By William K. Black
(Cross posted from Benzinga.com)
Robert Reich has written a column entitled “Why this is the Worst Recovery on Record.” It’s an odd title because the article makes no reference to this being “the worst recovery on record.” Unlike a newspaper column, we know that Reich chose the title, because it comes from his own blog.
The current U.S. recovery is not “the worst recovery on record” – it is not faintly close to the worst recovery on record. Rhetorical claims like this are dependent on highly selective choices of what years one compares. In 1937 and 1938, President Roosevelt listened to the incoherent claims of his economic advisors that stimulus was bankrupting the Nation and that it had spurred a sufficiently robust recovery that the private sector could now be relied upon to lead the Nation promptly back to prosperity. The advisors recommended that FDR act urgently to impose austerity. FDR cut spending and increased taxes and the Federal Reserve tightened the monetary supply. The result was that a robust recovery from the Great Depression that reduced unemployment by two-thirds during FDR’s first term from a high of 25%. Real GDP growth averaged 12% during that term.
Austerity promptly reversed this recovery and produced a second U.S. depression. In 1937-1938, there was a sudden rise in unemployment and a sudden fall in GDP. “Recovery” was not “weak” in this era, it was an oxymoron. The economy got sharply worse. Austerity perverted a robust recovery into a second depression.
Marshall Auerback has provided an admirably brief summary of these events.
The ongoing U.S. recovery is weak, but it is a sustained, modest recovery because of modest stimulus during the first two years of Obama’s first term. In Europe, austerity has twisted a modest recovery driven by material budget deficits into a severe contraction. Reich’s own writings demonstrate that he knows that the U.S. continues to recover while Europe has done the opposite. He cannot possibly believe that the U.S. recovery is the worst on record when he has observed and written about how austerity destroyed Europe’s recovery.
The Two Least Understood Aspect of the European Crisis
Anyone who has analyzed the European crisis understands that it was not initiated by a “debt crisis” or a “spending” crisis. Nations like Ireland, Iceland, and Spain were being praised by ultra-conservative groups like Cato as the supposed exemplars of success of fiscal rectitude. By now, anyone who has analyzed the European crisis understands the pernicious role that the euro has played in the crisis because it is not a sovereign currency. By now, anyone who has analyzed the European crisis – including the IMF – knows that austerity has been a disaster that has caused a sharp contraction.
What even those who follow the European crisis are rarely saying, however, is the intersection of two facts about the crisis. First, the current European contraction is not a “recession” in many nations; it is an über-Depression. I explained in a prior column that unemployment levels in much of Europe are roughly comparable to average unemployment rates in the largest European economies from 1930-1938. Unemployment rates in the periphery are sometimes multiples of the average unemployment rates in the largest European economies during the Great Depression.
The EU, however, claims that there is merely a “mild recession.” The EU’s credibility is, unsurprisingly, in tatters.
Unemployment in Greece and Spain is greater than peak U.S. unemployment during the Great Depression. The overall unemployment rate in the Eurozone is 12% – well over the U.S. unemployment rate in 1936, and half-again greater than the current U.S. unemployment rate.
The unemployment rate in Portugal – which the EU claims as an almost success – is roughly twice the U.S. unemployment rate in 1936. Austerity has produced a depression in much of Europe, a depression so severe in several nations that it is worse than the Great Depression, and the Eurozone contraction is becoming more severe. The Eurozone depression was gratuitous – it did not have to happen. It is the product of economic dogmas that were discredited in 1937. We have taught economists for 75 years not to inflict austerity in response to a contraction.
Second, the troika (the EU, ECB, and the IMF) was insane to inflict austerity and cause the über-Depression, but the aspect that should scare us the most is that the troika generally inflicted considerably less severe austerity on the Eurozone than FDR inflicted on the U.S. in 1937. In 1937, FDR sought to reduce the budget deficit to 0.1%. The Eurozone runs a far larger average budget deficit – and that includes Germany. Even in 2013, Germany is targeting a 0.5% budget deficit. The Dutch are great deficit hawks, and they hope that there budget deficit will not exceed 3.3% this year (a level that exceeds what is supposed to be the EU limit). Spain’s deficit is over 10% because austerity has caused an unemployment rate roughly three times as large as our best estimates of the average unemployment rate in 1930-1938 in several large European nations. As nations like Spain inflict the austerity forced on them by the troika and are thrown into the über-Depression the GDP falls sharply enough that the budget deficit-to-GDP ratio often increases instead of falling.
