WRFest 20Jan08(Economics): Oops...Recession Ahead
Economics and economic policy is one of those things that most people ignore, take for granted and find making their heads hurt. Unfortunately, for good or ill, it conditions most of the rest of what we can do. Just in case you were living in another world, or paying attention to purely "practical" things last week not only did the major US markets continue tanking but the escalating chorus of cries for some sort of combined monetary and fiscal stimulus effort to short-circuit an increasingly likely US recession were capstoned by Ben Bernanke's Congressional testimony and Pres. Bush's call for a $150B fiscal stimulus program. Please understand that these efforts are necessary and vital but are unlikely to prevent a recession that's likely already underway. The real goal here is to a) mitigate the damage and b) prevent it from metastasizing into something much worse given the weaknesses in credit markets and the housing sector. And also c) to keep worldwide problems from feeding back to severely, as it increasingly turns out that the rest of the world is not in fact decoupled from the US.
At this point you may be going, oh my god...he's off on economics. Please don't or why do I care ? Several of the excerpts below will speak directly to that question of course. And it's an interesting one - for several years now it seems a conversation I"ve been having with several friends, all of whom would rather not think about it, by and large. Part of the problem is that everyone confuses economics with business or finance, which are significant parts but not the subject as a whole. Economics on a small scale is about finding the best use of available resources to get the most done with those resources. On a large, or macro-, scale it's about the complexities of making sure that the most people have the most jobs and overall welfare and well-being is moving ahead as well as possible. Put another way all the other things we think we need to do from protect our national interests to reform education to changing healthcare to paying for pensions involve economics, on several levels. First off designing workable programs and paying for them is often 90% a problem in micro-economics. But second off without a healthy macro-economy we end up being unable to pursue any of these other initiatives.
There's a Latin tag phrase somebody explained to me once - sine qua non. That without which there is no other. Economics is the sine qua non of a healthy society.
When Antwerp fell to the besieging Spanish army in the 16thC and was sacked because the siege had been long & ugly and the bankrupt Spanish monarchy hadn't paid the troops in months it destroyed a major port and trading center that had risen to prominence as the major economic and financial powerhouse of Europe. Its' destruction during the Dutch-Spanish 80 Years War lead to the rise of Amsterdam as its' replacement and the eventual independence of the Dutch and their leading role on the world-stage for two centuries as a major trading, economic and politico-military power. After months of successfully defending themselves do you know what one of the primary triggers was ? The city fathers put price controls on smuggled food and smugglers would no longer take the risks to bring in the supplies that had been keeping the city alive. After a few months the starving city was so weakened it fell to the Spanish troops.
Be careful what you wish, understand that often supposed unintended consequences are the results not of ignorance but of either not thinking things thru to the next step. Or of believing what we'd like to believe in the face of all evidence to the contrary.
Speaking of which at least skim these readings and ask yourself a) how bad you think this problem might be, b) what you think of which candidates proposals and c) whether you're willing to let them "play politics" for partisan advantage for what could be a major problem shortly ? And for the next several years. Several of the excerpts are well worth at least skimming if not going to and reading but the three that are sort of the minimal set are one on the consequences for future generations (Change for our Children), the economic sense and sensibilities of the candidates (What Are They Thinking) and an introduction to some sound thinking on fiscal policy (which admittedly is a little more rigorous but...)General
Fallout from the global credit crunch has darkened the outlook for the U.S. and global economies since the World Economic Forum last met in Davos. The turnaround promises to create a whole new A-list of stars this year. When the elite of global business gather in Davos, Switzerland, for their annual retreat next week, the mood will be dramatically darker than just a year ago. Since the World Economic Forum last met in Davos, fallout from the global credit crunch has transformed the outlook for the U.S. and global economies for the worse. Power and wealth have shifted from West to East, from major oil companies to petro-governments, and from U.S. banks and hedge funds to the state-controlled investment funds of the Middle East and Asia. The turnaround promises to create a whole new A-list of stars this year in Davos, including once obscure sovereign-wealth-fund managers, formerly boring central bankers and previously ignored bearish economists. "There is a sea change going through business," said Nigel Doughty, chairman of British private-equity firm Doughty Hanson & Co. and a Davos veteran. "The whole landscape has changed, not least because of the decline in influence of Western nation states." Few saw it coming. When Citigroup Inc.'s then chief executive officer, Charles Prince, predicted a "benign" year for the global economy and financial markets last January in Davos, he was in good company. U.S. and European bankers, industry chiefs and political leaders bubbled with confidence as they clinked glasses in the tony ski resort.
