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The Meaning and Misuses of GDP

Thursday, April 25th, 2013

America’s Gross Domestic Product — GDP — is a very powerful statistic. Markets and politicians zealously track the quarterly numbers looking for a bottom line on how investors and the rest of us feel about our conditions and prospects. Compiled by some 2,000 economists and statisticians at the Bureau of Economic Analysis (BEA), GDP pulls together everything they can measure concerning how much America’s households and various industries earn, consume and invest, and for what purposes. Over the last two weeks, however, two new developments should have reminded us that we know less about GDP than we usually believe.

Early this week, the BEA itself tacitly acknowledged that the GDP measure lags behind the actual economy. The Bureau released a set of changes in how it calculates GDP, designed to take better account of the economic value of ideas and intangible assets. Today, few among us would question the notion that new ideas can have great economic value. But some 15 years ago, long before smart phones, tablets and protein-based medications, the BEA started to study how to revise the GDP measure to take better economic account of innovations. This week, the Bureau announced that when a company undertakes research and development or creates a new book, music, or movie, those costs will be counted as investments that add to GDP, rather than ordinary business expenses, which do not.

In an instant, the official accounting of the economy’s total current product increased some $400 billion. Business profits also have been larger than we thought, because ordinary business expenses reduce reported profits, while investments do not. Most important, the revisions told us that American businesses and government, together, now invest just 2.1 percent of GDP in R&D — less investment than in the 1990s here, especially by businesses, and less than much of Europe.

While this week’s BEA changes bring us closer to an accurate picture of GDP, last week we learned how naïve we can be about blatant misuses and distortions of GDP. This story began four years ago, when two well-respected economists, Carmen Reinhardt and Kenneth Rogoff, published an economic history of financial crises. R&R’s timing (2009) was impeccable, and their book was a bestseller for an academic treatise. More important, it gave its authors wide public credibility when they issued a paper the following year, “Growth in a Time of Debt,” that claimed to have found a deep and strong connection between high levels of government debt and a country’s economic growth. The data, they reported, showed that when a country’s government debt reaches and exceeds the equivalent of 90 percent of GDP, its growth slumps very sharply.

With the big run-up in government debt spurred by the financial crisis and subsequent deep recession, conservatives who had waited a long time for a plausible economic reason to slash government found it in the new R&R analysis. And based on its authors’ newly-elevated reputations, conventional wisdom-mongers from think tanks to editorial boards echoed the new line on austerity. Even the most liberal administration since LBJ couldn’t resist the new meme. Despite a palpably weak economy, the President and congressional Democrats grudgingly accepted large budget cuts, and then pumped the economy’s brakes some more by insisting on higher taxes. And we were not the only ones so economically addled. As government debt in Germany, France, Britain and most other advanced countries rose sharply, conservatives there argued that less government was a necessity for average Europeans as well.

Just last week, we learned that the R&R 2010 analysis was so riddled with technical mistakes that its “findings” about what moves GDP are meaningless. When three young economists from the University of Massachusetts found they couldn’t replicate the results – the standard test for scientific findings — they took R&R’s model apart, piece by piece, to figure out why. It turns out that R&R – or more likely, their graduate assistants – left out several years of data for some countries, miscoded other data, and then applied the wrong statistical technique to aggregate their flawed data. And as bad luck would have it, all of their disparate mistakes biased their results in the same direction, amplifying the errors. In the end, instead of advanced countries experiencing recessionary slumps averaging – 0.1 percent growth once their government debt exceeded 90 percent of their GDP, the correct result was average growth of 2.2 percent carrying that debt burden.

Utterly wrong as R&R’s analysis was, the austerity advocates proceeded to badly misuse it. The authors had merely reported a correlation between high debt and negative growth – or, as we now know, between high debt and moderate growth – without saying what that correlation might mean. Hard line conservatives and their think tank supporters, here and abroad, quickly insisted it could only mean that high debt drives down growth. That can happen, but only rarely — when high inflationary expectations drive up interest rates, which at once slows growth and increases government interest payments. In the much more common case, Keynes still rules: Slow or negative growth leads to higher debt, not the other way around. In those more typical instances, cutting government only depresses growth more, further expanding government debt. Occasionally, the correlation of negative growth and high government debt reflects some independent third cause. The tsunami and nuclear meltdown that struck Japan in 2012, for example, simultaneously drove down growth and drove up government debt. And sometimes, there is no correlation: Britain carried government debt burdens of 100 percent to 250 percent of GDP from the early-to-mid-19th century, while it was giving birth to the Industrial Revolution.

The R&R analysis did not distinguish between these various scenarios. Yet, the conservative interpretation became the received public wisdom. The IMF, the World Bank and most politically-unaffiliated economists insisted that slashing government on top of weak business and household spending would only make matters worse. No matter. The inevitable result was not the stronger growth as promised, but persistently high unemployment and slow growth here, and double-dip recessions for much for Europe and Japan. In the end, R&R deserve less criticism for their mistakes than for their failure to correct the damaging distortions of their deeply flawed work.

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The President’s Budget and the Case for Moving Beyond Austerity

Wednesday, April 10th, 2013

The President released his FY 2014 budget today, and right off, it makes more economic sense than most of what passes for serious fiscal discussion in DC. In particular, it offers up new public investments, uses revenues and entitlement changes to restore long-term fiscal sanity, and phases in those changes down the road when the economy (hopefully) is stronger. Apart from Fed policy, the budget is government’s most powerful tool for affecting economic growth. So, the critical economic question is what budget approach would most effectively boost U.S. growth, for both the near-term and longer. The best answer for now is a plan built around an ambitious public investment agenda, serious measures to broaden the tax base and pare entitlement benefits for well-to-do retirees, and reform that finally resolve the festering issues left over from the 2008-2009 financial meltdown.

