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Saturday, November 08, 2008

"More Pain to Come"

Will Obama be blamed if things don't turn around fast enough?:

More Pain to Come Even if He's Perfect, by Joseph Stiglitz, Commentary, Washington Post: This is one hell of a way to win.

Barack Obama owes his victory in large measure to the prospect of the longest and deepest economic downturn in a quarter-century and perhaps since the Great Depression. ... In the crassest political terms, it was good luck to have the financial crisis hit so close to the election. But Obama's lucky streak will end in a hurry if he can't find a way out of this mess. He will also have to manage expectations: Even if he does everything perfectly, we probably won't turn the corner for 18 months, and the downturn could last far longer than that.

The first task facing President-elect Obama, after eight years of misguided economic policies, will be to begin the recovery -- or at least forestall a further decline. It won't be easy. ...

So some steps are obvious: assistance to homeowners and bankruptcy reform; extending unemployment insurance; and making up for the gap in state revenue. The United States also has an infrastructure deficit ... which means that spending more on infrastructure ... will stimulate the economy in the short term and help us be more competitive in the long run. ...

The economy obviously needs a direct shot in the arm, but the 44th president needs to be careful about the design of the stimulus he proposes. That's because President Bush will bequeath him a national debt -- $10.5 trillion and rising -- that has almost doubled since he took office, even before you factor in the full costs of the financial bailout and the Medicare prescription benefit, as well as the price tag for ... returning Iraq war veterans.

To his credit, Obama knows much of this. During the campaign, he argued against cutting taxes on upper-income Americans, who have done so well in recent years. ...Obama should also consider taxing dividends and capital gains at the same rate as ordinary income: It would reduce the deficit, have few short-term adverse effects on an already reeling economy and make the tax code more fair. After all, why should speculators -- whether on oil, food or real estate -- be taxed less than those who work long hours to make a living?

Another major problem Obama has to tackle is growing inequality in this country. Some of these trends will take decades to reverse, but ensuring that no Americans are denied a college education because they can't afford it, providing adequate funding for public primary and secondary schools and so forth would be a good beginning...

Obama has also promised to wind down the war in Iraq. Spending a fraction of the war's cost ... on investments within the United States would help reduce the deficit and boost economic growth at home.

While the federal deficit looms over the Obama administration's economic deliberations, we must be careful not to let it block bold action. Sometimes, we're wiser to pay now rather than later. Borrowing for high-yielding investments (not just Wall Street bailouts) is common sense. The decisions not to reinforce the levees in New Orleans or upgrade the bridges in Minneapolis were penny-wise, pound-foolish blunders that we lived to regret.

The root of so many of our problems is the reeling financial sector. The plan cooked up by Bush and his Treasury secretary, Henry M. Paulson Jr., isn't likely to work, or work well enough. ... So Obama will have to push for major changes, in both regulations and the overall systems of carrots and sticks, to restore confidence, spur lending and ensure that our financial markets do what they are supposed to do. ...

Obama will also need to deal with some vast inefficiencies in our economy if we are to prevent further erosions in our standard of living. Some U.S. sectors are global leaders, such as our world-beating universities and the high-tech firms that thrive on the ideas hatched in our ivory towers. Others are embarrassing, such as health care... We need a bold approach here...

Similarly, we should think more broadly about the bang we get for our buck in international affairs. Our current military expenditures are a serious drain; we could get more security for far less money... Moreover, we might be the richest country in the world, but we have been among the stingiest of the advanced industrial countries when it comes to fighting global poverty and disease. ...

Obama is also inheriting a climate crisis. The United States and China have been racing to see which nation will contribute most to the greenhouse gases... We cannot save the planet without a global agreement, and we cannot get such an agreement without massive reductions in U.S. emissions. ...[W]e really have little choice here: Europe and other global players are likely to slap a carbon tax on U.S. goods if we don't deal with the issue at home. Their firms will not tolerate giving U.S. firms a competitive advantage simply because we refuse to bear our responsibility for the global environment. ... Perversely, the U.S. tax code has actually been subsidizing the production of the very fossil fuels that contribute to global warming. We have been pursuing a policy that amounts to "Drain America first." It has made us even more dependent on oil imports -- a stunningly short-sighted plan.

And in the rare cases when we have turned to renewable sources of fuel, we have done so in a manner driven by special interests, not by common sense. Subsidies to corn-based ethanol, for instance, offer little if any benefit to the environment...

In so many ways, the United States has reached a low point. Picking ourselves up off the ground is itself no mean achievement. But I hope that our new president will do even more for us than that.

It's a waste of a mandate if it is not used to make changes, but over reaching is a sure way to kill whatever mandate you have. We can't do everything all at once, so it's tricky to know just how far to push without exceeding the mandate, and how to set priorities for action. In the short-run, my preference is, first and foremost, to provide help to middle and lower income households affected by the downturn, and do so with an eye toward the long-run consequences (e.g. infrastructure needs where the construction is relatively labor intensive so that the employment effects are maximized). Over the longer-run, the priority is to set the economy on a sustainable path in terms of budgetary and environmental issues, and to provide a framework that can better insulate us against serious meltdowns like we are witnessing now.

I also hope we begin to think seriously about opportunity inequality - the chance to succeed in our society is far from equal and it's largely a matter of luck, i.e. if you are born in a poor, inner city neighborhood, all else equal, your chances in life are not the same as for people born in more affluent areas. We do not have a meritocracy, and we need to do far more than we are doing currently to address the opportunity inequality problem.

Update: On the question of how large the stimulus package should be, and how aggressively it should be pursued, Paul Krugman says:

New Deal economics, by Paul Krugman: Everybody’s talking new New Deal these days — and, predictably, the FDR-haters are out in force, with all the usual claims about FDR having actually made the Great Depression worse. (To the right, way back when, FDR was “That Man.” Now Obama is “that one.” Interesting.)

Eric Rauchway is all over this. Basically, the anti-FDR argument on the data is based on (a) considering people employed by the WPA “unemployed” (even though they were getting paid, and building public works that are in use to this day) plus (b) always focusing on 1938 — the year in which the economy suffered a serious setback from the progress of the previous four years.

Let me offer two pictures, beyond what Eric provides, to clarify things.

First, here’s real GDP (in logs) from 1929 to 1941, plus the trend [graph]. (That’s to bypass the employment nonsense). You can see that the economy made up a lot of the output gap before the 1938 setback, but by no means all.

Now, you might say that the incomplete recovery shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump. Here’s the Cary Brown estimates, from Brad DeLong [graph]

Net stimulus of around 3 percent of GDP — not much, when you’ve got a 42 percent output gap. FDR might have been more of a Keynesian if Keynesian economics had existed — The General Theory wasn’t published until 1936. Note in particular that in 1937-38 FDR was persuaded to do the “responsible” thing and cut back — and that’s what led to the bad year in 1938, which to the WSJ crowd defines the New Deal.

Implications for Obama: be inspired by FDR, but don’t imitate him slavishly. In particular, your economic policy should be bolder, not more cautious.

    Posted by on Saturday, November 8, 2008 at 11:34 AM in Economics, Policy, Politics | Permalink  TrackBack (0)  Comments (93)

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