Wednesday, November 3, 2010

Deficit and Jobs – It Could Get Worse

(Thoughts the morning after the election.)

In the elections yesterday, the voters sent a strong signal that they simply will not put up with the combination of 10 percent unemployment and huge budget deficits that we are seeing now. They want that one solved first, before we do anything else. That’s understandable. But – painful as it is, we need to first face up to reality. We need to understand that tinigs could easily become worse. If we get too angry and refuse to believe that we are stuck in a very difficult situation, and look for rescue from voodoo economics,
we could easily make things much worse.

That’s basically what actually happened to create the Great Depression. The initial recession was mild enough that even in 1931 the New Republic was asking “will there be a recession?” In order to “save the situation,” and get back to having more jobs, Congress passed the Smoot-Harley (sp?) tariffs, which set off a world competitive spiral, which resulted in unemployment much, much worse than what we have today. We could easily make the same kind of mistake all over again. In a way, some of China’s recent statements that they will not accept less than full employment in China, and will take international actions to assure that, could cause the same kind of thing. But even more serious, a lot of the perpetual motion ideas floating around in the US could do the same.

To address the issue in a serious way, we do need to begin by giving up gross illusions. One of the big, scary challenges is that a lot of key Republicans have committed themselves to the belief that we could make huge reductions in the deficit and in unemployment, both, immediately, by simply making deeper tax custs specifically for those who get more than $250,000 per year. It’s understandable why some folks find this to be a very convenient lie, but if they don’t pull off their dogs, and prevent the risk of depression, they won’t benefit in the end any more than the rest of us do. Careful reviews by professional financial economists, without any left-wing bias at all, like the Financial Times and the Economist, have spelled out in great detail why we can be certain that life is not so simple.

Back around January 2009, the story was pretty clear. The US Chamber of Commerce strongly supported the stimulus bill (and urged Senator Specter, for example, to vote for it), because they saw the numbers about the same way that the Financial Times and the Economist did. They saw a real prospect of 15% unemployment if we did nothing. They saw that the huge stimulus bill then under discussion would only be enough to cut the problem in half, to about 10%, when we really wanted to get back to 5%. There was quite a bit of discussion of what would be needed for “phase two,” but people wanted to get phase one finished first, to avoid the worst and postpone controversy.

So here we are, still stuck at around 10%, with deficits so high that many are very worried already. It’s a classic case of damned-if-you-do damned-if-you-don’t. Some hope that monetary policy could improve things, even with no net increase in federal budget deficit, but reports from the front lines say very clearly that we are caught in a classic “liquidity trap.” We have basically reached the limits of what lending people money can do, to increase ecnomic demand in the US. And the world in general is also in a bind. (I could say a lot more about the EU, Germany and China, but let’s stay on the main theme for now.)
To reduce raise demand and reduce unemployment, there are three classic tools – government spending,
tax breaks for the rich, and tax breaks for the middle class. To minimize deficit cost per job created, it’s VERY clear from economic research that reliable long-term tax breaks for the middle class do the best job … but even they impose a high deficit cost. We don’t have a really clear and rigorous way to decide what the optimal balance is right now between deficits and jobs but we can be sure, with these conventional tools, that we are stuck between a rock and a hard place. And the public won’t put up with bigger deficits, except perhaps with bigger middle class tax breaks.

Can we do better?


About a month ago, I was thinking – the politics of doing better are probably just too hard. With voodoo thinking permeating the relations between both parties, and big donors and money controllers limiting what the sane folks can get away with, we can forget getting out of the hole we are in now. (After all, Japan had its own lost decade.) But we could PERHAPS get bipartisan action to prevent another kind of “second dip” that could make things a whole lot worse. Some people may feel that $1 trillion/year is small change, with no ability to change the grand world of jobs and deficits,… but I see the numbers differently. We do have a clear opportunity to prevent a return of world oil prices to $150/barrel or higher, and encourage some new investments and jobs while we are at it. (See This has traditionally been an area of bipartisan collaboration, and we could afford to say some nice things about George Bush as part of the deal. Whatever it takes. Avoiding a real depression is too important to neglect.

But in fact, we do not REALLY have to stay in the hole. The entire world is in this bind right now. It’s an example of what game theorists call a “Nash equilibrium.” On the one hand, there are ways we could get a lot more jobs per dollar of deficit right now than any of the three traditional fiscal tools offer. (Japan’s”Three Pillars of Ecofriendly Economy” program gives some clues.) On the other hand, since the whole world is in the same bind (even if half of it is in denial and half the nations think they are God’s chosen people one way or another), international coopertaion does in principle allow for a Pareto optimum or a Pareto improvement which gets us out of the risk/jobs dilemma.

These three approaches are pretty much the honest choices, not only for the US, but for the world as a whole. And, for all the bullshit and all the lip service, I don’t see one iota of real progress here in the US or in Europe yet. (The “Pickens Plan” bill would only make it all worse.)


  1. One thing the economists don't like to look at is that we are really in a post full-employment economy.

    Pushing on increasing employment alone will not turn things around, because structurally, everything conspires against increases in employment. We have increased computerization of processes, robotization, we "rationalize" away jobs and we export the rest to countries that have a population with lower wage expectations. This is not going to change any time soon, and unfortunately, economists don't have an answer to the problem.

    What the lack of employment does is it throws a spanner in the works at the most basic level. Consumption crashes and with it the need to manufacture, and the need to hire. No consumption, no jobs. No jobs, no consumption. Catch 22.

    The solution might look like voodoo, especially for the US. Instead of paying the banks, or those who already make more money, institute a guaranteed basic income for everyone, irrespective of whether they work or not. The money certainly is there. We are talking about trillions of $$$ being spent like they were going out of style. Change only one thing: Give the money to those who will SPEND it, because they need to.

    There is really no way around it. The current economic paradigm will not get the US out of the doldrums. Time for creative thinking.

  2. There was a longer version of this, sent to some economist friends, where I did briefly raise the question: "Do we really WANT less than 10% unemployment, and, if not, how should we change policy accordingly?" That would indeed take a radical paradigm shift, and maybe we should be preparing for the possibility better.
    But for now, earth is still stuck in the economics and politics of scarcity. We need more sustainable growth but we need growth.
    If we could stabilize population within a reasonable factor of what we have now, there is no physical economic reason why humans all across earth could not have a living standard as high as what the average American has now.
    But terror, greed and psychopathology could well lead to violence, mismanagement of economies and misuse of technology enough to make the species extinct. More and more I find myself wondering where the light really is for us humans at the end of all those dark tunnels.