To appreciate why continued austerity would be economically reckless, just review the economic data from 2012. Yes, the United States grew faster than almost any other advanced economy. But that’s only because the Eurozone has been back in recession, France and Britain treaded water at 0.1 percent and 0.2 percent growth, and Germany grew less than 1 percent. Even in Northern Europe, Denmark contracted and Sweden expanded just 1.2 percent. So, the United States looked good with 2.2 percent growth — although only 0.4 percent in the final quarter of 2012 — in-between Canada’s 1.9 percent rate and Australia with 3.3 percent growth.

With such dismal growth, here and across the developed world, the budget’s first mission should be to strengthen it. There is no economic basis for any short-term spending cuts or tax increases, especially on top of the continuing, mindless sequester. To be sure, under very special conditions, austerity can stimulate economic activity in a weak economy — namely, when high inflationary expectations drive up interest rates, constraining investment and consumption. But those conditions have nothing to do with our current economy since interest rates here and across the advanced world are at or near record lows. The case for austerity, then, is simply politics, and the continuing calls from conservatives to slash federal programs merely mask their fervid preference for a small, weak government.

Economics matters more in this debate, and progressives should use our slow growth to promote an expanded agenda for public investment. They could call on Congress to dedicate an additional one percent of GDP to investments that will strengthen the factors that drive growth. That could mean, for example, more support for reforms to improve secondary education, reduce financial barriers to higher education, and provide retraining for any adult worker who wants it. It also could mean renewed public support to develop light rail systems across metropolitan areas and improve roads, ports and airports. This is also the right time economically for Washington to more actively promote the frontiers of technological innovation by expanding support for basic research. Finally, let’s review federal regulation with the aim of lowering barriers to new business formation. New and young businesses are reliable sources of new jobs and greater competition. Those elements, in turn, stimulate higher business investment, particularly in new technologies.

Progressives also would be well advised to accept long-term entitlement reforms that could accompany the new public investments. Since Social Security provides at least 90 percent of the income of more than one-third of retirees, pension reforms should focus on some form of means-testing. The best template to contain healthcare spending is more elusive. The Affordable Care Act includes a half-dozen measures calculated to slow rates of health spending. So, a bipartisan effort to strengthen those measures, perhaps with malpractice reforms to entice conservatives, would be a good place to start.

These initiatives, by themselves, still won’t be enough. Economic history teaches us — if only we’d listen — that the recovery that follows a financial crisis is always slow and bumpy, unless policymakers directly resolve the distortions that brought about the crisis. Many of those distortions in finance and housing linger on. In finance, the challenge is to get financial institutions to divest themselves of their remaining toxic assets and, equally important, further limit the impulse of these institutions to speculate in exotic financial instruments that remain only lightly regulated, like a hedge fund. The political resistance will be daunting, of course. But the economics is clear: Until such changes occur, Wall Street will not focus sufficient resources towards supporting home-grown business investment.

The challenge in housing is as difficult politically, though technically less complicated. Across the nation’s five largest mortgage holders, almost 12 percent of all mortgages were in serious trouble at the close of last year. Some 6.5 percent of all mortgages were delinquent, another 1.6 percent of them were in bankruptcy proceedings, and 3.6 percent were in foreclosure. So long as these rates are abnormally high, especially foreclosures, housing values will be weak — and the primary asset of most U.S. households will languish. Even worse, a weak housing market consigns most homeowners to stagnate economically or even grow steadily poorer; and that means they will consume less and the recovery will continue to be stunted. One sensible approach would be a new federal program to help people avoid home foreclosures through government bridge loans — like student loans — made available until the job market recovers.

This year’s budget debate will probably follow a now-familiar and sterile course, in which the President offers his plan, which is promptly met with partisan invective, followed by personal attacks from all sides. For average Americans to see their economic prospects really improve, progressives will have to forgo the partisan fights and instead use the Obama proposal to start a new public conversation, one focused on the challenges and changes necessary to get this economy back on track.

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How a Grand Bargain on the Deficit Could Erode Social Security

Wednesday, March 13th, 2013

Paul Ryan’s new budget blueprint released this week — details to follow, as usual — will only intensify the partisan warfare over the deficit. In truth, the deficit is just a cover story here, since the real debate is over the scope and role of government itself. Ryan at least is more upfront about it than most – he includes large new tax cuts as well as draconian spending reductions in what is ostensibly a plan to “balance the budget.”  In his fervor to miniaturize Washington’s domestic role, however, he cannot provide the resources to maintain the core commitments of Social Security and Medicare.

The ideological core of this debate also explains why most of the proposals and agreements of the past year have paid so little heed to the needs of the economy. There is no doubt that the spending cuts and tax hikes of the last six months have weakened economic growth — and as a result, deficits actually could be larger over the longer-term than they otherwise would have been. The additional spending cuts contemplated for the next six months under the sequester — and under most of the grand bargains being floated to supersede the sequester — would inflict more damage. In this regard, Ryan stands at the extreme with a plan that would drive us back into recession.

