Because most philosophies that frown on reproduction don't survive.

Tuesday, November 02, 2010

The Super Secret, Mystical Recession Cure

For some reason, I found myself reading through Paul Krugman's recent NY Times material. Perhaps it was a desire for a little mental vaunting, what with the direction the elections seem to be taking, and if so I should have come away quite satisfied as Mr. Krugman is in full Chicken Little mode. A GOP takeover of congress will be a disaster, and we should all be very afraid. Stupid people are allowing their emotions to run away with them and will destroy the world economy through getting all moralistic about debt. And of course, the reason why the entire world doesn't see things Krugman's way is because macroeconomics is too hard for them to understand.

Well, I'm certainly prepared to admit that Krugman's expertise in macroeconomics is greater than my own -- and I'll even stretch and say that my understanding probably goes farther than that of the average bear. However, I can't escape the feeling that Krugman is somewhere between singing:
The intelligent lot, the intuitive lot,
The infallible lot we are.
The marvellous mugs, miraculous mugs,
The mystical mugs we are.
But since he's rather less exuberant than Chesterton he says it like this:
The greatness of Keynes is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works.
It's true that most people are not very good at understanding complex systems with many, interdependent moving parts. This is why most people are confused by macroeconomics, or come to that microeconomics at the theoretical level. But then, it's also why even terribly clever people who think that they have a solid grasp of macroeconomic theory get themselves in trouble by believing that they understand all the factors in play and drawing up charts which demonstrate that unless we pass the President's recovery plan, unemployment might go as high as 9%.

Don't get me wrong, macroeconomics is indeed different from everyday business experience, as Krugman touches on:
Businesses are open systems; the world economy is a closed system, with feedback effects that are crucial but play no role in ordinary business experience. In particular, an individual businessman, no matter how brilliant, never has to worry about the fact that total income equals total spending, so that if some people spend less, either someone else must spend more, or aggregate income must fall.
But when the explanations become too mystical, I can't help (perhaps because it's just my simplistic, middle brow, self) cocking an eyebrow:
The years leading up to the 2008 crisis were indeed marked by unsustainable borrowing, going far beyond the subprime loans many people still believe, wrongly, were at the heart of the problem. Real estate speculation ran wild in Florida and Nevada, but also in Spain, Ireland and Latvia. And all of it was paid for with borrowed money.

This borrowing made the world as a whole neither richer nor poorer: one person’s debt is another person’s asset. But it made the world vulnerable. When lenders suddenly decided that they had lent too much, that debt levels were excessive, debtors were forced to slash spending. This pushed the world into the deepest recession since the 1930s. And recovery, such as it is, has been weak and uncertain — which is exactly what we should have expected, given the overhang of debt.

The key thing to bear in mind is that for the world as a whole, spending equals income. If one group of people — those with excessive debts — is forced to cut spending to pay down its debts, one of two things must happen: either someone else must spend more, or world income will fall.

Yet those parts of the private sector not burdened by high levels of debt see little reason to increase spending. Corporations are flush with cash — but why expand when so much of the capacity they already have is sitting idle? Consumers who didn’t overborrow can get loans at low rates — but that incentive to spend is more than outweighed by worries about a weak job market. Nobody in the private sector is willing to fill the hole created by the debt overhang.
Now, as a stand-alone economic model, this makes a great deal of mathematical sense -- and that's hardly a surprise as Krugman is a smart guy with an ability to understand complex mathematical models. Yet it's a model, it's not the real world. And as such, it's only as useful as its resemblance to the real world.

Mathematically speaking, if demand is not coming from one source (businesses and individuals spending money which they have or which they have borrowed) then you can make up for that demand from another source (the government spending money it has borrowed) and the effect will be the same. The two main problems I see, however, have nothing to do with the mathematics of the model -- they have to do with the relation of the model to reality.

