This post is an attempt to take a ‘look back’ and summarize the basic economic debate we’re having today in American and in Europe too, for that matter.

One side is alarmed at the size of governments deficits and, as a result, also alarmed at the growing debt that is being accumulated.    Their preferred corrective is to cut government spending and thus deficits and debt.  If that is not done as soon as possible, then nations with high deficits and debt are in danger of experiencing high interest rates and high inflation rates.  Under that scenario nations might not be able to shoulder their financial obligations and could renege on their obligations with catastrophic results.  This side also argues that without some short term pain, in the long run the pain will be far more severe.   That’s pretty much the basic argument being made by this side.

The other side  argues that a great and severe recession is the cause of the current deficits, and the long term threat of debt is being created primarily by  out of control increases in health care spending, both in the public and the private sector.  That side prefers to attack both problems by spurring economic growth and incomes, which ends the recession and thus decreases or eliminates the current deficits, while at the same time, reforming health care systems in an effort to attack the long term debt issue that is being created by out of control health care spending increases.  That’s pretty much the other side.

So the common ground is that deficits and debt must be decreased.  The dispute is over how best to accomplish this common goal.

So far a major stumbling block is that one side wants to concentrate primarily on government spending cuts and is reluctant to increase taxes and revenue.  The other side wants to rely on both tax increases and spending cuts.  At this particular moment the spending cuts only side has accepted modest tax increases and now wants to do more government spending cuts.   The revenue increasing side claims it has already accepted large cuts.  Neither side is happy with the size of each other’s concessions.

With this concentration on cuts and revenue, the basic idea of improving the economy (a goal both sides say they want) is sort of an orphan and neither side has made much in the way of concession to the other.   The cut side has maintained throughout that tax cuts are the best way to improve economic performance.  The revenue side points out that tax cuts haven’t historically correlated to having this effect, and anyway, tax cuts increase deficits without offsetting spending cuts.

In terms of this argument, neither side has had enough of a political victory to implement their preferred policies.   The revenue side has managed to get some increased, short term spending, but that’s it.  The cut side has managed to get some spending reductions (about $2.4 trillion over 10 years) but not the size in spending cuts it wants.  The end result economically is a muddle and, so far, while there’s been some improvement in economic performance  it is considered weak and vulnerable to any further economic headwinds.

This is pretty much a summary of the debate in the US.   The question is which side’s preferred methods might work best if they could be applied forcefully:  Big cuts, or Big job increases?  Some clues are coming out of Europe, which faces similar concerns over deficits and debt.  There are important differences between European economies, governments, and policies compared to those in the US.  One cannot ignore these differences in any honest analysis.   But the concerns are the same.  What are the differences?  One, Europe is many countries that share one currency.  Unlike the US there is no European central bank which can easily enforce and coordinate currency and monetary policies; Two, each country has its own sovereign government and its own unique political structure, which also impedes coordinated fiscal policies too.

In Europe the cuts people won the day politically early on.  They demanded so-called ‘austerity’ level spending cuts on some members whose economies were suffering the most, even if their fiscal policies were relatively conservative (lower debt levels, no deficits) when the recession showed up.  This hasn’t worked very well, as a practical matter.  Those countries who’s economies seemed healthy before the recession (Ireland, Spain, Italy being the foremost examples)  have seen their economies worsen substantially, showing unemployment rates not seen since the Great Depression.   Even Great Britain, which is essentially a European economic engine but has its own currency, has suffered from austerity policy application and now hovers on a ‘double dip’ recession.   As a result, the EU governing bodies have lightened up on monetary policies and, as was done in the US, is providing backstop guarantees, and liquidity facilities,  to the most troubled EU countries.  That’s helped, particularly in regards to the interest rates being charged the most troubled countries.  Unemployment, however, remains very stubborn.