The EU’s most recent economic forecast claims that austerity is growing more severe, so its models predict deficits will fall as a percentage of GDP. This might happen, but the EU models have consistently underestimated budget deficits because they have failed to predict that austerity will cause material falls in GDP and employment. Note that even under the assumption that austerity will succeed in reducing the ratio of budget deficits-to-GDP the EU expects the deficit ratio to be far higher than the 0.1% figure that FDR sought in 1937. “Since many Member States are implementing sizeable fiscal consolidation measures, the fiscal deficits are projected to decrease to 3.4% in the EU and 2.8% in the euro area in 2013.”
The same EU forecast provided historical information that shows graphically that the EU actually followed a fiscal policy of weak stimulus in 2008-2010, which helped it begin to recover from the Great Recession. In 2010, however, the EU switched to a fiscal policy of moderate austerity, which forced the eurozone back into recession by mid-2012.
Austerity is not simply a self-destructive policy – it is a weapon of mass economic destruction. The EU has managed to create the über-Depression through what was generally “only” moderate austerity. Unsurprisingly, it is the Nations that the troika forced to inflict the most severe austerity that are suffering the most severe depressions.
Reich does not understand Sovereign Currencies
Reich repeats a series of fictions someone has told him about Keynes and economics.
“Yet the biggest weakness of modern Keynesian economics is it doesn’t have a clear answer for how much spending is necessary in an economy, like ours, in which wages keep dropping and government debt keeps growing. Simply arguing ‘more’ won’t cut it.
John Maynard Keynes urged that governments ‘prime the pump’ to stimulate demand but pump priming has limited effect if the well is running dry.
Both sides of the modern debate have neglected the scourge of widening inequality.”
The first sentence is incoherent and illogical. The design problems with the stimulus were understood by modern economists from the beginning – it was too small, the tax reduction components were very poorly designed to stimulate growth and would increase inequality, and it was designed to end too soon. The administration’s economists understood each of these problems and many of their friends and former colleagues outside the administration repeatedly pressed these points. The economic advice was generally that the stimulus should be large enough to provide the lost demand. Economics successfully answered the “how much more” question. The administration did not like the answer and Republicans hated it.
The already flawed design suffered an additional critical weakness when a coalition of conservative (“blue dog”) Democrats joined Republicans in killing one of the best design features of the bill – the “revenue sharing” (a Republican initiative) provisions that would have protected the states from fiscal crises. Unfortunately, the administration let the provisions go down without a real fight. Unemployment would be roughly one percent lower if revenue sharing had survived. For over two years nearly every job report shows a gain in private sector employment and a fall in public sector unemployment.
Reich believes two, false, conservative memes. He thinks stimulus did not work: “pump priming has limited effect if the well is running dry.” The “well” that Reich claims “is running dry” has to be the U.S. dollar, though he appears to think it refers to federal tax revenues.
Reich also believes that if “government debt keeps growing” as we respond to the Great Recession something he cannot identify but assumes is terrible will happen. The two false memes interact – he assumes that “government debt keeps growing” because stimulus doesn’t work.
Others have refuted these myths in detail, so I will repeat the conclusions and note the irony that Reich accepted these long-falsified conservative memes even as the Reinhart and Rogoff study that launched one of the myths suffered a terrible body blow.
The economic consensus is that the modest Obama stimulus program produced a modest economic recovery. In contrast, the moderate EU austerity program produced the über-Depression. We had significantly higher debt-to-GDP ratios during and after World War II. This terrible burden meant that we, simultaneously, defeated the Fascist powers, fully employed Americans, recovered from the Great Depression (including the second depression self-inflicted by austerity in 1937 and 1938), implemented the Marshall Plan, began the GI Bill, the interstate highway program, and an enormous housing boom and emerged as the strongest economic and military power in the world. Unsurprisingly, Reinhart and Rogoff designed their study to exclude those accomplishments.
