DougJ’s post on the pure unadulterated badness of the recession has had me reading through the last few posts by Karl Smith over at Modeled Behavior. From the one DougJ linked to, this particularly compelling passage:
We have very low capacity utilization (75%) and very high unemployment (10%).
That is, we have factories sitting idle for lack of workers – low capacity utilization. At the same time we have workers sitting idle for lack of factories – high unemployment.
There are machines waiting to be worked and people waiting to work them but they are not getting together. The labor market is failing to clear.
This is a fucking disaster.
Excuse my language, but you have to get that this is a big deal. This is not a big deal like the GOP doesn’t appreciate public goods. Or, Democrats don’t understand incentives. Or some other such second order debate that could reasonably concern us in different times.
This is a failure of our basic institutions of production. The job of the market is to bring together willing buyers with willing sellers in order to produce value. This is not happening and as a result literally trillions of dollars in value are not being produced.
Let me say that again because I think it fails to sink in – literally trillions of dollars in value are not being produced. Not misallocated. Not spent on programs you don’t approve of or distributed in tax cuts you don’t like. Trillions of dollars in value are not produced at all. Gone from the world entirely. Never to be had, by anyone, anywhere, at any time. Pure unadulterated loss.
A couple posts down, Smith writes about his preferred methods of patching up the recession, noting that a payroll tax holiday would have been the quickest way to increase spending across the economy.
The key difference here is that is that payroll tax funds would have been spent nearly three times faster than the stimulus we actually got. At the current rate we were only stimulating a little over $300 Billion a year and nearly half of that was tax cuts.
The gain in multiplier effect from spending is simply dwarfed by the speed at which spending can be efficiently performed. Indeed, if you believe Zandi’s estimates that many of the tax cuts enacted as a part of ARRA had lower multipliers – in some cases much lower – than a payroll tax holiday then ARRA may have had no multiplier advantage at all. All we were looking at was a smaller, slower stimulus.
Note that this is argument doesn’t require you think that big government is bad for the economy or that tax cuts for the rich will stimulate entrepreneurship. We are merely analyzing the fastest way to get spending power into the hands of ordinary Americans. It seems clear to me that this was and has always been a payroll tax holiday.
His list of priorities:
1) Higher Inflation Target (and hence lower real rates)
2) Qualitative Easing (and hence easier credit)
3) Payroll Tax Stimulus (fast and fun!)
4) Other Stimulus (messy but better than nothing)
I guess my question would be how these two arguments jibe. If this is a “failure of our basic institutions of production” I’m not sure how a payroll tax holiday will really work the way it does in theory. I understand that the payroll tax holiday is the quickest, most efficient way to pump money into the economy and increase spending, but – if A) overly indebted consumers and businesses simply save the extra cash or use it to repair their balance sheets and B) the idle factories and idle workers still don’t end up connecting with one another due to a failed increase in private demand, how will the tax holiday actually lead to increased economic activity, lower unemployment, etc? Uncertainty over prices – especially deflation in the housing market – makes this more pronounced.
I understand how a higher inflation target and qualitative easing should lead to increased borrowing and lending and get our economic cogs turning to some degree, and if that’s happening already I can see how more people might be willing to part with their saved tax dollars. But that’s not happening. Maybe we haven’t done enough, but rational consumers are still not spending, firms are still not really hiring, lenders are still not really lending. And again – if workers still can’t find their way to the machines -then what?
Messy as direct government spending may be, doesn’t it make sense to generate demand with public dollars rather than gamble on an increase in demand by private consumers? Think of it like an economic defibrillator. You need to get the economy moving again, out of this state of paralysis and shock, and the only actor who can spend without risk is the government. Consumers, firms, lenders are all acting under the influence of massive uncertainty.
As Krugman notes, there are some places where government spending is simply necessary. Namely, infrastructure – though I was also surprised (though not that surprised) by how relatively tiny the $50 billion the president proposed for infrastructure stimulus was. Why not start big and whiddle your way down? The Bush administration, for instance, brought an entire Axis of Evil to the table, but settled for just one of three. Why can’t Democrats propose a $500 billion infrastructure bill? Anyways…
So suppose we’re going to put $50 billion of resources that would otherwise be idle to work. Is it better to use them to produce public goods like improved roads, or private goods like more consumer durables? That’s not at all obvious — and anyone who tells you that basic economics settles the question, that is says that devoting more resources to production of private goods is better, doesn’t understand Econ 101.
And there’s a pretty good argument to be made that we are, in fact, starved for public goods in this country, so that it would actually be a good idea to shift some resources to public goods production even if we were at full employment; in that case, we should definitely give priority to public goods when trying to put unemployed resources to work.
Infrastructure and other public goods aside, isn’t the point of stimulus to get the economy’s heart beating again? Unlike tax cuts, public spending will lead to an increase in demand by definition (supposing the money is actually spent in a timely fashion); demand will lead to a ramping up of production; this in turn leads to increased hiring, etc. Even if the spending is temporary, it still also generates secondary sources of demand. Newly hired workers will have money to spend on goods and services, leading to increased hiring in those sectors. Increased confidence economy wide will lead to increased borrowing and lending. If the government decided to purchase a new fleet of hybrid cars, for instance, this would immediately lead to workers finding their way to factories. And so on and so forth. At this point a payroll tax holiday might really pay off.[Edit – the formatting, as far as I can tell, goes entirely bonkers at this point and I can’t seem to fix it. Have amputated the last bit entirely until such a time as I can make proper repairs.]