Nonetheless, a major deal that includes entitlement reforms and tax-loophole closings remains possible. In the politics that could determine the relative weights of those two factors, Republicans will have less maneuvering room on taxes than Democrats will enjoy on entitlements. That’s because primary challengers from the far right already have taken down a number of conventional Republicans, heightening the GOP’s resistance to more revenues. By contrast, there have been no successful attacks so far on centrist Democrats for supporting the cutbacks in federal programs now in place. This political difference suggests that more of the burden in any grand bargain will likely fall on entitlements than on revenues. The next question is, what entitlement changes could Democrats accept and still preserve the essential missions of those programs.

Let’s consider Social Security and its core guarantee of basic economic security for more than 40 million retirees (plus nearly 9 million people with disabilities). Unfortunately for Ryan and his fellow supporters of austerity for the elderly and disabled, no change that would trim the benefits of all Social Security recipients is compatible with the program’s central mission. To begin, while countries such as Germany, France and Italy provide monthly pension checks equal on average to 75 percent or more of a person’s average monthly wages over a lifetime, this “replacement rate” for Social Security is only about 40 percent. That translates into an average monthly benefit of $1,230, or less than $15,000 per-year. Moreover, these bare benefits comprise at least 90 percent of the total income for more than one-third of all current Social Security recipients.

Let’s do the math. The terms just described translate into an annual income of less than $16,300, which amounts to a very bare minimum. After all, the average cost today of a small apartment (rent and utilities) is over $7,000 per-year. Even if elderly people pay 20 percent less than the average, their rent and utilities still claim an average of $5,600 per-year or nearly 40 percent of all their income. Add to that at least $335 per-month for food at a poverty level ($4,000 annually) and another $310 per-month for Medicare Part B and Part D premiums and other out-of-pocket medical expenses ($3,700 annually). That leaves tens of millions of elderly and disabled Americans with about $130 per-month ($1,600 per-year) to cover all other expenses such as clothes, transportation, recreation, state and local taxes, and any unexpected expenditures.

These data suggest that any across-the-board benefit cut today is incompatible with Social Security’s essential mission. That takes off-the-table changes in the annual inflation adjustment or the retirement age. Given current benefits, the only reforms consistent with the program’s central commitment are ones based on means-testing. For example, Congress could apply a smaller annual cost-of-living adjustment to the benefits of the top tier of retirees. And if Congress is set on guaranteeing the system’s solvency for the next 75 years, in the same spirit they should think about applying the payroll tax to the capital income of the top tier of workers. Not that there is an enormous rush, given the actuaries estimate that the system’s solvency is secure for at least another quarter-century.

Much like George W. Bush’s proposal to privatize part of Social Security, the 2013 Ryan budget is simply uninterested in the missions that animate federal entitlement programs. Democrats would commit a grave mistake, as a matter of both social policy and politics, if they also sacrificed those commitments in search of Republican acquiescence to more revenues.

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The New Nihilism in the Debate over the Debt Ceiling

Tuesday, January 8th, 2013

For decades, fiscal conservatives have used congressional debates over raising the debt limit to vent their frustrations with big government. But no one seriously questioned the need to do so, not until a band of Tea Party uber-conservatives in 2011 resolved to use the debt limit as a bargaining chip in budget talks. They ignored the fact that raising the debt ceiling does not in any way determine future spending or taxes. It simply allows the Treasury to borrow the funds to finance spending that past Congresses and Presidents already have undertaken. Raising the debt limit, in short, is a ministerial act that grants the government the technical legal authority to maintain the full faith and credit of the United States. And since the Treasury securities that comprise that credit underpin much of the operations of the American economy, withholding that technical authority could have devastating economic effects.

To understand how and why, start with the basics. When Washington runs a deficit, the Treasury has to borrow from investors not only to fund the deficit, but also to cover the interest on the government’s existing debt and to refinance much of that debt, all on a continuing basis. A failure to raise the debt limit, as many Tea Party denizens in Congress propose, therefore could force the Treasury to default on those obligations. Sovereign debt defaults have many well-known and very unpleasant consequences. Interest rates spike, stock and bond markets fall sharply, the value of the currency declines dramatically, and the country quickly falls into a deep recession. Given those consequences, no government with sane leadership would ever default voluntarily. Rather, the only reason any country has ever found itself unable to pay the interest on its bonds or issue new government debt is that domestic and foreign investors won’t lend it the funds to do so.

If, beyond all reason, Congress effectively forces our own government to default on our national debt, the results would be particularly nasty. Trillions of dollars in U.S. Treasury securities are held by financial institutions here and abroad, so the default would quickly freeze capital markets around the world. In other words, private lending to businesses and households here and in many other nations would halt. The reserves held by many of the world’s central banks include more trillions of dollars in U.S. Treasuries, so a U.S. default also would quickly bring on a global financial crisis that could dwarf the chaos of late-2008. In fact, even if the debt-limit debate merely increases the concerns of investors that a U.S. debt default somehow might occur, their heightened apprehension could have serious effects on interest rates, the dollar, and the stock and bond markets.

Even before a technical debt default could set in, however, the government would be forced to drastically cut current federal spending. Federal borrowing today covers between 35 and 40 percent of all federal spending. If Congress prevents the Treasury from legally borrowing any more funds, the government will be forced at once to slash spending by 35 percent to 40 percent. Such truly unimaginable cuts — more than ten times those contemplated under the sequester provisions of the 2011 budget Act — would force the President to shut down many parts of the federal government, including some national security operations, and even cut income support programs for tens of millions of retired Americans. And since the President and the Treasury would determine the distribution of these cuts, failure to raise the debt ceiling would effectively shift the power of appropriations from Congress to the Executive.