And that’s pretty much where everything stands.  Neither side has marshaled enough political power to translate their viewpoints into strong policies.  In the US, for example, infrastructure or other direct hiring such as direct money transfers to cash strapped states (something the EU cannot do) are not being done, and that’s a key component of the revenue side’s policies.   For the cost cutters, major benefit and spending cuts in social safety net spending like Social Security, Medicare and Medicaid are extremely unpopular.  Outside of Obamacare, which implements $716 billion in cost savings and implements a 3.8% tax hike to help match revenues with bills, nothing has been accomplished in an area both sides agree is otherwise going to be a major driver in national debt (private and public).

Beezer here.  So it goes, back and forth and extremely divisive at the political level.  That said, public opinion has been and continues to be in favor of job creation over almost anything else.  That would seem to politically favor the revenue side whose policies heavily favor government spending on creating jobs via infrastructure spending, or in direct money transfers to states.

Over at the Financial Times blogsite, economist Gavyn Davies sketches out the potential impact of renewed fiscal tightening in the United States, and points out that increased consumer spending,  a re-invigorated housing industry and exports to South America are needed to avoid a double dip recession.

The tax measures which emerged last week will tighten fiscal policy by about 1.2 per cent of GDP in 2013. In addition, there will be a further tightening of about 0.6 per cent of GDP from public spending reductions resulting from the 2011 sequestration agreement, and from the expiration of the 2009 Obama stimulus package. The result will be a tightening in the fiscal stance of about 1.8 per cent of GDP, which will be front-end loaded into the first half of the calendar year. Furthermore, additional expenditure cuts could emerge from the negotiations on the debt ceiling in March, though these are not likely to be very large in 2013.

Using a rough rule of thumb in today’s economy, every 1% drop in GDP translates into a loss of 1 million jobs, so a 1.8% drop in GDP Davies projects could result in a loss of 1.8 million jobs!  Outside of a radicalized Republican Party, few citizens would make this kind of choice.  Davis says the US might escape this unemployment because, unlike Great Britain as one example, we have some good trends in place that could mitigate this kind of disaster.

So what are the key differences between the US and the UK? One is the much greater exposure of the US export sector to the rapidly growing export markets of Latin America and other emerging economies, instead of the depressed eurozone, which dominates UK export markets. Keynesian analyses of the causes of UK economic stagnation regularly seem to ignore this trade factor, while emphasising the role of fiscal policy in explaining weak growth in Britain. In fact, export markets and the fiscal tightening have both been critical in explaining UK underperformance (see here).

However, the real reason for being more confident about prospects for the US is that the private sector is now rapidly reducing the financial surplus it acquired during the crisis:

The private sector financial balance represents the excess of private income over expenditure, or equivalently the difference between total savings and total investment. When the balance is positive, the private sector is paying down debt or acquiring financial assets, and vice versa. From 2009-11, the US private sector reduced its expenditure so sharply that it ran a financial surplus of about 6 per cent of GDP, but in the last six quarters, this surplus has fallen by 2.5 percentage points as household savings have been reduced, and fixed investment has recovered, notably in homebuilding.

The US private sector is still paying down debt, but is doing so less rapidly than it was a couple of years ago, and that has allowed the economy to expand. In the UK, we have also seen some reduction in the private surplus, but not by enough to offset the fiscal tightening and the weakness of export markets.

Prospects for a further trend reduction in the private sector financial surplus as confidence rebounds seem to be better in the US than in the UK, where the outlook for homebuilding is relatively poor, and the banking sector remains dysfunctional. Recent work by Jan Hatzius and Sven Jari Stehn at Goldman Sachs suggests that the US private surplus could diminish at an annual rate of 1.5-2 per cent of GDP over the next three years, which is much more than seems likely in the UK. If correct, this would greatly mitigate the damage to growth from the fiscal tightening.

Same strategy, different results? That is what the markets seem to be betting upon, and they may well be right.

