Monday, February 28, 2011

Are we still in an economic march of folly?

Historian Barbara Tuchman used the phrase "march of folly" to describe incidents in history in which which leaders had good reason to know what they were doing was foolish and self-destructive, yet kept on doing it anyway. Her examples included American policymakers in the Vietnam War and the Catholic hierarchy in the years leading up to the Protestant Reformation.

We in the United States had more than one marches of folly in the 2000s: the Iraq War from the start; the Afghanistan War once the initial phase of direct targeting of Bin Laden's Al Qa'ida group was done; and, an economic march of folly built on a housing bubble, unsustainable levels of consumer debt and reckless financial institutions operating without the necessary government controls.

The economic march of folly isn't over yet. Brad DeLong adds his voice to the chorus of economists asking what US and European politicians think they are doing pursuing fiscal policies to reduce growth in the midst of high unemployment and a sustained slump. (Pain without Purpose Project Syndicate 02/28/2011) Although still confessing himself to be a "neoliberal", he describes his own learning process over the last two decades as follows:

Three times in my life (so far), I have concluded that my understanding of the world was substantially wrong. The first time was after the passage in 1994 of the North America Free Trade Agreement (NAFTA), when the flow of finance to Mexico to build factories to export to the largest consumer market in the world was overwhelmed by the flow of capital headed to the United States in search of a friendlier investment climate. The result was the Mexican peso crisis of later that year (which I, as US Assistant Secretary of the Treasury, had to help contain).

My second epiphany came in the fall and winter of 2008, when it became clear that large banks had no control over either their leverage or their derivatives books, and that the world’s central banks had neither the power nor the will to maintain aggregate demand in the face of a large financial crisis.

The third moment is now. Today, we face a nominal demand shortfall of 8% relative to the pre-recession trend, no signs of gathering inflation, and unemployment rates in the North Atlantic region that are at least three percentage points higher than any credible estimate of the sustainable rate. And yet, even though politicians who fail to safeguard economic growth and high employment tend to lose the next election, leaders in Europe and the US are clamoring to enact policies that would reduce output and employment in the short run. [my emphasis]
This is the problem with conspiracy theories. Yes, there are powerful interests involved, such as financial institutions lobbying for their freedom to operate irresponsibly without notable consequences for their senior executives.

But sometimes the world is run on just plain dumb. At least for a while. Such was the case in the Western countries during the early years of the Great Depression. And such appears to be the case now in the situation DeLong describes.

Fears of inflation, partly if not largely stimulated by conservative scare-mongers as an excuse to hold down civilian government spending and keep the wealthy as free as possible from the excruciating burden of paying taxes to support their countries, contribute to the current policy of demand contraction by governments. But, as DeLong says, "if inflationary expectations become embedded in an economy, it may be impossible" for the most desirable Keynesian policies "to work. But that is not our situation today." And he concludes:

Nevertheless, when you listen to the speeches of policymakers on both sides of the Atlantic, you hear presidents and prime ministers say things like: "Just as families and companies have had to be cautious about spending, government must tighten its belt as well."

And here we reach the limits of my mental horizons as a neoliberal, as a technocrat, and as a mainstream neoclassical economist. Right now, the global economy is suffering a grand mal seizure of slack demand and high unemployment. We know the cures. Yet we seem determined to inflict further suffering on the patient.
The Obama Administration from its first days essentially bet on bailing out the big banks and hoping the economy would start chugging along comfortably again. They did do things a McCain-Palin Administration would not have done, such as not using the GM bankruptcy to let the company go belly-up and out of business and thereby take a big whack at the power of the United Auto Workers (UAW) union. The Obama Administration did, however, force GM into bankruptcy and temporary nationalization, in dramatic contrast to the treatment of shaky financial institutions like Citigroup and Bank of America, who instead received federal funds and a generous change in accounting rules that allowed them to value the bad mortgages on their books as something other than what they were.

But now, with his Catfood Commission to target Social Security for phaseout, his austerity budget for 2011-12 and his continued obsession with bipartisan compromise with a Republican Party whose goal is to wreck his Presidency, Obama isn't pushing for more stimulus. Instead, he's validating the Republicans' gubment-is-the-problem narrative and encouraging spending reductions that will slow economic growth. As economics writer Robert Kuttner puts it in his article on pushing American politics beyond what now appears to be The Left Edge of the Possible Huffington Post 02/27/2011, "Unfortunately, both parties are mainly jousting over budget cutting. We have the party of cuts versus the party of deeper cuts. Neither is putting forth a serious recovery plan."

One of the most short-sighted features of both the 2009 budget plan and his Administration's subsequent actions has been Obama's decision to provide only limited aid to state and local governments that have been facing and still face massive cuts. The federal stimulus of 2009 was real. But it was also largely if not completely offset by reductions in government spending at state and local level, which reduced aggregate demand at the same time federal spending was boosting it. The consequences of those state cuts are real and destructive, both in the short and long run, as Paul Krugman analyzes in the case of the State of Texas in Leaving Children Behind New York Times 02/27/2011.

Krugman also notes the bizarreness of our current political discussions in the US and Europe over budgets and economics in his blog post Hoot-Smalley 02/21/2011:

From where I sit, it looks as if the ascendant doctrines in our policy/political debate are coming precisely from people who don’t know and don’t care about technical economics. The revival of goldbuggy sentiment, the fear of hyperinflation in the face of high unemployment, the continuing force of the notion that tax cuts don’t increase the deficit, aren’t coming from some subtle battle among mathematical modelers; they’re coming from the same people who reject evolution, climate science, and more. They don’t need no stinking technical analysis. The truth is that the economics profession is proving far less relevant to public debate, even in the face of economic crisis, than was dreamed of in our philosophy. [my emphasis]
Oh, then there are the dramatic democratic movements in the Arab world, the Arab world which has a lot of oil. And oil prices have been spiking lately (Jeff Mason and Amena Bakr, U.S., Saudi reassure on growth as Libya turmoil drives oil Reuters).

For more on the complicated mix of oil politics and democratic revolution, see Juan Cole, The World Oil Politics of the Libyan Revolt 02/28/2011.

At the national level this year, we're looking at the wreckage of lost opportunities on the part of the Obama Administration. A more aggressive stimulus policy from the start could have done a lot more to jolt the economy back into a healthy growth mode and combat unemployment. A more-consumer friendly rescue program, especially on the huge problem of mortgage defaults and foreclosures, would have bluntly some of the (probably inevitable) resentment of the bank bailouts. So would a more real-accounting based approach to the problems of big banks like Citigroup and Bank of America. If Obama had used the golden opportunity presented to him by the horrible BP oil spill in the Gulf of Mexico in 2010 to highlight the misconduct of the oil monopolies and to dramatize the need for alternative energy development, he would be in a better position to both push such developments and to credibly suggests measures like price controls or excess-profits taxes in response to spiking oil prices.

There are real examples in the states of fighting Democrats: the legislative Democrats and public employees unions in Wisconsin's, Jerry Brown in California. They could use an ally in the Democratic Administration in Washington right now.

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