Conservatives have serious and sincere differences with progressives over certain federal programs and functions. Whether Republican leaders recognize it or not, putting at risk the government’s legal authority to issue new bonds as a lever to press their policy preferences is a form of political nihilism. It easily dismisses the costs of wrecking the operations of government, because it places so little value on government itself. As such, the new political nihilism is as far from genuine conservatism, which seeks to preserve traditional political arrangements, as it is from a progressivism that uses government to reform those arrangements. Nevertheless, by vowing to block any increase in the debt limit until the administration accedes to their budget demands, congressional conservatives have embraced this new nihilism.

Nor, as some Tea Partiers would have it, should a failure to raise the debt limit be seen as a “preemptive default” intended to head off a real one. Global investors continue to lend the United States whatever funding we require — and judging by the low interest rates they accept, they are eager do so. We also are one of only two countries in the world (Denmark is the other) that places a legal limit on the debt its government can issue. So, now a handful of radical members would have the Congress refuse to raise that limit, knowing that the country will face another recession as government programs are slashed, followed by the chaos of a sovereign debt default. Republican leaders have no reasonable alternative but to join the President in rejecting such nihilism. 

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Modest Progress on the Deficit Is Just What the U.S. Economy Needs

Wednesday, January 2nd, 2013

One argument nearly entirely absent in the debate over the fiscal cliff issues is the effect on the economy. True, some diehard conservatives warn that without drastic steps to privatize part of Social Security and much of Medicare, our national debt will soon make us pariahs in global capital markets, on the Greek model. But there was never any economic evidence or reasoning behind their feverish scenario. In fact, throughout our long fiscal debate, worldwide investors have been eager to lend the Treasury virtually unlimited funds in 10-year tranches and accept annual yields of less than 2 percent.

Based on that, some diehard liberals insist that we do not have to cut spending at all, especially when there are plenty of well-heeled Americans around who can afford to pay higher income taxes. Their position ignores economic history — namely, that whenever our deficits have climbed and the national debt has threatened to soar, we earned the confidence of global investors by addressing those problems in measured ways. The only genuine economic imperative in this entire dismal fight is not that we should raise taxes on the wealthy or cut domestic spending, but simply that we once again have to take care of our fiscal business in a reasonable manner.

Despite the protestations of partisan economists, the economy is largely indifferent to whether we address these imbalances by cutting spending or raising taxes. The first stage of this effort, in 2011, brought $1.2 trillion in spending cuts over 10 years. The verdict of the markets was, “well done”; and, despite the heated rhetoric of last year’s campaign, the 2011 deal was followed by a generally strengthening economy. Stage two was resolved in this week’s agreement to raise nearly $700 billion in new revenues over 10 years, including substantially higher taxes on capital income. The markets are satisfied with that, too, and the economy almost certainly will continue to strengthen.

Stage three will come in a few months, when the President and Congress will likely agree to modest entitlement changes in exchange for additional revenues raised through some version of corporate tax reform. The economy will be fine with that resolution as well.

In fact, this process has been a quiet refutation of the slash-the-deficit chorus. That includes those of the Paul Ryan variety who would upend entitlements to finance more tax cuts, and “responsible budget” types who would hike taxes and slash spending as much as possible to reduce the cost of business borrowing in years to come. The truth is, the economy does not usually respond to drastic measures that confound the expectations of investors and consumers. For all of the complaints that rather than make a meal of the deficit, we take a nibble here, another nibble there and then a third nibble somewhere else, this tortured course allows businesses and households to adjust little by little. And that is the best course for the economy.

So, setting aside politics and social policy, the economic imperative remains that Washington must manage to take care of its fiscal business in measured and reasonable ways, whether through taxes or spending cuts of almost any variety. Looking ahead, this means that the debt limit can never again become a negotiating chip in fiscal politics. The last time that House and Senate hyper-conservatives went down that path, it cost the U.S. government its triple-A rating from one of the three major credit-rating agencies. A government capable of letting lapse its own legal authority to issue new debt and pay interest on its existing debts is one that, by definition, cannot take care of its basic business. And that is especially so in the current circumstances, when there are no market pressures on the government to default and when the government’s debt securities comprise much of the reserves of most of the world’s central banks.

Global investors would be anything but indifferent to such contempt for predictable economic consequences. A technical sovereign debt default triggered by a debt-ceiling stalemate would be a calamity for the U.S. and world economies. Any political leader or party that helps to bring about such a catastrophe will prove themselves unfit to govern for a very long time.

 

 

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The Truth about Job Creation under Obama and Bush

Wednesday, November 16th, 2011

Everyone knows that unemployment is high today and unlikely to fall by much soon. Yet, a longer view of the official jobs data would startle most people, including virtually everyone in the media. Nearly three years into Barack Obama’s presidency, his record on private job creation has actually been much stronger than George W. Bush’s at the same point in his first term. Whatever the public perception, the real record provides strong evidence for both the relative success of Obama’s economic program and how hard it now is for American businesses to create large numbers of new jobs — as they did once so effortlessly, and without political prodding.

Let’s go to the numbers reported by the Bureau of Labor Statistics (BLS). In the first 33 months of George W. Bush’s presidency, from February 2001 to October 2003, the number of Americans with private jobs fell by 3,054,000 or 2.74 percent. Perhaps Americans were too distracted by Osama bin Laden to pay attention, or everyone was lulled by the dependably strong job creation of the 1980s and 1990s.  Whatever the reason back then, Americans are certainly paying attention to jobs now. Yet, few seem to have noticed that Barack Obama’s jobs record has unquestionably been much better. In the first 33 months of his presidency, from February 2009 to October 2011, private sector employment fell by 723,000 jobs or 0.66 percent. That means that over the first 33 months of the two presidents’ terms, jobs were lost at more than four times the rate under Bush as under Obama. 