Beezer here.  My spending is your income.  The current high unemployment came, to a great degree, from the greatly increased savings rate Americans went collectively through in response to the financial meltdown of 2007-2008.  We all trimmed our spending at the same time, which means we all trimmed our incomes at the same time and that results in lost jobs and severe unemployment.  That savings rate is declining now, which means there’s more spending and thus more income which should result in more jobs.  Add in a housing market that’s stopped declining and an export boom to South America and we might escape much of the damage created by fiscal tightening.  If these positive trends don’t continue, or worse even reverse, we’re in for a very poor economic performance in 2013.  Congress should be continuing stimulus, particularly in the form of infrastructure spending which guarantees jobs and income gains.  Failure to use this fiscal tool to help offset the damage of fiscal tightening is to invite disaster.

Nobel Laureate economist Paul Krugman, in a New York Times column, laments that even though conventional wisdom has been proven wrong for the past 5 years, it still remains powerful enough to influence public policy.

Back in the 1950s three social psychologists joined a cult that was predicting the imminent end of the world. Their purpose was to observe the cultists’ response when the world did not, in fact, end on schedule. What they discovered, and described in their classic book, “When Prophecy Fails,” is that the irrefutable failure of a prophecy does not cause true believers — people who have committed themselves to a belief both emotionally and by their life choices — to reconsider. On the contrary, they become even more fervent, and proselytize even harder.

This insight seems highly relevant as 2012 draws to a close. After all, a lot of people came to believe that we were on the brink of catastrophe — and these views were given extraordinary reach by the mass media. As it turned out, of course, the predicted catastrophe failed to materialize. But we can be sure that the cultists won’t admit to having been wrong. No, the people who told us that a fiscal crisis was imminent will just keep at it, more convinced than ever. ..

Seriously, at every stage of our ongoing economic crisis — and in particular, every time anyone has suggested actually trying to do something about mass unemployment — a chorus of voices has warned that unless we bring down budget deficits now now now, financial markets will turn on America, driving interest rates sky-high. And these prophecies of doom have had a powerful effect on our economic discourse….

Regular readers know that I and other economists argued from the beginning that these dire warnings of fiscal catastrophe were all wrong, that budget deficits won’t cause soaring interest rates as long as the economy is depressed — and that the biggest risk to the economy is that we might try to slash the deficit too soon. And surely that point of view has been strongly validated by events.

The key thing we need to understand, however, is that the prophets of fiscal disaster, no matter how respectable they may seem, are at this point effectively members of a doomsday cult. They are emotionally and professionally committed to the belief that fiscal crisis lurks just around the corner, and they will hold to their belief no matter how many corners we turn without encountering that crisis.

So we cannot and will not persuade these people to reconsider their views in the light of the evidence. All we can do is stop paying attention. It’s going to be difficult, because many members of the deficit cult seem highly respectable. But they’ve been hugely, absurdly wrong for years on end, and it’s time to stop taking them seriously.

Beezer here. In his seminal book The General Theory of Employment, Interest, and Money economist John Maynard Keynes made a similar argument regarding Ricardian economics, that it had ‘conquered England as completely as the Holy Inquisition conquered Spain.’ He then went on the write this iconic paragraph:

“That it (Ricardian economics) reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose to its intellectual prestige. That its teaching translated into practice, was austere, and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it would explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.”

Beezer again.  As Keynes did 76 years ago, Krugman pushes back against the Ricardian view that it is impossible for effective demand to be deficient.  Fortunately when Keynes wrote the then President, Franklin Delano Roosevelt, listened and used the power of the state to hire more than 8 million people during his first two terms, clipping more than 10% off the unemployment rate.  Unfortunately today this President, Barack Obama, has not listened to Krugman as FDR listened to Keynes.  And that is why unemployment remains too high and comes down grudgingly.

Republican politicians of every stripe, from the lowest municipal level to Congress, have promoted so-called ‘Right to Work’ legislation that is aimed at weakening labor union power by eliminating mandatory union dues.  This is an obvious attempt to limit the ability of unions to fund campaigns for pro-organized labor politicians.  So the effort isn’t about producing jobs it’s about reducing union jobs, which traditionally gain labor higher wage rates,  benefits and safer working conditions.