First off, however much it clearly annoys Krugman that this is the case, voters simply do not like the idea of the government spending endless amounts of borrowed money on projects which might not otherwise be funded because it's important to "prime the pump" of the economy. People can't escape the idea that this is their money, as taxpayers, which is being spent, and that they're going to have to pay it back. During a recession, people are particularly troubled by their own debts and bills -- and since one of the bills that they see every so often is a tax bill, they don't like thinking about the government racking up endless debts which they are going to have to pay back later. So while in theory government spending could make up for a private demand shortfall and keep the economy up, it seems to me that in practice it's simply not sustainable in a situation where that public spending would have to be financed through massive borrowing, because since people would be thinking "that's borrowed money" they would continue to be afflicted by economic anxiety and to sit tight on their savings. Knowing that the public money being used to "prime the pump" was "fake" demand would keep people from recovering their confidence and prolong the lack of private demand.

The second big issue that comes up, it seems to me, it the question of what the government should spend its money on in order to stimulate demand. This was comparatively easy during the New Deal programs of the Great Depression -- a significant percentage of the country was employed in manual labor, and many major public works projects required large numbers of manual laborers, so it was easy to start up a big project, pay the workers, and expect that money to filter out into the economy. Today's workforce is much more heavily focused on skilled/specialized labor, and so even if we assume that the government could use deficit spending to employ lots of people through public spending, this brings up the question of what the government should spend on which wouldn't cause mal-investment in capital and labor training.

Say, for instance, the government were to announce a major project of putting up wind farms. Huge amounts of money are spent, lots of new wind turbine making factories are built and wind turbine makers and installers are trained. All this spending helps get the economy back on track, as those wind turbine installers head down to Wal-Mart and spend their paychecks. After two years the program is a success, and so the wind turbine program ends. Now what happens to those workers and the capital investments in those factories? How easily are they turned to other work, and how long are they unemployed in the interim? Do we simply end up with another economic slowdown as a result of massive unemployment in the windfarm industry?

The problem is, even a wonderfully complex economic model dreamed up by an intelligent lot, and intuitive lot, and infallible lot of marvelous, mystical mugs will end up being simpler than the actual world. And as a result, it's not always as easy to get the real world to do what you want as it is to get a model to do so.


Anonymous said...

The most obvious potential for effective stimulus spending is construction. Utilities and assorted infrastructure, highways, improvements to military bases and national parks and the like - there's a huge number of projects that the federal gov't could fund.

And *should* fund. With only minimal planning it would be easy to generate a long list of such projects that would be of lasting benefit to the economy. And since construction and finance are the two sectors of the economy that saw the most job losses during the downturn, executing these projects would put a huge number of currently jobless people back to work. The benefit to the economy would be enormous - though to be fair the benefit would also be delayed by a year or more, since big construction projects take time to plan and get relevant approvals.

Anyway, it's not as hard as you make it sound for the gov't to stimulate the economy if it wants to. And it's also not as hard to pay back federal debt as people seem to think. Remember, during the last three years of the Clinton administration we paid down over $600bn in federal debt, and doing so did not require anything that any reasonable person would call "austerity".


Anonymous said...

The point about specialization applies in your example also. Building roads and bridges requires fewer workers now than it did in the 30's. The crane operator, and bull dozer driver take the place of scores of workers. So you would need an obscene amount of government construction projects to put to work large numbers of unemployed.

Darwin said...

Not to mention that someone laid off from an IT department or factory line may not be readily equipped to start driving a bulldozer or operating a crane.

Anonymous said...

Construction is the largest single sector of the unemployed.


Darwin said...

True, but that's primarily residential housing construction, and secondarily commercial building construction. It's not highway, high-speed-rail, energy and other government infrastructure construction.

Now, maybe the skills translate pretty directly, in which case public works could, in theory (if we waved the kind of regulation which delays most of those projects for years doing impact surveys) we could deal with unemployment there in the short term by moving people from private construction jobs to public ones. I suppose if that really is needed infrastructure, and we had the money to pay for it, that would be better than having them on unemployment. Though my concern would be that we probably can't expect to see private construction to return to 2007 levels any time soon because that construction boom was fueled by... a real estate bubble. Which we don't want again. And we won't be able to absorb all of those people into public works construction indefinitely. So a some point, we're going to have to go through a painful process in which construction contracts again and people are forced to find new jobs in another sector. Stimulus will, at best, put off and perhaps ease a tiny bit the pain, but eventually we've got to let order emerge and it won't happen when we've got a finger on the scale.

Brandon said...

