Two columns in the Washington Post this week provided serious misinformation. One misleads the making of economic policy in the future; the other slanders the innocent dead. Both fail to recognize shlock economics when they see it.
The first column, “The denier in chief,” was written by Michael Gerson. Gerson was a speechwriter for President George W. Bush for six years, and this column is a very straightforward election-campaign attack on President Barack Obama, which of course is Gerson’s right. However, he should be called to task for a fundamental economic error in his argument, because that error is gradually making its way into the conventional wisdom and could hamper policymaking crucially in the future.
Gerson grants that the severe financial crisis that began in 2007 pre-ordained a long and difficult economic downturn. However, Gerson still believes that the President “did not deliver recovery,” because
‘He turned a temporary expansion of government, through TARP and the auto bailouts, into a permanent expansion of government,’ argues Keith Hennessey [link in original, to Hennessey’s home page rather than the specific reference, which I confess I cannot find] of the Hoover Institution. ‘Government, measured by federal spending, is this year about 15 percent bigger than the historical average, measured relative to the economy. . . . This drains resources from private firms and individuals and means slower productivity growth.’
But Keith Hennessey (a George W. Bush Administration colleague of Gerson) has sold, and Gerson has bought, some bad economics. The reality is that federal spending at this time and for the foreseeable future does not “drain resources from private firms and individuals.” The truly fundamental economic point is that when an economy is slack and resources are idle, putting those otherwise idle resources to work does not “crowd out” the pre-existing sub-par economic activity. Rather, it creates employment and income, and accelerates recovery and the utilization of other idle resources.
Emblematic of this fundamental economic point are the record-high cash balances of U.S. non-financial corporations (see here). Some on the far left have hatched a conspiracy theory that large U.S. firms have gone on an investment strike to keep the economy weak and influence the presidential election. The more-plausible but almost-as-sad interpretation is that firms do not see profitable investment opportunities because demand is so weak. So if even firms with their own cash balances to invest – at a time when interest rates are at historic lows – choose to sit on the sidelines, there is no “opportunity cost” for the federal government to borrow those funds and stiffen demand in the flaccid economy. Accelerating the recovery of economic activity will only hasten the day when tax revenues begin to improve the federal budget.
The bad economics that Gerson has bought from Hennessey is potentially harmful because it could be misused if our economy should grow still weaker. Europe remains a dead weight on the global economy, even China has encountered a slowdown, points of strength are hard to find, and the downside risk is considerable. So when Gerson, Hennessey, and others in this country argue that all government activity, at all times, retards economic growth, it could preempt one of the few tools available to interrupt a cascading downturn if worst comes to worst.
A caveat: Hennessey’s estimate that federal spending is “15 percent bigger than the historical average, measured relative to the economy” – which is about 3 percentage points of GDP – is roughly accurate. But Gerson quotes Hennessey as asserting that this is a permanent increase in the size of government. If so, then eventually, when the economy does recover and resources are more full utilized (hasten the day!), that expansion of government would crowd out private-sector activity. But it is far too early to make any assertion about a permanent change in the size of government. For example, according to the Congressional Budget Office, as of last year GDP was almost 6 percent below its potential; so more than one-third of that increment to spending is spurious – arising not because the size of government (the numerator of the fraction) is up, but because the size of the economy (the denominator) is down. How much of the rest of the asserted 15 percent is temporary – such as higher outlays because of the weak economy (there often are large “technical reestimates” when the economy recovers), war costs, or slow spending of the 2009 stimulus program – remains to be seen. But the 15 percent estimate clearly is an upper bound and far from reality.
Talk about the size of government often cohabits with complaints about the size of the budget deficit. Another Washington Post columnist, Robert Samuelson, weighed in on the current budget deficit this week titled “Why U.S. economic policy is paralyzed.” And to Samuelson, it turns out that it is all the fault of John F. Kennedy and his economic team.
