2012 Look Back: Economic Beliefs that Have Served Us Poorly

December 23rd, 2012 at 9:07 pm

Well…in honor of the fact that the world did not end on Friday, how’s about one of those renowned OTE end-of-the-year features?  I’m compiling another CBPPs-greatest-graphs post, but as I’ve been writing something on economics education, I stumbled on a number of economic precepts that have taken a hit over the past year.

Budget Deficits Will Drive up Interest Rates: No, they won’t.  Not with the Federal Reserve holding the Fed funds rate at zero and QE bond purchases targeting longer term bond yields.  And not with large output gaps in advanced economies and lots of corporate cash on the sidelines (i.e., there’s no case to be made that government borrowing is crowding out private borrowing).

Yet, policy makers continue to be driven by this phantom menace.  Of course, for many, attacking deficits is just a tactic to push for spending cuts—“cut social insurance before we’re Greece”!  But the simple textbook argument—budget deficits crowd out private borrowing and lead to higher interest rates—has taken a big hit in recent years.

Re Growth, Austerity Works, Keynesian Stimulus Doesn’t: There’s the evidence of actual trends in the UK and Europe, there’s the ongoing slog—slow-growth recovery—here in the US as we’ve pivoted too soon to “negative fiscal impulse” (i.e., diminished fiscal stimulus over time, see figure below—which btw assumes an economically reasonable resolution of the cliff), and there’s solid econometric evidence (see Box 1.1 here).  And then there’s the wide-spread economic fears about the fiscal cliff, which are very much Keynesian, driven by the legitimate concern that excessive fiscal contraction will derail the recovery.  So perhaps it’s unfair to accuse policy makers of believing that austerity works, though given that many are simultaneously arguing “we must offset the cliff—we must implement large, immediate spending cuts,” I would say that austerity/growth myths persist.

The US Safety Net Doesn’t Work: This is less an argument about economic precepts than conventional conservative wisdom, though some micro-economists (in this case, ones who fail to understand macro) like Casey Mulligan (numerous posts at the NYT) wrongly argue that the safety net has killed recipients’ work ethic.

In fact, the safety net along with progressive taxation (i.e., federal—state systems, not so much)—in such systems, tax burdens automatically fall when incomes go down—have helped to largely reverse income losses to low-income households and keep poverty from rising much at all.  Extension of refundable tax credits, food assistance, and unemployment insurance have been particularly important.

The argument that such measures disincentivize work is an old precept of micro-economics and at the heart of on-going critiques.  And while there’s definitely something to the critique, as I describe in detail in recent testimony, this is a) an empirical question, and b) such critiques are far weaker in recession (that’s where the macro comes in) when depressed labor demand dominates any behavioral effects.  The empirics are clear: an exhaustive study I review in the testimony linked to above finds the American safety net to effectively reduce market-driven poverty and that “…this impact is only negligibly affected by work incentives which, in the aggregate, have almost no effect on the pre-transfer rates of poverty in the population as a whole.”

High Unemployment is Driven by Skills Mismatch: Again, this is mistake driven by a failure to discern structural impacts from cyclical ones.  Policy wise, it’s actually a portentous mistake because it allows policy makers to nudge aside weak demand as a key diagnosis and instead blame the unemployed for not having the skills employers need.

The evidence has been trotted out in lots of places, most rigorously by Jesse Rothstein here (Fed Governor Janet Yellin summarizes the argument here as well—must be a Berkeley thing).  Key points:

–you don’t see it in the wages, i.e., no obvious wage premiums generated by unmet skill demands (though this observation seems least cited in this debate, I find it the most persuasive, especially for economists—if it ain’t in the wages, where is it??!).

–the increase in unemployment has been pretty uniform across occupations and industries suggesting a broad demand shock.

–workers of all types and all skill levels have faced higher unemployment.

–allowing for statistical noise, changes in unemployment have generally been consistent with Okun’s rule related cyclical weakness to higher joblessness.

As I’ve often stressed, however, cyclical could of course morph to structural if it keeps going on for too long—workers’ skills could deteriorate or we could settle into a weaker demand regime with slower growth and less job creation.  But most analysts agree that this hasn’t happened yet.  All the more reason to try to prevent it.

I’m sure there’s more—like any other, this past year’s been littered with predictions that haven’t come true: Europe will sink us, inflation’s about to bust out, going over the fiscal cliff—even for a minute—will cause a double-dip (OK, calling that wrong is premature, but not by much…).  But those are a few of the top of the head…feel free to add others in comments and I’ll collect and maybe post ‘em.

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8 comments in reply to "2012 Look Back: Economic Beliefs that Have Served Us Poorly"

  1. PC in SC says:

    i read articles on how “austerity isn’t working” — and comments on those articles say that this is because the countries raised taxes on the wealthy. is that true?


    • Jared Bernstein says:

      No–there’s good evidence that tax hikes on the wealthy have a very small negative effect because the wealthy are not income constrained so a bit more or less in their after-tax income tends not to affect their consumption or investment.

      It’s been more cuts on the spending side and reduction in public services and jobs, though broader tax increases have been in the mix too (they tend to depend more on sales taxes in Europe so increases are more broadly felt).


