Oh dear. Michael Boskin’s project syndicate article is a mess–though it seems as if Boskin has let his ideological priors impact his punditry on more than one occasion before. I have so many issues with this piece it’s hard to know where to start—I guess I’ll work my way through it from top to bottom, so here goes (Boskin quotes offset and italicized):
The political left clamors for more spending, higher taxes on high-income earners, and delayed fiscal consolidation. For example, the economist and New York Times columnist Paul Krugman proposes waiting 10-15 years.
I’ve read pretty much everything Krugman has written in the past 5 years, and I can say fairly confidently that this is not his position—Krugman’s overarching argument has been that when the economy is depressed and when interest rates are at the zero bound then fiscal policy can be a useful (temporary) stimulus stop-gap. Because our current economy fits both of those criteria, monetary policy is not an effective form of stimulus—Krugman would like to see temporary short-term stimulus (at this point he would probably take just maintaining current spending levels rather than continuing to cut spending) until the economy is off the zero bound. At that point, (when monetary policy can offset fiscal contraction), fiscal consolidation is fine. Krugman argues for a couple years (at most) of increased (or sustained) spending rather than immediate consolidation—Krugman argues that this is affordable because interest rates are low, and the real driver of long-term debt is health care costs (which won’t become a huge issue for another decade or so).
Republicans propose to balance the budget within ten years by reforming entitlement spending and taxes (with fewer exemptions, deductions, and credits providing the revenue needed to reduce personal tax rates and a corporate rate that, at 35%, is the highest in the OECD).
It is (or, rather, should be) fairly common knowledge by now, but Ryan’s proposal only balances the budget in 10 years through the use of highly dubious assumptions about revenue generation (for which he specifies exactly 0 proposals to raise the money). Theoretically it’s possible, but it would amount to a massive tax hike on lower and middle income families (as top earners receive a tax cut and social spending is slashed). Obviously it would be political suicide for either party to actually enact something like this so I think it’s fair to say the Republicans don’t have a serious proposal for balancing the budget in 10 years.
Economists agree that, at full employment, higher government spending crowds out private spending. Keynesian models claiming a quick boost from higher government spending below full employment show that the effect soon turns negative.
Boskin doesn’t cite which specific ‘Keynesian’ model he refers to in this paragraph—if I had to guess, however, I would posit that he is referring to Stanford and Hoover Institute colleague John Taylor’s recent paper—in this paper, John Taylor models the effect of increasing government spending, and concludes that within a short amount of time the spending multiplier from fiscal stimulus is negative.
The catch: Taylor assumes that a central bank counteracts the fiscal stimulus by raising interest rates and contracting the money supply. So, Taylor’s conclusion is that if fiscal and monetary policy actions offset one another, the effect on the economy is, in the short run, fairly small in either direction. Hardly a surprising result—a much more interesting and informative model would have asked what would happen if we combine fiscal stimulus w/ aggressive monetary easing at the Federal Reserve. Brad Delong (Berkeley) and Larry Summers (Harvard) did just this, and concluded that at current interest levels, fiscal stimulus pays for itself through long-run impacts on growth and tax revenue.
To be sure, recent research suggests that increased government spending can be effective in temporarily raising output and employment during deep, long-lasting recessions when the central bank has reduced its short-term policy interest rate to zero. But the same research suggests that the government spending multiplier is likely to be small or even negative in a variety of circumstances and, in any event, would quickly shrink.
Such circumstances include, first, a high debt/GDP ratio, with rising interest rates impeding growth. Likewise, during expansions, higher government spending is more likely to crowd out private spending. Spending on transfer payments and/or nonmilitary purchases – which can become entrenched or be procured more cheaply from abroad (for example, solar panels and wind turbines, respectively, in America’s 2009 fiscal stimulus) – is also likely to yield only a small multiplier. And, when the economy has flexible exchange rates, if government spending raises interest rates, the currency will strengthen, leading to a decrease in investment and net exports. Finally, the effects of additional government spending may be offset by people’s expectations of higher taxes once the central bank exits the zero lower bound on interest rates (causing them to spend less now).
OK there was a lot packed into those two paragraphs, but Boskin’s main arguments seem to boil down to 1) debt and spending are bad because they cause rising interest rates and 2) spending money on anything but the military is dumb.