Reich’s claim that economics’ central flaw is being unable to predict exactly how much “more” stimulus is needed is wrong for at least four reasons. One, the crisis proved Keynesian economists outside the administration were accurate about the necessary stimulus. They predicted that it should be far larger. Two, there is no requirement to get the “how much more” question exactly correct. A much larger stimulus would have caused no serious harm even if it had proved larger than essential. The concern is always with the real economy. If we saw that we were rapidly approaching full employment we could reduce federal spending without any legislative changes. This is an area of economics that is sharply asymmetrical. A small amount of deflation can be very dangerous because it can cause markets to take actions that cause long-term recessions. A small amount of inflation causes so little harm that virtually every central bank in the world that “targets” has a positive inflation target. Three, there is a wonderful program available that is self-adjusting and provides a superb “automatic stabilizer” that will make future recessions vastly less harmful. If we have a federal jobs guarantee program we will ensure that everyone who wishes to work and is capable of doing so will be able to work. Such a program would adjust automatically to a surging recovery because millions of Americans would leave the guarantee program and take jobs in other sectors. This would automatically reduce federal spending significantly. Four, if we produce “too successful” a recovery by providing “too much” stimulus such that we quickly attain full employment we will not have a problem with budget deficits – we will tend to produce budget surpluses because full employment causes tax revenues to surge and many federal expenditures (e.g., food stamps) to fall.
Note that rapidly restoring full employment through stimulus, particularly with the aid of the federal job guarantee program that we (UMKC economists) have long championed, is a superb means of substantially reducing income inequality and avoiding the terrible psychological and social damage caused by unemployment and resulting poverty. These full employment programs also make far more working class males “marriageable” – which also reduces inequality, particularly among the black working class. The good news is that the most effective policies to restore a robust economy would reduce inequality.
Reich errs when he thinks we can run out of money. The U.S. has a sovereign currency. As with any Nation with a sovereign currency we literally create our money by electronic keystrokes. Taxes do not provide the money we spend. We do not need to borrow to create money that the federal government can spend. As a Nation, we are nothing like a household when it comes to budgets. Reich is concerned that households are running out of funds that they can use to consume.
“The underlying problem is the vast middle class is running out of money. They can’t borrow more — and shouldn’t, given what happened after the last borrowing binge.”
So far, so good – households can run out of cash and they do need to be careful about how much debt they take on. But note how Reich moves from households to the federal government and implicitly assumes that they face the same types of constraints. As I have long emphasized, implicit assumptions are the most dangerous because we do not even know that we have made an assumption. That means we never test the validity of implicit assumptions and grievous errors result.
Reich lists a series of policy options to reduce inequality, but then pursuant to his implicit assumption he suggests we need to increase taxes if we increase spending and he suggests that we would only find his policy suggestions attractive if our focus were on reducing inequality.
“We could raise the minimum wage to half the average wage.
We could increase public investment in education, including early-childhood.
We could eliminate college loans and allow all students to repay the cost of their higher education with a 10 percent surcharge on the first 10 years of income from full-time employment.
We could expand the Earned Income Tax Credit.
And we could pay for all this by adding additional tax brackets at the top and increasing the top marginal tax rate to what it was before 1981 – at least 70 percent.
But none of this will happen until the public understands why widening inequality is so damaging. Even the rich would do better with a smaller share of a rapidly-growing economy than a large share of one that’s barely growing at all.”
These four policy recommendations are desirable as stimulus measures as well as means to reduce inequality (though I would substantially amend the third recommendation). We not only do not need to “pay for all this” by increasing taxes in our present context where we are struggling to recover from the Great Recession, it would be a terrible idea to do so. Reich says he opposes austerity and then proposes it. If Reich feels it is critical to raise marginal income tax rates to reduce inequality he should be proposing a far larger package of tax cuts and spending increases that would (net) produce a strong fiscal stimulus.
Reich will not produce a “rapidly-growing economy” through these very limited proposals for increased spending and an expanded EITC offset dollar-for-dollar by increased taxes. His policies would reduce inequality, but far less than he hopes because weakening our recovery through his variant of austerity will primarily harm the working and middle classes.