Real ‘right to work’ legislation would be that when the private sector cannot hire enough workers the government will hire them.  That’s by definition a real ‘right to work.’  All Americans willing and able to work have a right to paid employment.

From an article in the New York Times, written by UMass economics professor Nancy Folbre.

…

Most of us live in a world in which paid employment is the only avenue to economic self-sufficiency. Without it, families maintained by working-age adults are largely dependent on the kindness of strangers, otherwise known as extended unemployment insurance and food stamps. Yet, for more than four years, this nation has tolerated levels of unemployment that have essentially made it impossible for most of those seeking paid employment to find it, with a ratio of unemployed workers to job openings of more than three to one.

Some Republicans have long insisted that many of the jobless, relaxing in a billowy social safety net, simply aren’t trying hard enough to find a job. My fellow Economix contributor Casey Mulligan makes a similar argument when he contends that the poverty rate should have risen ­between 2007 and 2011, but didn’t ­because public assistance was neutralizing the effect of job loss and undermining incentives to work.
But Shawn Fremstad of the Center for Economic Policy and Research challenges that methodology, pointing to measurements showing that the poverty rate did rise significantly among working-age adults over this period.

Further, increased unemployment contributed to economic stress across most of the social spectrum, not just among the poor and near poor. Between 2007 and 2011, average household income declined in all four bottom quintiles.

Expansion of unemployment insurance and means-tested benefits are not the best solution to persistently high unemployment. As John Stuart Mill emphasized many years ago, those who are capable of supporting themselves should not rely on the habitual aid of others. But Mill went on to explain why such aid is sometimes necessary:

Energy and self-dependence are, however, liable to be impaired by the absence of help, as well as by its excess. It is even more fatal to exertion to have no hope of succeeding by it, than to be assured of succeeding without it. When the condition of any one is so disastrous that his energies are paralyzed by discouragement, assistance is a tonic, not a sedative: it braces instead of deadening the active faculties.

Paralysis by discouragement is a pretty good description of a growing segment of the United States population. In general, the higher the unemployment rate in a state, the higher the percentage of discouraged workers (those who did not search for work in the previous four weeks, for the specific reason that they believed no jobs were available for them) and the higher the percentage of marginally attached workers (those who did not search for work in the previous four weeks, for any reason).

Labor force participation has declined significantly since the last recession began, especially among less-educated men.

The best way to encourage American workers, increase family income and reduce public spending on unemployment insurance and food stamps is to create more jobs. The simplest way to create more jobs is to increase public-sector employment. The federal government could also invest in programs to encourage small businesses to hire workers to improve our aging physical infrastructure (including roads and bridges), our social infrastructure (including early childhood education and home services for the elderly) and our environmental sustainability (including improved energy efficiency and installation of the solar voltaic technologies that Germany now heavily relies upon).

All these investments offer a high social rate of return that private businesses can’t easily capture on their own.

By contrast, there is no evidence that lower tax rates for the rich promote either job creation or economic growth (a detailed study on this topic by the Congressional Research Service was withdrawn as a direct result of Republican protest).

President Obama and Congressional Democrats have called for more stimulus spending aimed at job creation, only to meet tremendous opposition from Republicans. Preoccupation with deficit reduction has crowded out discussion of job creation. Public employment grew steadily during the previous Bush administration. During the Obama administration, however, it has significantly declined.

Now, it appears that any remaining concern with job creation may be thrown over the fiscal cliff.

The next time someone with a comfortable paycheck tells you that American workers no longer have a work ethic, please explain to them that right now, there’s not enough paid work to go around.

Which is why we should fight for a real right to work.

Beezer here.  We certainly have a need for infrastructure work that, if we completed it, would not only produce millions of jobs but would give a tremendous boost to America’s economic competitiveness.  That we don’t make this national policy is a tragedy.

