Government Spending to Boost Demand

In an opinion piece entitled “Obama Should Devote Final Years to Changing Economic Conversation” http://tinyurl.com/lschb9o economist Dean Baker of the Center for Economic and Policy Research argues that during recessions the federal government should increase spending to stabilize the economy.

Dean explains that the economy went into recession in 2008 because of “an enormous shortfall in demand created by the collapse of the housing bubble”.  The loss in demand resulted in a decrease in spending on everything from homes to vacations to consumer goods.  Almost every sector of the economy was adversely affected from building contractors to retail stores to hotels to the auto industry.  The sharp drop in consumer demand hurt almost all of us.  People lost their jobs.  People lost their savings.  People lost their homes.  It was bad.

And economists and politicians brainstormed to find a remedy.  From tax cuts to stimulus spending to bailouts to quantitative easing to changes in regulations, there wasn’t any idea that wasn’t proposed.

Dean Baker’s remedy is for the government “to fill the gap in demand with spending of its own.”  The spending, Baker adds, should be financed through debt.  “[T]the country has nothing to fear from higher debt,” writes Baker. He says that the government can easily continue to borrow and borrow and borrow and borrow.  Dean argues that increased government spending to the tune of hundreds of billions of dollars a year  or even over a trillion dollars a year (in addition to current deficits) would make up for the slack in demand and provide jobs for the unemployed.

My question is whether the government should be doing this.  Should the government borrow hundreds of billions of dollars a year to spend money to boost the economy and increase jobs?  Should the government engage in activities to manipulate the economy like this?

There is no question that the government does act to manipulate the economy.  The mortgage interest deduction in the Internal Revenue Code was designed to encourage people to buy houses.  The Federal Reserve manipulates the value of the dollar and interest rates.  Interest rates were lowered in the early 00s during a mild recession to encourage people to borrow and spend.  Auto loans could be obtained for less than 2 percent.  Loans to students are guaranteed by the government and offered at a lower than market interest rate to encourage people to further their education.

Should the government be doing this?  The mortgage interest deduction does encourage people to buy houses and acts as a subsidy to housing for everyone.  The lower interest rates did and do encourage people to take on debt to buy things like cars and houses.  And student loans do encourage people to spend for further education.  But the end result is that people are put further and further into debt.  The government has encouraged people to go into debt just so they’ll spend more to stimulate the economy.  This has been going on for decades, and in the interest of pushing up GDP, the nation has gone from the world’s largest creditor to the world’s largest debtor in just three decades as people and the government have gone deeper and deeper into debt.

And the nation experienced prosperity that had never been seen before in the history of the world, and it was all supported by consumer spending through debt accumulation encouraged by government programs.  Everything seemed fine, and the economy kept rolling right along, until the party ended.

So Baker suggests that the federal government increase its debt to finance spending to boost the economy because consumers lack the ability.  He argues that the debt accumulation poses no threat to us.  Baker basis his conclusion that additional debt accumulation poses no threat is based solely on the fact that people are willing to continue to buy bonds.  If people are willing to loan us money at low interest rates, then everything must be ok.  He misses the fact that making loans to people with bad credit during the build-up of the housing bubble didn’t render those people able to make the payments.

As an economist, Baker may not have taken a chemistry class or paid rapt attention when he did.  Consider water.  As water gets cooler, what happens?  When the temperature of water goes from 80 degrees to 50 degrees, what happens?  Nothing.  When it goes from 50 degrees to 45 degrees, what happens?  Nothing.  When it goes from 45 degrees to 40 degrees, what happens?  40 degrees to 35 degrees?  Still nothing.  So based on this data, one would conclude that reducing the temperature of water has no effect on its character.  The only problem is that at some point, 32 degrees, the water turns to ice.

This is similar to what happened with the build-up of consumer debt.  As people borrowed to buy things, maxed out their credit cards, obtained auto loans, obtained mortgages, etc. things were going smoothly.  There was no danger.  But then it reached a tipping point.  Like the straw that broke the camel’s back.  It eventually crashed.

And Baker’s promise that the country has nothing to fear from higher debt will be of little consolation in the event that it does all come crashing down.

Marriage as an Economic Stimulus?

