Government Failure vs. Market Failure

May 21st, 2013 at 10:11 am

Chuck Lane’s got an interesting piece out today about austerity and Keynesian stimulus that leads to a smart, simple policy recommendation (and ftr, “simple” is a beautiful word when it comes to policy). 

Lane’s argument, which suffers a few serious empirical oversights I’ll get to in a moment, is that while Keynesians rightly call for temporary deficit spending to offset private sector contractions, politicians ignore the temporary part.  The pols like spending and dislike taxes, so they’ll neglect to shut off the stimulus spending once the bona fide expansion is underway.

A good solution for that is to set triggers based on real variables to shut off your stimulus, as the Federal Reserve has done, announcing that wind down will commence (roughly) when unemployment goes below 6.5% or inflation about 2.5%.

What’s the empirical problem?  In fact, policy makers have shut off the stimulus—and far too soon!  The Recovery Act has gone the way of Monty Python’s parrot, as has the payroll tax break.  States have cut back on extended UI benefits and the sequester is taking a further whack at UI, despite historically very high levels of long-term unemployment.

In that regard, the reason I like Lane’s trigger solution is that were it in effect, these stimulus measures would still be switched on.

Moreover, the fact that budget deficits are counter-cyclical (economy tanks, they go up and vice versa) poses a broader challenge to Lane’s thesis.  A simple correlation between annual deficits (as a share of GDP) and the unemployment rate is a pretty large -0.73, suggesting adjustments of the type Lane worries about are in fact made (as unemployment goes up, the deficit/GDP “goes down”–becomes more negative).  Of course, part of this is the ebb and flow of “automatic stabilizers,” i.e., the safety net.  But take them out of the picture and the correlation is still a significant -0.53.

Still, structural budget deficits—the type that go up even in expansions—exist, so Lane’s got a point.  Though here too, it’s worth noting that long term pressures have far more to do with the unsustainable pace of health care costs than the politicians’ pet cats and dogs implicated in Lane’s rap.

In fact, I would amend Lane in a way with which he might agree.  Keynesian spending often really is temporary.  What lasts forever are foolish, unnecessary tax cuts and tax expenditures (i.e., spending by another name).

Putting it all together, if Lane is saying that austerity never comes, he’s demonstrably wrong—see Europe and especially the US.  But if his point is that Dick Cheney allegedly said “deficits don’t matter” and meant it, and that we’re stuck with asymmetric tax policy—taxes get cut, but almost never go up—then he’s on to something.

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6 comments in reply to "Government Failure vs. Market Failure"

  1. Daniel Kuehn says:

    I’ve been having an email conversation over this… he’s got a lot of very odd ideas in his head around all this: missing the automatic stabilizers point, claiming we’ve been having years of stimulus, and asserting that Krugman’s concerns about Ryan’s Medicare plans are proof he’s not serious about structural reforms.

  2. tyler healey says:

    We can only estimate how low unemployment would be today if President Obama and Congress had not raised taxes and cut spending.

  3. Robert Goodman says:

    An interesting idea to solve a problem that doesn’t exist?
    That’s an interesting idea in itself Jared.

  4. rootless (@root_e) says:

    Thanks to especially GW Bush’s bloating of the Federal Budget, it is possible to increase Keynsian stimulus and at the same time reduce total government spending. In fact, this is exactly what the Obama administration has done, e.g. by bringing US troops back from Iraq and spending DOD funds on green energy. All you have to do is reduce spending (or tax expenditures) on non-stimulative subsidies to the rich or protections of obsolete industries and redirect part of that to stimulative spending.

  5. Perplexed says:

    Lane’s concludes that: “It is also essentially about value judgments and trade-offs. Nobelists may be better qualified to describe the issues than the average voter, but they are no better qualified to decide them.”

    When economists can’t “achieve the kind of scientific victory that, say, Copernicus won over the Ptolemaic model of planetary motion” what do they add to what is essentially a decision about “value judgments and trade-offs”? By providing “evidence” for both sides to claim that their “science based” solution is in the “national interest,” do they “add value” to the discussion or simply provide cover for whoever happens to win the political battle? Obfuscation is extremely effective because it distracts attention and keeps the intended target of it from focusing on the most important criteria for their own success. (The same principle that makes flash-bombs or flash-bangs so effective).

    Rather than arguing over “such basic parameters as the multiplier effect of taxes and spending…” maybe economists should be doing to more to define the trade-offs. These decisions are ultimately about who wins and who loses from alternative decisions. Lane claims that “Nobelists may be better qualified to describe the issues than the average voter, but they are no better qualified to decide them,” but never addresses the issue of why the “average voter” is not the one making the decisions in these “democracies.” If economists would do more to explain (and count) who wins from austerity and who loses, the fallacy of the underlying claims of it being “in the national interest” would be exposed. Then maybe “we the people” could focus on how such a tiny minority grabbed such enormous power in supposedly “democratic” governments. Who should really be deciding these “trade-offs” in a democracy, and why aren’t they the ones making these decisions? How was it that nearly all of the policy decisions implemented had in common that the trade-off chosen was what was best for the plutocrats? In a functioning democracy, the large number of austerities losers should have easily overwhelmed austerities winners. Why is the reverse policy the one that was actually implemented?

    Keynes warned that:”Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.” But is it even worse than “too easy” and “too useless”? If they can’t acknowledge the “limits” of their own “science,” are they really anything more than political actors trying to sway the discussion in favor of who they would like to see win and against those who would lose? “Even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist” – J.M. Keynes How many ultimately political arguments are hidden behind the holy-grail of “greater GNP for all”?

    Maybe a good first step would be for economists to take a “do no harm pledge” and stop trying to sell the us the “best for everyone GNP” juice. Why not just explain that its a political choice of who wins and who loses and here’s who they are? At least, by removing the obfuscation, large numbers of people could see more clearly just how powerless they have become in the decision making process, regardless of their overwhelming numbers. What percentage of a population with a wealth Gini of .87 and income Gini of .48 could possibly benefit from austerity policies in a severe recession? What percentage would likely benefit from stimulus spending and who are they?

    Krugman suggests in this post today, that: “And if this leads to hurt feelings – well, this is not a game. We’re having a discussion about policies that affect tens of millions of people. And you have no business participating in this discussion if you’re so busy trying to sound clever that you can’t be bothered to do your homework.” But what if you’re an economist that’s only doing enough “homework” to support you’re ultimately political position where the “science” itself is ambiguous? Do you have any business participating in the discussion as an “economics expert” then or should you be required to disclose that your “expert economic” opinion is ultimately a political one hidden inside an “economic” argument? Does the “science” of economics even attempt to protect its credibility from being undermined by political actors with “economist” credentials, or is the the ability to be a political actor with “superpowers” really what an “economics” PhD. is all about?

  6. Tan S. Taafl says:

    The author is right: austerity eventually comes, but (what he forgets mentioning) always at the expense of the private sector. The famous Keynesian hole-diggers quickly become unionized public servants with above average wages and pension claims. The subsequent efforts to cut the growing deficit lead to higher corporate taxes and spending cuts hurting the private sector. The result, which can be clearly seen in Europe are ever rising shares of the public sector, which in the meantime exceed 50% in many European states.