  2. PJR says:

    A great list. How about the Fed’s ability to lower unemployment levels–seems rather weak, no? And from state-level data, how about the notion that cutting taxes on job-creators, and spending reductions, will boost employment, whereas raising taxes and spending will increase unemployment?


  3. readerOfTeaLeaves says:

    Looking forward to another annual CBPP graph-fest. I hope Dr. Bernstein can find some way to highlight its link on the right side of the page.

    Another economic precept that IMVHO needs to tumble into history’s dustbin: “diminishing rates of marginal utility”. To wit: under this idea, every book ordered from a big online outfit “should” alter the ratio of development-infrastructure versus profit. Based on the notion of ‘diminishing marginal utility’, there is pressure to give the eComm bookseller all kinds of tax loopholes, plus turn a blind eye to any use of tax havens.

    But consider: if I buy a book online, I get the book. But in exchange, the seller gets my data: credit card number, shipping address, name, email. And as this process iterates with multiple purchases, and additional buyers, each sale further enriches the online bookseller by continually developing and enlarging its database(s) — even if it is selling ‘below cost’ — because the key item of value in that exchange is quite often the ‘data’, rather than the book.

    “Marginal utility” as a theory obsesses on the book as the *only* factor in the transaction. It fails to address what is truly being exchanged, and it doesn’t accurately identify what has value.

    Worse, yet, the notion of ‘marginal utility’ fails to describe the ‘informating’ process by which the bookseller’s database continually enriches itself. This process perpetually creates new economic assets called ‘data’, which are the result of ‘creating information about information’. This activity is more biological than mechanical. It is biological in the sense of being ‘self-replicating’ — in a fashion that railroad tracks, steam engines, and sailing ships never were: none of those could self-replicate. New technologies can reproduce versions of themselves; like plants in a garden, they grow. And grow.

    Neoclassical economists claim that the eComm bookseller is gaining ‘marginal rates’ of one thing or another.

    However, even ‘marginal utility’ does not fully address the ‘Long Tail’ phenomenon; in which rather obscure books gain new value, because they are now available via a network of used booksellers. (In a brick and mortar store, the inventory costs were simply too high to carry these books.) The “Long Tail” is a function of scale, based upon ‘informating’ technologies (like networks and databases and blogs) that track details. The “Long Tail” is logarithmic.

    Frustratingly, the ‘marginal rates of utility’ notion, which might have worked well for railroads and steam engines, makes it harder to explain a lot of contemporary economic behavior as we move into a digital era and more people access networks more often, for more kinds of things (including tv and movies).

    We are at a strange moment in human history: this year, smartphones and tablets began to outsell the PC (and the PC is only about 30 years old). Telecom is making its big profits on data usage and mobile networks. Yet apart from Nick Hanaeur and Eric Liu, very few of our economic conversations reflect these fundamental shifts in economic activity, which utilize networks — and view economics as distinctively social behavior, within an economic system that is organic.

    Which leads me to point out that I sincerely hope that new research into metabolism (including obesity) will affect economic thinking in coming years. Yes, I realize this seems pretty far out in ‘left field’ but bear with me…

    Researchers are honing in on the notion that the roots of obesity can be traced to hormone disruptors.

    Hormone disruptors are a common factor in recent years: many stem from 20th century technologies (plastics, petrochemicals, etc.). When hormone disruptions occur, the cells do not function correctly.

    Even more ominous, cells do not communicate effectively with one another; as if you had an orchestra of out-of-tune instruments, each using a different score and tempo. Ominous. Chaotic.

    In this paradigm of disrupted hormones triggering metabolic dysfunction, if you try to ‘starve the beast,’ by ‘putting it on a diet’, you are likely to kill it. But before it dies, it will become even more obese and little by little, it will become exhausted. It’s an insidious paradox. The body, thinking it is starving because it can’t receive the correct molecular messages about how to break down the food inside cells, goes into starvation mode and clings jealously to each molecule. This is tragically counter-productive.

    Norquist and his fantabulists all seem to think that the economy needs to be on some kind of ‘crash diet’. They act as if ‘a few ‘cutbacks’ are roughly the equivalent of denying pretzels and beer for the lazy sloths among the populace. But this is not ‘efficiency'; it is a death sentence. It is like ordaining economic anorexia.

    Metabolic research is taking several avenues, aiming at restoring the ability of cells to communicate with each other. I’m constantly struck, watching economic discussions, at how tax loopholes and accounting gimmicks interfere with clean, simple, accurate communication between a source and its end recipient. Under my rough approximation of a metabolic paradigm, tax havens and loopholes for ‘carried interest’ function like hormone disruptors; they create dangerous muddles by promoting miscommunication.

    We need to unmuddle.


  4. save_the_rustbelt says:

    Rapid globalization has already caused a huge structural shift, but the shift does not fit the conventional models so economists pretend it doesn’t exist.

    Rustbelt cities have realistically been in recession for about two decades.

    Under employment is rampant and chronic.

    Think outside the box a little.


  5. save_the_rustbelt says:

    Jared:

    Have a great holiday season, you are always my favorite liberal.

    Next year is gonna be interesting = again.


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