Prepare for a global economic downturn Any assessment of the world economy in 2008 depends on the likelihood, depth and length of a US economic downturn and the magnitude of a global spillover. Any forecast is thus contingent on how we answer the following three questions. Will the financial crisis continue in 2008? Will inflation expectations rise further? Last, will there be a disorderly process of global rebalancing? If we answer all three questions with Yes, we should prepare for a global depression. If the answer is No, the world economy will have another good year. There are many intermediate scenarios as well. I would answer the first question with an unqualified Yes. The financial crisis will probably linger on for most of the year and may get worse before it gets better. The macroeconomic effects of a financial and banking crisis of such scale are not trivial. Economic forecasters frequently underestimate the importance of credit and financial channels. What saved the US economy during the 2001 recession was a booming housing market and the availability of cheap consumer credit. This time many of those mechanisms work in reverse. The third risk is a disorderly unwinding of global imbalances, in particular a collapse in the exchange rate of the dollar against the euro and the yen. That could occur if central banks in Asia, Russia and the Middle East were to shift reserve assets out of dollars on a large scale. On this score, I am more optimistic. What about the rest of the world? Can it decouple? The answer is No. Both Asia and Europe should expect to see a significant reduction in economic growth, too. Asia will be mainly affected through the trade channel, given its reliance on the US as consumer of last resort. The biggest crisis transmission mechanism to Europe is the financial market. But Asia and Europe are in a relatively strong position to avoid recessions. Asia’s economic health will rest crucially on continued financial stability. The biggest current risk to China, for example, would be an implosion of overvalued stock prices. In the eurozone, there are already signs of an economic downturn, but fiscal policy could prove to be an important counter-cyclical stabiliser this time.
What Are They Thinking? In the past week, I have been in the car coming home late from work, with the presidential debates are on the radio. It is very discouraging to listen to what passes for economic literacy among the candidates. In reality, many candidates are espousing policies that are quite dangerous at worst, or simply misleading at best. Far too many in both parties tell a frustrated America what it wants to hear, rather than the economic reality. The Republicans have some of the worst offenders. So, today we will look at some economic reality. We tackle trade deficits, the dollar, taxes (the "Fair Tax"), how should we stimulate the economy as we slip into recession, and global trade. I think we will cover enough that I can just about guarantee to offend most of my readers at some point. But the main point I want you to take away from all this is that the simple one-line answers given at these debates might work to fool most of the voters and tell them what they want to hear, but they are not based in economic reality. While this is of more interest to US citizens, the principles apply across borders. So, let's jump right in.
A Primer on Fiscal Stimulus Although monetary policy should generally be the first line of defense against an economic slowdown, there are several circumstances in which fiscal stimulus can be helpful or even crucial. Two of these circumstances are potentially relevant today: one is if a sharp economic downturn appears imminent, and well-designed tax or spending changes could be implemented quickly; such fiscal stimulus could boost economic activity more quickly than monetary stimulus. The other circumstance is if, allowing for uncertainty about the effects of fiscal and monetary stimulus, a mixture of the two provides greater confidence about the economic outcome. However, it would be better not to have a fiscal stimulus at all than to have tax cuts or spending increases that are poorly timed, badly targeted, or permanently increase the budget deficit. A purported stimulus package with these characteristics could have small or non-existent short-run benefits and a substantial long-run cost.
Politics, Policy and Economics
'Change' For Our Children Our children face a future of rising taxes, squeezed -- and perhaps falling -- public services, and aging -- perhaps deteriorating -- public infrastructure (roads, sewers, transit systems). Today's young workers and children are about to be engulfed by a massive income transfer from young to old that will perversely make it harder for them to afford their own children. No major candidate of either party proposes to do much about this, even though the facts are well-known. Spending for Social Security, Medicare and Medicaid -- three programs that go overwhelmingly to older Americans -- already represents more than 40 percent of federal spending. A new report from the Congressional Budget Office projects these programs could equal about 70 percent of the present budget by 2030. Without implausibly large budget deficits, the only way to preserve most other government programs would be huge tax increases (about 40 percent from today's levels). Avoiding the tax increases would require draconian cuts in other programs (about 60 percent). Workers and young families, not retirees, would bear the brunt of either higher taxes or degraded public services. Similar pressures, though less ferocious, exist at the state and local levels. Schools, police, libraries and parks will be squeezed by the need to pay benefits for retired government workers.