To be fair, new presidents shouldn’t be held responsible for job losses or job gains in the first five or six months of their administrations.  Bush’s signature tax cuts, for example, weren’t enacted until June 2001; and while Congress passed Obama’s signature stimulus program earlier in his term, it didn’t take effect for several more months. But the story is the same when we start counting up jobs without the first five months of each president’s term. The BLS reports that from July 2001 to October 2003 under Bush’s program, U.S. businesses shed 2,167,000 jobs, or about 2 percent of the workforce. Over the comparable period under Obama’s policies, from July 2009 to October 2011, American businesses added 1,890,000 jobs, expanding the workforce by 1.75 percent. In fact, private employment in Bush’s first term didn’t begin to turn around in a sustained way until March 2004, 38 months into his term. By contrast, private employment under Obama started to score gains by April and May of 2010, 14 to 15 months into his term.

The same dynamics have played out with manufacturing workers. While they have taken a beating under both presidents, they suffered much harder blows under Bush than Obama. Setting aside, once again, the first five months of each president’s term, the data show that under Bush, 2,141,000 Americans employed in producing goods lost their jobs by October 2003, a 9 percent decline. Under Obama, job losses in goods production totaled 183,000 over the comparable period, a 1.0 percent decline.

Public perceptions, especially of Obama’s record, may be skewed by the collapse of the jobs market in the months before he took office. In the final, dismal year of Bush’s second term, from February 2008 through January 2009, American businesses laid off an astonishing 5,220,000 workers, 4.5 percent of the entire private-sector workforce. Obama and the Fed managed to staunch the hemorrhaging. But the huge job losses in the year before he took office have become a political hurdle which Obama must overcome before he can take credit for putting Americans back to work.

Apart from the obvious disconnect between conventional wisdom and what actually has happened with jobs, the data also speak to certain features of the labor market and the policies we use to affect it. For example, both presidents began their terms with large fiscal stimulus programs, backed up by more stimulus from the Federal Reserve. So, the record now shows clearly that when the economy is depressed, spending stimulus has a more powerful effect on jobs than personal tax cuts.

Beyond that, why couldn’t either president restore the much stronger job creation rates of the 1990s and 1980s? Obama’s economic team can point to the long-term effects of the 2008 housing collapse and financial crisis, especially the impact of four years of falling home values on middle-class consumption. But another factor also has been at work here, one which contributed mightily to the slow job creation under both presidents, and will similarly affect the next president.

The tectonic change from strong job creation of the 1980s and 1990s to the current times is, in a word, globalization. From 1990 to 2008, the share of worldwide GDP traded across national borders jumped from 18 percent to more than 30 percent, the highest level ever recorded. Intense, new competition from all of that additional trade has made it harder for American businesses to raise their prices, as competition usually does. That’s why inflation has remained tame for more than decade, here and nearly everywhere else in the world. The problem that American employers have faced — and still do — is that certain costs have risen sharply over the same years, especially health care and energy costs. Businesses that cannot pass along higher costs in higher prices have to cut back elsewhere, and they started with jobs and wages.

One irony here is that the Obama health care reform should relieve some of the pressure on jobs, by slowing medical cost increases. The administration’s energy program, still stalled in Congress, also might slow fuel cost increases, at least over time. So, if he does win reelection in the face of high unemployment, there is a reasonable prospect of stronger job creation in his second term than in his first one — or in either of George W. Bush’s terms.

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The Economic Appeal of the Occupy Wall Street Movement to Middle-Class Americans

Monday, October 24th, 2011

Seemingly out of nowhere, economic inequality is no longer the political issue that dares not speak its name. Since the days of Ronald Reagan, politicians who talk about reducing disparities in incomes or wealth have been promptly charged with “class warfare.” The stunning success of the Occupy Wall Street movement in attracting adherents and sympathizers could change that, at least for the current political season. What lies behind the movement’s surprising middle-class appeal, however, isn’t high unemployment or slow economic growth. The real reason is that the 2008 meltdown and its economic aftermath have cut the wealth of millions of average Americans by up to half — and Washington has been unwilling to do anything about it.

There is little controversy among economists that the fabled U.S. land of opportunity has become one of the world’s most unequal societies. Using the standard measure (the “Gini Coefficient”), America now ranks 93rd in the world in terms of economic equality. That puts us behind places like Iran, Russia and China. The poverty in those places is much worse, but the concentration of wealth is much greater here. According to the Federal Reserve, the top 1 percent of us in 2007 owned nearly 35 percent of everything of value, net of debt — that includes savings, stocks and bonds, real estate, art, furniture, clothing, on and on. Perhaps more important, the top 20 percent of Americans owned 85 percent of the country’s net wealth.
Yet, such striking inequality still cannot explain the appeal of Occupy Wall Streeters — I’ll call it the OWS movement — because comparable disparities of wealth have been around for a generation. Go back to 1983, and the top 1 percent of Americans owned 34 percent of the country, and the top 20 percent claimed 82 percent.

The answer here lies in the particular way that the financial and housing meltdown has affected middle-class families. Consider the following: While the bottom 80 percent held only 15 percent of the nation’s wealth in 2007, most of it was tied up in the value of their homes. We know that, because when we break down that 15 percent figure, we find that the bottom 80 percent held just 7 percent of all financial assets in 2007 but 40 percent of all residential real estate assets. And the housing boom topped out in 2007.