I confess that this one is personal. I arrived at the Yale University Graduate School 41 years ago because I wanted to study from the late James Tobin, who had been a member of President Kennedy’s Council of Economic Advisers. By ill coincidence I never had a class with Tobin, but I soon learned what others had – that he was not only a brilliant economist, but a stellar human being. (Read a tribute from his students here. The story on the bottom half of page 15 of the electronic document, the printed page numbered 512, will send your jaw crashing to the floor.) A part of that team of economists, later a member and then chair of the Council under President Lyndon B. Johnson, was Arthur M. Okun, a colleague in my first job as an economist until his untimely death in 1980. Okun shared not only Tobin’s brilliance, but also his humanity. So I write this partly because of Samuelson’s adverse references (without specifying their names) to two people I admired, but mostly because Samuelson is terribly, terribly wrong. And again, this misconception, if accepted as truth, could have real-world consequences.
Samuelson’s central assertion is that “Until the 1960s, Americans generally believed in low inflation and balanced budgets. President John Kennedy shared the consensus but was persuaded to change his mind. His economic advisers argued that, through deficit spending and modest increases in inflation, government could raise economic growth, lower unemployment and smooth business cycles. None of this proved true; all of it led to grief…Kennedy’s economists…shattered this consensus…This destroyed the intellectual and moral props for balanced budgets.”
As evidence of this alleged failure of policymaking in the early 1960s, Samuelson cites inflation in 1980; four business cycles from 1969 to 1981; and large budget deficits that have been too numerous to specify, and extend to today (the point of the column). It is unbelievable that Samuelson transits from the budget policy of the Kennedy Administration through the 1970s and the 1980s to the economic circumstances of the present without ever mentioning (1) President Johnson’s fiscal miscalculation of the financing of the war in Vietnam; (2) the turmoil in the oil markets in the 1970s; and (3) the application of “supply-side economics” in the early 1980 and the early 2000s.
First of all, contrary to Samuelson’s assertion, the Kennedy economic team was not blithe to the problem of inflation. Okun’s writings after he left government (The Political Economy of Prosperity, Brookings, 1969, among others) make that clear. The problem in the early 1960s was a chronically underperforming economy, which entailed considerable human costs. Yes, the Kennedy team recognized the element of risk, but inflation was low by then-recent standards, the economy was well under capacity, and the team believed that the risk was measured and worth it.
And the program worked – until 1965, by which time the economy was approaching what was considered full employment. But it was just at that time when, for a combination of reasons, President Johnson chose to escalate the war effort in Vietnam; and to maintain political support for that effort, the President refused either to raise taxes (which the economic team was considering for macroeconomic reasons even without the war expansion) or to reduce other government spending. It was not the Kennedy-Johnson-tax-cut-fiscal strategy, but rather the totally separate war-finance blunder, that caused the subsequent outbreak of inflation (Okun, “The Fiscal Fiasco of the Vietnam Period,” in Okun, editor, The Battle Against Unemployment, Norton, 1972). Then, before the war stress could be unwound, the oil-market shock of the early 1970s injected still more inflation into the economy. Given Samuelson’s focus on economic policy, it is inexplicable that he would blame the Kennedy-Johnson tax cuts for developments that so clearly followed not from that strategy but from the unconnected mistakes and shocks that came later.
Samuelson claims that the Kennedy fiscal strategy eroded the public preference for a balanced budget. But that is by no means clear. The initial budget documents of the Administration of President Ronald Reagan claimed that their program would balance the budget by 1984, and that budget surpluses would grow in the subsequent years. That this failed to transpire – that in fact budget deficits reached new peacetime heights – followed directly from another part of the Reagan program, which was the belief that cutting tax rates increased tax revenue. Revenues trailed the Administration’s initial forecasts by more than 18 percent by 1986, and budget deficits reached record levels. So it was not that the Reagan Administration and the public had lost interest in a balanced budget, but rather that the tools that they chose were foreordained to fail to achieve it. Again, Samuelson’s total omission of this essential fact from his narrative is impossible to justify.
This story could go on. But the sum and total is that Samuelson has told the story of the Great Flood without mentioning Noah, the arc, or the rain. Three developments subsequent to and separate from President Kennedy’s tax-cut fiscal strategy – specifically, the financing of the Vietnam war, the oil shocks, and supply-side economics – are far more responsible for the erosion of the nation’s budget situation than the Kennedy strategy itself. To attribute that erosion to President Kennedy’s economic team in absentia seems to be not just poor form but also substantively wrong. Failing to learn these lessons properly, like the economic misunderstanding in the Gerson column, could lead to bad choices in a weak economy in the future.