Stephen Moore, chief economist at the Heritage Foundation and founder and former president of the Club for Growth, wrote a column in the Washington Times http://tinyurl.com/lp2hjeo entitled “Marriage, the Surest Economic Stimulus” in which he argues that marriage is the best anti-poverty program in America.

Moore correctly provides data that “poverty rates are very low among intact families” and that homes without a father experience higher rates of poverty. In addition, he explains that children who grow up in an intact family generally experience higher incomes and lower rates of poverty.

But then he takes a left turn.  He argues that it is irrefutable “that marriage with a devoted husband and wife in the home is a far better social program than food stamps, Medicaid, public housing or even all of them combined.”  He bases this conclusion on a report called the “Index of Culture and Opportunity” (“ICO”) by the Heritage Foundation.  Moore concludes by saying that a “national commitment to sturdy families” is needed to save our economy from “a path of decline”.

The ICO Report tracks trends in a variety of statistics from the marriage rate to the labor participation rate to crime statistics.  An overview that only includes some information is available at the following link: http://index.heritage.org/culture/overview-of-2014-index/. 

Notice that for all the economic data, including the labor force participation rate, self-sufficiency and the percentage of welfare recipients working, the trend analysis goes from an economic boom to a recession. During the Great Recession, unemployment increased, the poverty rate increased, the labor force participation rate decreased, and many other economic statistics decreased.  By choosing the Great Depression as the end of the trend analysis, one can make the figures appear to support the theory that lower marriage rates adversely affect the economy.

For example, marriage rates have been falling for half a century, and divorce rates have increased during that time as have out-of-wedlock births, but the economy and incomes have grown during that time, and the poverty rate has remained about the same.  The fluctuations of these statistics are more of a result of the economic cycle than the number of marriages per 1,000 single women.  But by carefully choosing the time period for the trend, the Heritage Foundation can make the data seem to support their pre-drawn conclusion.

There is, however, an undeniable correlation between standard of living and lifestyle choices at the family-unit level.  Families with two heads of household, i.e. married couples, generally have higher incomes and stability than families headed by one parent.  In addition, children growing up in households headed by married couples perform better in school and have higher incomes as adults than those who grow up in households headed by single parents.  There’s no questioning that.  But does correlation mean causation?

Years ago, educators noted that students with high self-esteem performed better in school and on standardized tests.  So an effort was made to raise the self-esteem of all the students thinking that they would thenceforth perform better in school.  The result was that we now have millions of American idiots with high self-esteem.  It wasn’t the high self-esteem that was causing the high performance in school.  Higher performance resulted in higher self-esteem.

In his book “Leviathan on the Right”, The Cato Institute’s Michael D. Tanner questions whether getting married causes prosperity or whether certain behavioral patterns result in stable relationships as well as prosperity.

For example, imagine Mother A who has is constantly late for school and work, gets bad grades, parties in lieu of studying, can’t hold a job and performs poorly when she does decide to show up for her job.  This pattern of behavior, if also extended to her relationships, is likely to lead to divorce and/or having a child out of wedlock.  Meanwhile, Mother B has good attendance, works hard to get good grades, has a job and shows up on time and works hard.  This type of person is more likely to be a good marriage partner and a good mother.

The fact is that getting married isn’t going to make Mother A more responsible, and it won’t make her a better mother.  It’s not going to lift the family out of poverty, and it certainly isn’t going to have much of an effect on the national economy.  There may be some benefit of having two adult wage earners in the household, but Stephen Moore’s conclusions that a commitment to sturdy families is going to save our economy from a path of decline.

The Great Depression

The Great Depression is a frustrating topic.  So many economists and politicians explain the cause(s) of the Great Depression in accordance with their pre-determined narrative.  Some conservatives say that it was caused by government spending.  People who think that we should go back to the gold standard say that the Federal Reserve caused the Great Depression.  Some anti-immigration fanatics even argue that it was caused by immigration.  People on the other side of the political spectrum might argue that it was caused by unrestrained capitalism or inequality.  And they play the same game when explaining what ended the Great Depression.

Hack economist Stephen Moore writes a column in The Washington Times (“How did the Great Depression actually run its course?”) arguing that the rapid decrease in government spending after World War II caused the economy to surge thereby ending the Great Depression.  He is arguing that a decrease in government spending caused the end of the Great Depression and, therefore, in 2014 we should do likewise.

