrong response to the current economic situation. Better to trim government borrowing, by cutting spending, thus improving prospects for Treasury debt offerings and avoiding higher tax rates and new taxes, to leave more money in the private sector. That money will either be spent, or invested, according to private sector appetites, leading, either way, to economic growth.

Why can't we just do that? Allow the private sector to spend and invest its own money as it chooses, rather than force it to either disgorge its money to the government via taxes, or force it to take on liabilities as our government continues to borrow- and spend- on the private sector's account?

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