Bobo and the Race to the Bottom

These days, if you work for the WaPo, lip service to deficit hawkism is becoming a job qualification. The New York Times is more divided on things. Krugman has been on a crusade against austerity and has had some good blogs recently, Bob Herbert had a great one on jobs the other day, and the editorial page actually opposed the growing chorus for austerity.

But Bobo, on the other hand, is offering the theory that we are ending the period of fiscal stimulus and moving into the period of fiscal consolidation, and is, assembling “evidence” from various studies that austerity has often been “associated” with great economic gains.

But he conveniently overlooks that “correlation is not causation,” and offers little by way of explanation why the associations he’s seeing signal causation and not mere correlation. Bobo talks about the need to target spending more intelligently while consolidating, and also talks about “cutting middle-class entitlements” while “directing more money to address the trends that threaten to hollow out the middle class.”

In other words, Bobo, as is often his wont, speaks out of both sides of his mouth. But his bottom line is “cuts.” He also says:

Some theorists will tell you that if governments shift their emphasis to deficit cutting, they risk sending the world back into recession. There are some reasons to think this is so, but events tell a more complicated story.

Events do not tell a more complicated story. They tell the story that Government stimulus spending has been half-hearted at best across the world, where Governments have been much more concerned with inflating banking bubbles than they have been with helping Main Street. In the US, there’s been stimulus at the Federal level coupled with increasing austerity at the State level because the Federal stimulus was too small. And more generally, there’s plenty of data showing that when Governments cut back on deficit spending, such cuts are often followed by recessions or depressions. There’s also the famous case of Roosevelt’s pulling back on the New Deal in response to conservative democrats concern over deficits, and the recession occurring in 1937 following this mistake.

Also, the latest trend toward formulating and implementing austerity programs throughout Europe, and to a lesser extent in the US, Australia, and Canada, is analogous to the tariff Wars of the late 1920s and early 30s that helped trigger the great depression. The austerity programs are coupled with efforts to hold down the value of currencies and to encourage exports, hopes of encouraging an export-led recovery.

While this seems like a rational course for each individual nation, especially those, like Eurozone nations, that are not sovereign in their own currency, what happens when everybody does austerity at once? There is a fallacy of composition here. Namely, if every nation does it, then not only do working people in all of them suffer, but export-led recovery plans are frustrated because every nation is trying to export and hold down the value of its currency at the very time when every nation’s consumers have severely lowered demand capacity to import the products of other nations. International austerity is a recipe for a race to the bottom and mutual economic suicide as surely as the Tariff Wars were in earlier times. In fact, mutual austerity can even lead to renewed tariff wars, because the losers in the competitive export sector will suddenly find some of their industries failing, and their balance of payments becoming severely negative. At that point, political pressures to protect industries will be be nearly irresistible and protection may re-emerge as a major factor in international trade.

In recommending austerity, what Bobo, and authorities all over the world are missing is a simple accounting identity that describes the saving/spending relationship between Government and non-Government (private, State and local Government, and foreign) sectors of any national economy. That identity is:

govt sector + nongovt sector = 0.

So, when Government spending during any period exceeds its tax revenue, that Government deficit is “to the penny,” the amount of non-Government savings during the period. So, if the aggregate amount of Government spending is cut through austerity programs, that will surely and certainly decrease non-Government savings and hence investment and consumption too. So, austerity, especially, if all nations are doing it at the same time, must result in a race to the bottom all over the world.

Bobo, also suggests that austerity can be alleviated by better targeting of Government expenditures. That is an old idea that was given much credence and application during the Carter Administration, perhaps the first American Administration in the post-War period that made a mighty, but unsuccessful effort to bring the budget into balance. Its targeting efforts however, were unsuccessful in creating economic recovery, however. Rather it was looser money, and Reagan’s deficit spending, that led to the recovery of the 19080s, as I’m sure Bobo remembers very well.

This is not to say, that targeting is not important. Government spending should always be carefully targeted toward public purposes. Not because of the need for austerity, but just because expenditures that have negative impacts on economy and society don’t help us achieve the public purpose, and often simply are instances of looting of the public treasury of the sort we are all too familiar with both before and after the crash of 2008.

So, yes Bobo, we do need targeting, but we don’t need austerity. We need Government deficit spending and we will need it until we reach full employment. At that point, we can reduce deficits, not because we’ll run out of money, or need lower deficits to establish “a better fiscal balance” according to some arbitrary numerical standard, but because our problem will then become preventing inflation, a problem that must be fought with some combination of lower Government spending and higher taxes.

(Cross-posted at Fiscal Sustainability and All Life Is Problem Solving)

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