Boskin’s whole argument here seems to miss the fact that interest rates are functionally 0 right now. Short term rates are held at 0 by the Fed, and long term rates are a function of expected inflation and the expected path of short term rates—because growth expectations are so low right now, long-term interest rates are paying a negative real interest rate. The only way that these rates start to rise is if the market expects the US economy to return to full strength in the near future. At that point, fiscal stimulus would no longer be necessary—as I mentioned above—fiscal stimulus proponents just want to use it very temporarily to get US interest rates off of the lower bound. (More technical Delong summary). Boskin’s entire argument is irrelevant because no credible macro-economist is suggesting America continue to engage in counter-cyclical fiscal policy if interest rates rise significantly. Boskin’s other argument about non-defense spending is also weird—sure, there are inefficient things the government can (and does) spend money on—but defense isn’t the only efficient way to spend money (and DoD spending is inefficient as well–DoD contracts are typically run on a long-term, sole-source, profit guaranteed basis; firms have no incentive to keep down costs because profits are guaranteed and there is no competition because contracts are sole-source). There is no economic reason to favor defense spending over other sorts of spending; Boskin was making a purely ideological argument there. Last, Boskin seems to be making some sort of argument about Ricardian equivalence—households today will cut spending (if government spending increases) because of an expected rise in future taxes. Krugman has the take-down here; basically, even if spending did fall in anticipation of higher expected future taxes, it would, at most, offset only a small proportion of current spending.
These considerations apply to the US and some European countries today. Together with poor design, they explain why America’s 2009 stimulus cost several hundred thousand dollars per temporary job created.
This argument is just silly—the stimulus was a one-off spending surge—jobs created today continue to be valuable and add to GDP well into the future. Let’s say the government spent 200k to save a teacher’s job and then that teacher works for 10 more years (without the stimulus the teacher is laid off; due to her/his age, the teacher cannot find meaningful work again and eventually leaves the labor force). At an average salary of $56k, that teacher’s job will have contributed 560k to GDP over 10 yrs for the cost of 200k, over 100k of which will have been paid back to the government in the form of taxes—seems like a reasonable investment to me. This, of course, also neglects the significant (but more difficult to measure) benefit that stemmed from more cash in hand from payroll tax cuts, etc.
Recent research also reveals that in OECD countries since World War II, successful fiscal consolidation – defined as stabilizing the budget while avoiding recession – averaged $5-$6 of actual spending cuts per dollar of tax hikes. Cuts in spending, especially on entitlements and transfers, were far less likely to cause recessions than tax increases were.
Again, here, Boskin fails to cite which specific research he is referring to, but I am fairly confident that it is an Alesina and Ardagna paper from 2009 in which the authors argue that successful fiscal consolidation in the OECD between 1970 and 2007 has occurred through spending cuts rather than tax increases. Of course, what Boskin (again) fails to mention is that the fiscal adjustments that Alesina+Ardagna examine differ significantly from current economic conditions in the US and Europe—in many cases, the spending cuts were enacted as the economy was already expanding—in the few cases where the fiscal contraction occurred in a troubled economy, monetary policy offset fiscal contraction.
Faced with these criticisms in 2010, Alesina responded that “Several European countries have started drastic plans of fiscal adjustment in the middle of a fragile recovery. At the time of this writing, it appears that European speed of recovery is sustained, faster than that of the U.S., and the ECB has recently significantly raised growth forecasts for the Euro area.” Unfortunately for Alesina, this prediction turned out to be utterly laughable–austerity has caused significant economic harm in Europe while also causing debt-to-GDP ratios to grow in countries practicing austerity.
Worse yet, the cost of delay and increased deficits and debt is enormous. For example, without major reform in the US entitlement programs – which are exploding in size as a result of rising real benefits per beneficiary and an aging population – the next generation can expect a 20% reduction in living standards.
We’ve already touched on this, so I’ll go through this point quickly. As I’ve already discussed, debt costs are at historic lows today. The deficit is already under control, and will be even more so once a full economic recovery takes place and automatic stabilizer spending drops and tax revenue rises. Then there will be plenty of time to deal with rising medical care costs (which are the true driver of long-term deficits).
The one thing I want to add is to just touch on the circular nature of this logic—Boskin is arguing that we should actively reduce living standards today to avoid a completely hypothetical (at this point) reduction in living standards 30 years in the future. I just do not understand this logic…if Congress is so untrustworthy and inept, even if we do make costly adjustments today to better our fiscal prospects 30 years down the road, there is no guarantee that a future Congress won’t undo the changes before that time—look at the Bush administration’s squandering of the Clinton surplus (is it unfair to point out that Boskin was an economic advisor for Bush?) It seems to me that Congress has a responsibility to its current constituents—it would be relatively simple to end the current reduction in living standards caused by continuing economic under-performance; we should focus on solving that problem rather than worrying about hypothetical problems a generation off.
I should also point out that Boskin’s proposed policies—“structural” changes to benefit formulas and raising retirement ages—will do nothing to constrain actual costs; instead, they will just pay out less and less money over time (which, while lowering government expenditures, will lead to the exact reduction in living standards that Boskin claims to want to avoid as medical costs price millions of individuals out of insurance markets). This is just another thinly veiled ideological argument that is much more about Boskin’s personal views on what the government should and should not be doing, and Project Syndicate deserves better analysis from its paid contributors.