One thing that's often overlooked is how heavily federal projects can strain state and local governments due to increased costs (e.g., with matching funds) or incidental complications (political and economic) that have to be accommodated. Improving water infrastructure in the West, for instance, would be a good thing, but it necessarily moves at a snail's pace because there's a never-ending stream of water-right and property issues. You can't put infrastructure in a void; you need a place to put it, which requires acquiring property. If you upgrade infrastructure already in place, you disrupt its use while you are making the upgrade. And so forth. Unless the federal government is just going to try to buoy the entire economy by continually making bike and hiking trails (which is what they've just recently started doing around the corner from my apartment), they are going to have to do some very big projects, and very big projects bottleneck at what state and local governments can handle (or want to handle). There are reasons why we don't constantly go around doing Hoover-Dam-and-TVA-style projects, and penny-pinching is certainly not one of them.

Anonymous said...

I, myself, live within five miles of two large stimulus-funded construction projects:

1) Widening of SR-76 from Oceanside to Bonsall. Heavy Highway construction, $170M.

2) New Naval Hospital at Camp Pendleton. Institutional Building construction, $451M.

Brandon's concerns are completely off both of these projects: land acquisition was not an issue for either one, no state or local matching funds are involved, the local politicians are all wildly supportive of both, and while the hospital will indeed increase the load on the local infrastructure, this is a concern for SDG&E, not the local government.

Meanwhile, these projects are providing jobs for ~2,000 people for the next three years, and will benefit the local economy and quality of life for decades to come. And (hopefully) by the time the jobs peter out the economy will have recovered and the guys will be able to find work elsewhere, which is the main idea.


Brandon said...

Which would be lovely if all of America lived within five miles of major military bases with major hospitals that have been needing to expand for a while and of highways that already had their plans for development in the works.

The point, of course, was not that no major projects ever get done; some will get through more easily than others, and that by sheer chance you happen to live next door to one of the Defense Department's star projects tells us nothing about stimulus. The point was the simple fact that there is a bottleneck, one that already regularly holds up major projects, at the level of state and local governments.

Anonymous said...

"one of the Defense Department's star projects tells us nothing about stimulus."

Um, yes it does. The hospital is not being funded by DoD, it's funded by ARRA. The Marines had been asking for this project for a decade, but it never got funded until ARRA.


Brandon said...

I didn't say it was funded by the Defense Department; I said it was oen of the Defense Department's star projects, which it is, since it's one of the major recovery projects currently within the Defense Department. I can see how you could find the description confusing, though.

It still doesn't tell us anything about stimulus that you by sheer chance happen to live within five miles of it (I notice that you cut off the initial part of the clause, which specified the actual context of the claim; obviously, ignoring the context of the claim changes its meaning, and I don't see why you would cut it off unless you're deliberately pretending that I'm stupid). It actually doesn't tell us much about stimulus in general, because like almost every military project in the works now the plans are mostly in place and it is just backlogged. The Army, for instance, which is finally getting a new hospital at Fort Hood soon, has a maintenance and infrastructure backlog that's up to something like $20 billion now. These are things that have to be done eventually anyway and would have been done years ago if money weren't continuously diverted from them for less intelligent projects. They are catch-up projects.

Most projects can't be of this sort (and most people don't live all that close to such ready-made candidates anyway) but have to be carefully maneuvered into place as one goes by civil servants dealing with more local structures of government; such work, contrary to your absurd statement, is not "minimal planning". This is what really bugs me about your whole line of argument. I have never heard another statement about government projects that expresses such an astoundingly glib and dismissive contempt for, or else complete ignorance about, the people who actually make such projects viable at all. As someone from a civil service family, I simply have no patience for such pseudo-liberal nonsense; if you're going to advocate government action, do so with an actual respect for the work it takes and the people who do it. Projects don't magically appear in viable form; they have to be made viable.

Anonymous said...

"I have never heard another statement about government projects that expresses such an astoundingly glib and dismissive contempt for, or else complete ignorance about, the people who actually make such projects viable at all. As someone from a civil service family, I simply have no patience for such pseudo-liberal nonsense; if you're going to advocate government action, do so with an actual respect for the work it takes and the people who do it. Projects don't magically appear in viable form; they have to be made viable"

I'm a federal employee, NAVFAC SW. If you don't know what NAVFAC is, I suggest you google it before posting again here.