A large portion of the American public believes the following:  A government dollar spent is a dollar the private economy can’t spend, the government always screws up its spending, therefore don’t let the government spend.  This sounds rational if the assumptions are correct.  Unfortunately the assumptions are not correct.

Economists have something they call ‘fiscal multipliers’ associated most often with government spending.  To those who believe the theory of the first paragraph, government spending has a multiplier of zero or even less,  but certainly less than 1.    Libertarians, for example, would fall into this category.  A lot of so-called ‘fiscal conservatives,’ would too.   Even some economists, for example those who advise austerity right now when it comes to government spending, believe this line of reasoning.

So too did the International Monetary Fund (IMF) the leading global organization when it comes to matters economic.   Until recently, that is, when it published the first chapter on the IMF’s global outlook.

The thing is that the IMF is noticing larger negative economic effects of austerity policies than it expected.  Their models didn’t foretell the magnitude of the negative effects.  Remember that fiscal multipliers work both ways, negative as well as positive.  If government spending doesn’t mean a whole heck of a lot, then not spending these dollars won’t have much negative effect.  Whoops.

The truth is that government spending can have a big impact, positive and negative.  The multipliers are most likely greater than 1, not zero or less.  At least the multipliers are greater than 1 right now.  Which doesn’t mean all government spending has these multipliers.  It just means that sometimes that spending does have a positive impact economically.

And we are currently in one of those ‘sometimes.’  When you have a recession, especially when you have a recession caused by a financial collapse in the private sector, government spending has a multiplier greater than 1.   Of course just throwing money around willy nilly is going to have a smaller multiplier.   But spending on direct hiring is probably going to have an effect of 1.5 or greater:  That is each government dollar spent hiring someone will produce a $1.50 in economic spending.   It will produce an economic expansion, in other words.  Conversely, a dollar not spent hiring someone, is going to create the loss of $1.50 in spending.   It will produce economic decline.

And surprise, surprise that’s exactly what austerity policies in Europe are doing.   These economies are either not growing, or are in contraction.   Debt, most often used by those as a reason to be austere,  has become less manageable, not more.   The IMF sees this and as a result is reconsidering the fiscal multipliers they use in their models.

“With many economies in fiscal consolidation mode, a debate has been raging about the size of fiscal multipliers. The smaller the multipliers, the less costly the fiscal consolidation. At the same time, activity has disappointed in a number of economies undertaking fiscal consolidation. So a natural question is whether the negative short-term effects of fiscal cutbacks have been larger than expected because fiscal multipliers were underestimated.”

The effects of austerity may even be showing  up in the US.  Here we still have the ongoing stimulative effect of a series of tax cuts, but direct government spending stopped being stimulative a year ago, and right now is contracting.   Most economic estimates show that contraction has added 1% to our unemployment rate, for one example.

When there’s a big drop in private production where a large number of people become unemployed, then government spending multipliers will be greater than they would be when there’s low unemployment and productive capacities are expanding.   Unfortunately, this economic reality runs counter to the philosophy outlined at the beginning of this article.

Until those who believe austerity is the cure for what ails us change their minds (the IMF reversal is an important step in this direction), we will continue to have poor political policies, weak economies, high unemployment and troubles with debt.

Beezer here.  Once again, thanks to economist’s view and Prof. Mark Thoma for drawing attention to the IMF report and articles about the import of changes in estimating fiscal multipliers.

The Bureau of Labor Statistics will apparently add almost 400,000 new jobs to what has been reported so far this year.  From the WSJ.

The Bureau of Labor Statistics on Thursday released an early look at its annual “benchmark revision” of its payroll data. When the preliminary revisions become final early next year, the official data should show that there were 386,000 more jobs in March than previously believed. The private sector did even better, adding 453,000 jobs versus previous estimates.

Beezer here.  Notice that the private sector number is 67,000 jobs higher than the net gain of 386,000.  The difference is no doubt the continuing contraction in public employment.