The reason the OWS movement resonates so broadly today lies in the subsequent loss of so much housing wealth.  The 2008 meltdown and its aftermath have driven down the value of residential real estate by about 35 percent. And that 35 percent included most or all of the equity that millions of middle class families had in their homes in 2007.  America already was a place where 80 percent of the people held only 15 percent of the country’s wealth. Now, do the math. About half of that wealth was in financial assets like savings and pensions (the Fed’s 7 percent figure), and the rest was in home equity. So, since 2007, the bottom 80 percent of Americans have lost up to half of their net wealth.

Those losses also aren’t distributed evenly:  Households in their 30′s and 40’s, for example, usually have almost everything they own tied up in their home equity, and which typically adds up to less than one-third of their homes’ value.  They’ve been wiped out, wealth-wise.  Older households, on average, have larger home equity, so they still have some modest increment of wealth. But if they’re approaching retirement or already retired, there’s also little they can ever do to make up their losses.
When middle-class Americans turn to Washington, they see the resounding success of the government’s efforts to stabilize the financial markets – where the top 1 percent derive most of their wealth. The rich are back to becoming even richer. That’s the way America has operated for at least the last generation. What grates on middle-class Americans this time is that they’ve been getting poorer. And Washington has done little to stabilize the market from which they derive most of their wealth, which is housing.

To be fair, President Obama can claim a little credit here, since he has proposed a series of initiatives to support housing, mainly by giving banks incentives to refinance more mortgages at favorable terms.  But the largest force driving down housing prices and wiping out middle-class home equity is sky-high home foreclosure rates.  The President hasn’t yet taken on those foreclosures, but he still has time to champion a new initiative.  For instance, he could call for temporary loans for families whose mortgages are in trouble, financed through lending by the Federal Home Loan Banks.

Mitt Romney, Obama’s most likely challenger, can’t call for anything.  Last week, Romney went to the state with the highest foreclosure rate in the country, Nevada, and made what may turn out to be a very costly mistake.  Embracing GOP dogma that “the right course is to let markets work,” he declared that Washington should let the foreclosure process “run its course and hit the bottom.”

Yet, this is the very process now hollowing out a good-sized slice of the American middle class.  Given Romney’s position, the issue provides a new opportunity for the Obama campaign.  Much more important, however, the problem itself presents a critical challenge for economic policy makers. If they and the next President ignore it, inequality in America almost certainly will enter a very nasty, new phase.

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Grading Obama and the GOP Hopefuls on their Plans for Jobs and the Economy

Monday, September 12th, 2011

Last week’s GOP debate at the Reagan Library, followed the next night by the President’s address to Congress, threw into stark relief the strengths and weaknesses of each side’s understanding of jobs and the economy. The Republican hopefuls get a gentleman’s C on the impact of regulation on economic activity. But their approaches to the overall economy and job creation ranged from silly to dangerous, and earn them all F’s. The President has to produce results, and his ideas aren’t constrained by primary challengers. This may help explain why his approaches are broader and more thoughtful, earning him a solid B on the overall economy and an A-minus on job creation.

All of the Republican hopefuls — the two leaders Rick Perry and Mitt Romney, the so-serious minded Jon Huntsman and Ron Paul, and the media-infatuated Michelle Bachmann and the rest — agreed on one economic prescription: Apply deep and immediate budget cuts to an economy generating little growth and no jobs. This common position not only defies the basic dynamics of supply and demand in a slow economy. It also rejects the policies of the last five GOP presidents. After all, it was true-blue conservatives Ronald Reagan and George W. Bush who justified big spending increases for defense and big tax cuts to boost the flagging economies of their own times.   

Nor are the Republican wanna-be’s chastened by the current examples of Germany, France and Britain, which all embarked on austerity programs this year while the European Central Bank (ECB) raised EU interest rates. The results have been even more anemic growth than our own. In fact, the two GOP frontrunners along with the inimitable Mr. Paul not only demanded deep spending cuts, but also sided with the ECB by denouncing Fed chairman Ben Bernanke as an inveterate inflationist. The markets they all claim to worship don’t see it that way, since our long-term interest rates remain near record lows. For their determined contempt of introductory macroeconomics, all of the GOP putative presidents flunk.

The current President at least appreciates that this economy needs a boost, not more headwinds. His package adds $450 billion over 12 months, in theory adding new demand equal to 3 percentage points of GDP. In practice, it would work out to be less than that, since people will save some of the money they gain from lower payroll taxes, and some of the tax cuts for businesses won’t be taken up. The administration also gets credit for recognizing that the sick housing market is a critical piece of the puzzle behind the slow economy. Their answer, however, misses the most basic point: Mr. Obama called for expediting Fannie Mae refinancings to put more money in the pockets of some homeowners. But that won’t affect the more economically consequential, high foreclosure rates that have been pushing down housing values, and so dampening people’s willingness to spend. On balance, give the President’s economic team a solid B on the overall economy.

Both sides also call for tax cuts to spur job creation. All of the GOP candidates, however, would focus on cutting corporate taxes. Now, most economists agree that the corporate tax cries out for reforms, especially a lower marginal rate tied to ending distorting tax breaks for favored industries.  But no reputable economist who doesn’t aspire to a top position in the next GOP administration has found that those reforms would have noticeable effects on jobs in any short or medium-term. With large U.S. businesses already holding some $1 trillion in banked profits, by what economic logic would additional tax cuts move them to create jobs?