“The Keynesians,” he writes, “were sure that the massive reduction in government spending would catastrophically tank the economy.”  But, according to Moore, the economy “surge[d] after the war was over.”  Moore goes on to say how personal consumption and private investment spending grew after the war.

“In sum, it wasn't government spending, but the shrinkage of government that finally ended the Great Depression. That's what should be in every history book — but isn't,” writes Moore.

His problem is that the economy DIDN’T grow after WWII.  The economy actually declined considerably when the government drastically cut spending at the end of the war, and GDP didn’t fully recover until years later.  In 1945 GDP was measured as $2,217.8 billion.  The following year GDP crap-dived to $1,960.9 billion according to the Bureau of Economic Research, a loss of well over 10%.  It wasn’t until 1951, six years later, when the economy finally recovered its losses.

The lesson here is not that government spending is good for the economy.  It can be, but it can also be damaging to the economy.  The lesson here is, first of all, that Stephen Moore is an incompetent hack.  Second of all sudden, massive cuts in government spending can have an adverse effect on the economy, and it could take years to recover.

Free Market Allocation of Goods and Services

The Center for Economic and Policy Research (“CEPR”) is an economic think tank.  It was co-founded in 1999 by economists Dean Baker and Mark Weisbrot.  They tend to have somewhat of a liberal perspective, but to define them as “liberal” is inadequate.  The guys have unique perspectives on a lot of issues which is why I frequently visit their website.  Weisbrot spends a lot of time on Latin American countries.  Dean Baker had been predicting the residential real estate bubble years before anyone suspected there might be a bubble.  But he’s not right about everything.

Dean has been incessantly promoting the idea that the United States should actively seek to have qualified medical doctors immigrate to the country.   Dean claims that the medical profession has influenced the Federal government to impose barriers on the immigration of foreign born doctors thereby limiting competition thereby boosting the salaries of affected medical professionals.  Dean believes that permitting foreign born medical professionals to practice in the United States would reduce medical costs in the United States.

In a recent column http://tinyurl.com/k5kvbsf, Dean writes:

“We can use trade agreements to open our economy to foreign doctors. Our doctors get paid more than twice as much as the average for doctors in other wealthy countries. The pay gap with doctors in developing countries is even larger.  There are hundreds of thousands of smart kids in countries like Mexico, India, and China who would be happy to train to U.S. standards and work as doctors in the United States for half the pay our doctors receive.”

And he’s right.  Not only will the immigration of more doctors reduce doctors’ salaries and reduce costs of medical care in the United States, it will make more medical care available.  Dean thinks it would be a good idea for doctors from Mexico, India and China to come to the United States to provide care for Americans.  That would be good for America.

The only problem is that it won’t be so good for other countries.

Dean has considered this.  Dean thinks it’s “silly” to discuss how this will hurt the quality of health care in developing countries.  That’s right.  He thinks it’s silly.  We should encourage a doctor in India to leave his malaria and leprosy patients behind and come to the United States to treat soda sipping obese Americans who spent over $10 billion on cosmetic surgery last year.

It brings up the issue of free trade.  Most economists believe that free trade increases economic growth and raises living standards.  Studies of economies over the years have almost unanimously confirmed this belief.  Free trade and free markets are also the best way to allocate resources, theoretically. People in Brisbane are generally willing to pay more for surfboards than people in Nebraska.  This is because surfboards are of more use in Brisbane.  Therefore, surfboard manufacturers ship their product to sell them in Brisbane where they will get more money.  The surfboards are used for their intended purpose in Brisbane instead of occupying a shelf in the garage in Nebraska.  The free market system works so that the surfboards are put to their most beneficial use to society.  There’s no debate.

The problem that I have is that free trade and free markets do not always allocate resources efficiently.  If a doctor treating children for cholera in Haiti moves to Los Angeles and sets up a liposuction and bariatric surgery practice, this will benefit the doctor who will be able to earn more money, and his family will be able to live a better lifestyle.  It will benefit those in Los Angeles seeking liposuction and bariatric surgery because they will have more options and probably lower cost service.  But what about the kids in Haiti?  Is this situation really the best allocation of resources?  Is it best for society as a whole for a doctor to treat lazy-assed fat bastards in Los Angeles than to save the lives of children?

Dean Baker considers this discussion to be “silly”.