Economic anxieties for the middle-class Republican candidates could be in big trouble in 2008 if the sluggish U.S. economy doesn't turn around quickly as worries about jobs, housing, and energy prices are overtaking war concerns. Presidential elections often become a referendum on the economy, with the party of the White House incumbent assigned the credit or the blame for whatever happens in the economy. The official stats may say the economy grew at a 4.9% rate in the third quarter, but what's more important to voters is what will happen over the next 11 months. Most economists are forecasting much slower growth, perhaps just 1% in the current quarter. The odds of a recession next year have grown to more than 40%, according to some big Wall Street firms. Even the White House, which is much more optimistic than private forecasters, is projecting only average growth in 2008. A bigger problem for the Republicans is that voters aren't hopeful about the economy, and weren't even during the best days of expansion in 2004 and 2005.Where's leadership on economic issues? The best presidents know when to lead and when to follow. The current crop of candidates isn't doing either when it comes to the biggest issues facing the economy: health care and energy. The campaign stop in Michigan this week was tailor-made for one candidate to break away from the pack by showing a willingness to follow the public's lead on health care while providing some real leadership on energy. But it didn't happen. Michigan's economy has been devastated by the transformation of motor vehicle manufacturing. Once Detroit was the center of that world, with the best designers, engineers and production workers. But now, the Big Three auto companies are only a shadow of their former greatness. What's happened to Michigan? The same thing that's hurting companies and consumers all over America: Exploding costs for health care and energy. Fixing those problems would go a long way toward fixing Michigan, and the rest of the U.S. economy as well. Fixing those problems requires a flexible approach and an awareness that the problem with health care is that it's too expensive, while the problem with energy is that it's too cheap.
A Revival of 1992’s Glum Mood The details of the economic slump have changed since the ’92 presidential race, but the main story line remains much the same. The economic worries of 1992 helped elect Mr. Clinton, of course. And by the end of the decade, thanks to both his policies and a huge stock market bubble, the American economy was roaring along again. The deep anxiety of 1992 seemed to be a piece of economic history. No more. Almost 16 years after Mr. Clinton’s speech at Wharton, the economy is again dominating a presidential race. While the details have changed, the main story line remains remarkably similar. A downturn has reawakened fears that the economy no longer works very well for the middle class. Today, as was the case 16 years ago, the downturn itself isn’t the main problem. By 1992, as a matter of fact, the economy was already growing again. This year, it’s still possible — if less likely after Tuesday’s dismal retail sales report and another sharp decline in stock prices — that the country will avoid a full-blown recession. The main problem now is that the good times are no longer good enough to carry the middle class through the bad times. For much of the last 35 years, the incomes of most workers have been growing far more slowly than they once did. In the current expansion, which started in 2001, the median weekly paycheck of workers has actually fallen 1 percent, once inflation is taken into account, according to the Labor Department. Economists argue about the reasons for the great wage slowdown — technology, globalization, health care costs, the decline of unions, the rise of the new wealthy — but it clearly seems to have made people feel more vulnerable to small economic swings. In the latest New York Times/CBS News poll, only 19 percent of those responding said the country was headed in the right direction. That was the lowest percentage since the early 1990s.
Economic handouts we don't need Everyone from the Bush administration and the presidential candidates to your barber has a plan to ward off a recession -- and they're mostly lousy ideas that'll waste our tax money. If you believe in the tooth fairy, the Democratic candidates' proposals are the most compelling. Sen. Hillary Clinton has offered a $70 billion stimulus plan that includes low-income fuel assistance, extended unemployment benefits and outright grants to local governments for things such as health care and street repair, as well as a $40 billion tax cut contingent on certain negative events occurring, such as continued job market contraction. Meanwhile, the Republican candidates have mostly focused on toeing the administration line, with Rudy Giuliani, for one, pushing permanent tax cuts for individuals and corporations. A pair of economists have written a great paper for the Brookings Institution that lays out an analytical framework for understanding what has worked in the past, and though that institution has served as a think tank for Democrats and will therefore be dismissed out of hand by the GOP, I hope all sides will take the paper's findings to heart. The paper by Douglas W. Elmendorf and Jason Furman says effective stimulus must be timely, targeted and temporary, and that a combination of tax rebates and direct government spending on anything but infrastructure (because it takes too long) has the most immediate boost to the economy. The paper says the most popular Republican ideas, such as cuts in marginal tax rates and investment incentives, take effect too slowly.
Bush Calls for Major Stimulus Bush unveiled a stimulus plan of tax cuts and rebates that could reach $150 billion, aimed at boosting business and consumer spending. Democrats argue that the plan doesn't address the problems of homeowners and low-income people hit by high oil prices.