The only route from this GOP position to new jobs depends on lower corporate taxes translating into higher dividends, mainly for the very affluent, which they would then spend, boosting demand. Even so, much of those additional dividends probably would be saved, which wouldn’t create any jobs under today’s conditions. Moreover, the GOP hopefuls also insist on spending cuts to offset any lower corporate tax revenues — and that would mean job losses. For their resolute ignorance of labor economics and public finance, these hopefuls score another F.

President Obama’s tax plan is both more detailed and better targeted to creating jobs — which should be unsurprising, given how much he has riding on near-term results. He would reduce the cost to businesses of creating new jobs and maintaining their current workers. To do this, he would temporarily suspend the employer side of the payroll tax for new hires by firms with about 1,000 employees or less, and temporarily cut by half all employer-side payroll taxes for firms with about 100 workers or less. This strategy is eminently sensible — and downright brilliant compared to the broad corporate tax cut championed by the Republican hopefuls. Full disclosure: I’ve urged the administration to propose cutting the employer side of the payroll tax since December 2009, including eleven times in these blog essays.

The decision to limit these new tax incentives to small and medium-size companies is less than ideal, since big businesses employ nearly half of all workers. On the other hand, big businesses are sitting on hundreds of billions of dollars in banked profits, so they clearly have the means to hire more workers. On balance, these proposals deserve an A-minus.

The same score goes to the President’s call for more direct, job-related spending. This includes new funds for the states to prevent more layoffs of teachers, police and firefighters; new support for school construction; and additional investments in infrastructure (through a National Infrastructure Bank). More problematic are the jobs benefits from other parts of the plan, including support for expanded access to high-speed wireless and public-private partnerships to rehab homes and businesses. There’s also little direct jobs benefit in the administration’s otherwise-laudable plans to reform the unemployment insurance system and bar employers from discriminating in hiring against long-term jobless people. All told, another A-minus.

The Republican hopefuls have time to develop better strategies for growth and jobs, especially compared to their current dismal positions. They’ll have to play catch-up, however, because President Obama has proposed a sound new jobs agenda. And if congressional Republicans refuse to work with him on it, the public will know whom to blame.

 

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The Cost of Playing Games with the Full Faith and Credit of the United States

Thursday, June 2nd, 2011

I spent last week in Rio attending a meeting of the IMF’s advisory board for the Western Hemisphere — and returned this week to Washington for the latest round of threats and charges over raising the U.S. debt limit. The contrast was, at once, disturbing and farcical. At the IMF meeting, former finance ministers, prime ministers and other ex-economic policy officials tried to unravel the grim implications for all of us if (when) Greece, Portugal or, in the worst case, Spain is forced to default on their sovereign debts. Back in Washington, congressional Republicans laid out their terms for not driving the United States into a voluntary default on its sovereign debt. Perhaps holding onto a child-like faith that bad things don’t happen to the United States, under God, they spelled out terms which everyone knows will never be accepted by President Obama and a Democratic Senate. The irony is that the GOP gambit of holding out a potential debt default if they don’t get their way could, in itself, make long-term control over deficits much harder.

The reason lies in the powerful influence of worldwide investors on our interest rates. Thankfully, global capital markets still have confidence that our two political parties can settle this dispute on reasonable terms, and that in time the United States will regain control over its deficits and debt. We know that confidence is still there, because the interest rates and yields on U.S. Treasury bills, notes and bonds all remain near historic lows. If there were real doubts about our capacity to control long-term deficits, those interest rates would be rising as investors demanded higher returns to offset the risk that we’ll fail. This confidence makes sense, because we succeeded at the same task twice before, in the 1980s and again in the 1990s. It took several years of squabbling and compromise, but President Reagan and a Democratic House agreed to raise taxes, cut defense and reduce Medicare and Medicaid spending in the 1980s — and the same pattern played out again a decade later with President Clinton and, first, a Democratic House and then a GOP one. That combination of revenues, defense and health care was, and remains today, inevitable, since those are the only pieces of fiscal policy big enough for cuts and reforms that can make a significant difference for deficits.

But neither Reagan nor Clinton faced opponents prepared to hold the full faith and credit of the United States hostage to their own partisan approach to the deficit. To make this gambit appear respectable, House Majority Leader Cantor even claimed last week that major players on Wall Street had assured him that a U.S. default would be a matter of economic indifference. The only explanation is that Mr. Cantor, without realizing it, was talking to short-sellers getting ready to bet billions that U.S. stocks and bonds might crash — as they will if we actually do default.

Happily, worldwide investors are probably correct that the likelihood of a U.S. debt default is still very, very small. If it ever came close to that, the real players on Wall Street would face down the U.S. Congress. But cutting it close may turn out to be very expensive, too.

Let’s perform a small thought experiment. A Tea-Party infused GOP takes us to the edge of default and then pulls back. A really close call, however, would almost certainly make worldwide investors nervous. They would begin to question whether our politics truly are up to the task of dealing with our deficits, so they add a small risk premium to our interest rates. Let’s say — and this would be optimistic in this scenario — that short-term rates on Treasury bills go up one-half of a percentage-point; medium-term rates on Treasury notes rise three-quarters of a percentage-point, and long-term rates on U.S. bonds increase by 1.25 percentage-points.

