Four broad approaches to the aftermath of the banking panic and financial crash of 2007-09 have been proposed: stimulus, forgiveness, somewhat accelerated central bank-mediated inflation and structural reform (aka spending cuts). In the course of making an argument in the Financial Times (registration required) last week for a little inflation, his preferred option, Harvard’s Kenneth Rogoff supplied a useful reminder.
Noting the widespread skepticism about the efficacy of heavy government spending on public works as a means of stimulating growth, Rogoff explained, “Higher debt adds to an overhang of higher future expected taxes on top of existing private debt overhang. True, in the classic [Keynesian] analysis… the ideal policy is a money-financed temporary surge in government spending. But the canonical model completely ignores debt overhang.”
This is a light touch of “Ricardian equivalence,” named for the great classical economist David Ricardo, who in an essay in 1820 supposed that it wouldn’t make much difference to present-day demand whether a government financed a war through taxes or debt, since most canny citizens, recognizing the pay-me-now-or-pay-me-later logic of the situation, would begin to reduce their present-day spending accordingly. Robert Barro, today of Harvard University, translated the proposition into a influential (and hotly debated) formal model in 1974, just as forward-looking expectations were beginning to make their way into macroeconomic reasoning. They have become a standard feature since.
But neither Barro nor the others who have worked on public finance over the years have been honored with a Nobel prize. When that happens, expect the popular conversation about the economics of government deficits to go through the usual adjustments. Barro, meanwhile, has compared the generous “multiplier” that White House economists assigned to their stimulus to the extravagant claims in the early 1980s that the Reagan tax cuts would be self-financing.
An unusually bold specimen of a structural reform has been proposed by the irrepressible Reuven Brenner, of McGill University’s Faculty of Management, author of eight highly original books and a frequent consultant to banks and hedge funds. His “Three-Year Plan” advocates graduating high school students into the labor force after three years instead of four, and junior college students after one instead of two.
Sending four million new workers a year into the labor force and keeping them there until they retire would add something like $1 trillion in wealth per cohort, Brenner figures – assuming starting salaries of $20,000 that, for the sake of argument, never go up, and an 8 percent discount rate – a gain to be realized not just once, but year after year. Moving up the starting line could as save as much as or even more than moving back the retirement age, he says.
What would be lost? Not much, according to Brenner, a long-time critic of higher education. (He thinks far too many Americans go to college anyway). There is plenty of slack in the high school curriculum, at least where most students are concerned. Gifted teachers could be attracted back to public schools with the promise of teaching better-motivated students.
But would those sixteen- and seventeen-year-olds find jobs after they were turned out of the nest? Or would the measure simply add most of another 4 million job-seekers annually to the unemployment rolls? For that, Brenner has an even less politically correct solution: let large numbers of young, ambitious immigrants into the US. Educational bureaucrats do a lousy job matching talent and capital, he says; get rid of them and let entrepreneurs do the job instead.
Whatever else, Brenner makes his readers think.
The Economist in its cover editorial this week dismisses the possibility that the riots in Great Britain have something to do with the Conservative government’s public-spending cuts. That the disturbances are the first looting since the Thatcher cuts is often pointed out. But this is just “lazy fantasy” of the Left, says the editorial “Unlike the riots in Britain in the 1980s, Los Angeles in 1992 or France in 2005, these [riots] were not overtly political or racial. And since the cuts have barely bitten yet, that explanation doesn’t wash.”
Perhaps the prospective spending cuts on police themselves played a role – a topic that was the talk of London last week (here, here, and here), but which rates a single sentence in The Economist’s five pages of coverage. Conservative Prime Minister David Cameron last week told Parliament that he can cut the police force some twenty percent over the next few years, including around 16,000 officers, and keep the same presence on the street, by sending office cops back to the beat.
What the police think about the cuts is not much mentioned, still less how the changes might influence their behavior, and their relationships with the communities whom they protect. A sidebar notes that police computer countermeasures units are chronically understaffed. “All they can do is kiddie porn, terrorism and murder,” notes a Cambridge expert. “They don’t even bother with bank fraud…. If you want the surveillance society to become a reality, you’re going t have to increase budgets by an order of magnitude.”
The value of EconomicPrincipals as a source of alternative views has rarely been displayed more clearly than last week, when The New York Times ran What Happened to Obama?, an essay by Drew Westen, in its weekly Review section.
Westen, a peripatetic psychology professor at Emory University, is author of The Political Brain: The Role of Emotion in Deciding the Fate of the Nation, in which he argues that strong narratives are an essential part of our political lives.
The story he tells involves a close parallel between the 1930s and the present day. He wishes Barack Obama was more like Franklin D. Roosevelt: bold, confrontational, and possessed of a winning hand. But he ignores both the sharp political divisions of the present day and the sources of the present crisis.
It is true that the leverage-fueled technology boom that led to the crisis bears a strong resemblance to the 1920s. And Rogoff is probably right in labeling the current event “the Second Great Contraction,” to stress its magnitude resemblance to the events that followed the 1929 stock market Crash.
The differences are more striking. Unemployment is 9 percent today instead of 25 percent, thanks to effective central banking. And instead of being mired in depression, much of the rest of the world is growing rapidly.
The shock to American self-esteem has been considerable. But the situation more nearly resembles the beginning of the Cold War than the global disorder and domestic despair that gave momentum to Roosevelt’s presidency. Obama has doing the right thing, more or less, given the presence of a wholly intransigent minority of zealots: seek unity, isolate the fear-mongers, and move ahead.
2 responses to “A Three Year Plan and Other Topics”
There’s “debt overhang” argument is not valid in the context of temporary government spending increases in a recession.
1. “When there is spare capacity. . . demand policies can bring the economy closer to potential. . . By doing so they will be increasing the overall output and income of the country. And this additional income is the source of potential increases in private spending and tax revenues.”
2. “. . . standard lifecycle models of consumptions (e.g., Ricardian Equivalence) do not predict a fully offsetting reduction in consumption [for temporary increases in government spending].”
3. “And even when the change is permanent, the empirical evidence does not support anything close to the full offset predicted theoretically from Ricardian equivalence.”
“What would be lost?”
What would be lost is much of the consumption of people in the 17-to-25 years, if we measure “consumption” by the enjoyment of life. As far as I can tell, even more than in the past, college students major in drinking and the occasional hookup. Forcing them to study harder would be as welcome as telling Americans they have to live in houses so small that they can actually afford them…