Now, let’s be optimistic again and assume that Congress and the President eventually agree to cut the 2012 deficit by 10 percent — $108 billion off of the current projection of $1.081 trillion. That will leave a 2012 deficit of $973 billion to be financed. The small increases to interest rates would add about $7 billion just to the first-year interest costs of the 2012 deficit. And that’s just the beginning: All publicly-held Treasury bills also have to be refinanced in 2012 — nearly $2 trillion worth at last count. The tiny 0.50 percentage-point increase in those rates would add another $10 billion to next year’s interest costs. That comes to $17 billion in extra interest costs in just the first year, and just on publically-held debt. Those premiums would become embedded in those interest rates, adding much more to our interest costs, year after year, as additional deficits have to be financed and some $7 trillion in publicly-held Treasury notes and bonds come due for refinancing. A single refinancing of that current stock of publicly-held Treasury notes and bonds, with the new risk premiums, would add more than $50 billion, per-year, to interest costs. And the actual risk premiums demanded by global investors could be significantly higher than we assume here, and so that much more expensive.

These incremental increases in interest rates also wouldn’t be confined to U.S. Treasury rates; they would be transmitted immediately to other interest rates, from mortgages to credit cards. That means the expansion would further slow, American incomes and the government’s revenues would grow less, and, lo and behold, the deficits would be even bigger.

That’s the math. Even if congressional Republicans don’t mean it, the political games they’re playing today with a U.S. debt default, purportedly in the name of fiscal responsibility, could make U.S. deficits and debt even more unmanageable, and U.S. prosperity more problematic.

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Forget about Spending and Get Serious about the Economy

Thursday, March 31st, 2011

Washington today, especially the Congress, has a textbook case of cognitive dissonance. A confluence of black swan developments may well threaten the American and global recoveries. There’s the civil war in Libya and unrest across much of the Middle East that could disrupt world energy supplies, the natural catastrophes in Japan may upend the world’s third largest economy, and several European governments are flirting with junk-bond status. On top of all this, recent data on housing, investment, and consumer spending all point to a still-fragile U.S. expansion. Yet, with all of this, Congress spends its time bickering over funds the federal government needs week to week just to keep operating.

This debate has become almost willfully wrong-headed. An economy not yet recovered fully from a historic financial meltdown and deep recession, and now facing possible major shocks from three directions, is no candidate for budget cuts. In fact, a new National Journal survey of 44 Washington economists and “economic insiders,” Democratic and Republican, found only one of the 44 who sees immediate spending cuts as the highest priority. (Full disclosure: I am one of the 44 surveyed.) If there are still any doubts about what happens when governments ignore this basic economics, consider Great Britain and Germany. Both embraced the austerity snake oil and plowed ahead with sharp spending cuts and tax increases. Two quarters later, the recoveries in both countries are stumbling badly.

Of course, these debates are not about economics at all. Here and in Europe, they’re driven by anti-government factions inside the base of each country’s conservative party. Congressional Republicans might take note, however, that this approach no better politics than it is economics. After enacting their programs, the governments of David Cameron and Angela Merkel find themselves hemorrhaging public support.

There is a time for serious debate about the role of American government in our economy and daily lives. The 2012 elections could provide a platform for real public deliberation about how much the government should do in the future to provide health care for elderly and poor people, ensure access to higher education for young people unlucky enough not to be born into affluence, or support the weapon systems, manpower and womanpower needed to wage multiple wars. At a minimum, the campaign should include some serious talk about whether the Obama administration did the right thing in driving health care coverage for most Americans.

Right now, however, is the time to focus on the clear and present dangers to the jobs and incomes of average Americans. The President made a good start this week with proposals to make the U.S. economy less energy intensive and especially less dependent on imported oil. Dealing with the continuing problems in Japan and Europe will be tougher. As we outlined last week, if the crisis in Japan persists for another month or longer, it will disrupt production here of everything that uses parts or elements made-in-Japan, from automobiles and electronics to medical equipment and even pharmaceuticals. Congress should take this time to consider steps that will help our manufacturers keep their U.S. workforces intact through such supply chain disruptions — for example, a temporary tax break on foreign earnings brought back home by manufacturers who expand their U.S. jobs. If Japan’s crisis deepens, it also will absorb all of Japanese saving, and then some. That development would likely drive sales of U.S. stocks by Japanese investors and sales of U.S. government securities by the Japanese government, creating new downward pressures on U.S. stock prices and new upward pressures on our interest rates. All of this means that the Federal Reserve and Treasury should take this time to prepare for another round of quantitative easing.  

A new debt crisis in Europe would threaten the balance sheets of our large financial institutions, yet one more time. They don’t have large holdings of Greek, Irish, Portuguese, Belgian or Spanish government debt, all of which now hang in the balance. But our big banks do have hundreds of billions of dollars in normal business with the large European banks that do carry huge portfolios of those bonds — and which might find themselves unable to carry out their contracts with our banks if another crisis hit. That’s what happened, in reverse, in September 2008, when American banks couldn’t honor their contracts with many European banks in the post-Lehman panic. Today, instead of arguing about PBS funding, congressional leaders should be quietly talking with the administration about ways to contain another financial crisis without bailouts which the public would never support again.

If the Congress and administration could refocus their current debate around these real and pressing issues, perhaps they could then move on to the longer-term problems that matter to most Americans outside the Tea Party. To begin, what can Washington do to help American businesses create new jobs at the vigorous rates we all considered merely normal, until the last decade?  There might even come a time for a serious public discussion about what steps might help reverse the corrosive income patterns of the last 30 years, which have seen a small minority of very rich and very highly-skilled Americans capture nearly all of the nation’s income gains, while middle class people stagnated and poor people lost ground.

And one point should be very clear: Budget cuts are no more of an answer to these long-term issues than they are for the more immediate problems facing the American economy.

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