Depression 2.0--Evidence & Expert Opinion

Evidence for the economic downturn continues to pile up:

Evidence of a recession piled ever higher Friday, with new figures showing Americans are spending less and gloomy about the economy, while the government signaled it won't buy stock in the financing arms of auto companies to prop them up. The Commerce Department reported consumer spending dropped a sharp 0.3 percent in September while their incomes, the fuel for future spending, managed only a small 0.2 percent gain. That followed a report a day earlier that the U.S. economy shrank by 0.3 percent in the third quarter.

Note the small income gain.

Nobel laureate Joseph Stiglitz has an article, "Reversal of Fortune," in the November issue of Vanity Fair. He argues that the Bush administration's feckless stewardship of the American economy, focusing mostly on tax cuts for the wealthiest, have left American nearly adrift, with few good options going forward.

He writes:

A unique combination of ideology, special-interest pressure, populist politics, bad economics, and sheer incompetence has brought us to our present condition.

Ideology proclaimed that markets were always good and government always bad. While George W. Bush has done as much as he can to ensure that government lives up to that reputation—it is the one area where he has overperformed—the fact is that key problems facing our society cannot be addressed without an effective government, whether it’s maintaining national security or protecting the environment. Our economy rests on public investments in technology, such as the Internet. While Bush’s ideology led him to underestimate the importance of government, it also led him to underestimate the limitations of markets.

We should note immediately that the ideology described above is identical to the one proposed by the McCain campaign. It is implicit in the Joe the Plumber show, and is sharply apparent in the "redistributionist" charges leveled at Obama.

Stiglitz goes on to note that free market fundamentalism is a failure:

Economic theory—and historical experience—long ago proved the need for regulation of financial markets. But ever since the Reagan presidency, deregulation has been the prevailing religion. Never mind that the few times “free banking” has been tried—most recently in Pinochet’s Chile, under the influence of the doctrinaire free-market theorist Milton Friedman—the experiment has ended in disaster. Chile is still paying back the debts from its misadventure. With massive problems in 1987 (remember Black Friday, when stock markets plunged almost 25 percent), 1989 (the savings-and-loan debacle), 1997 (the East Asia financial crisis), 1998 (the bailout of Long Term Capital Management), and 2001–02 (the collapses of Enron and WorldCom), one might think there would be more skepticism about the wisdom of leaving markets to themselves.

The new populist rhetoric of the right—persuading taxpayers that ordinary people always know how to spend money better than the government does, and promising a new world without budget constraints, where every tax cut generates more revenue—hasn’t helped matters. Special interests took advantage of this seductive mixture of populism and free-market ideology. They also bent the rules to suit themselves. Corporations and the wealthy argued that lowering their tax rates would lead to more savings; they got the tax breaks, but America’s household savings rate not only didn’t rise, it dropped to levels not seen in 75 years.

Those two paragraphs really matter, for they should lead to an outright rejection of the hypothesis that "growing the economy" is best accomplished by cutting taxes of the "job creators" (the top 2%). But this particular hypothesis no longer functions as a provisional statement detailing relationships in reality. Rather, it is a dogma, a quasi-religious faith in markets, one that far exceeds any cheering Adam Smith ever did, for he, at least, recognized the potential for market failures.

More tax breaks for the rich, a la McCain/Palin, is irrational, for those at lower income levels deserve tax relief, too, as Stiglitz argues:

Our tax policies need to be changed. There is something deeply peculiar about having rich individuals who make their money speculating on real estate or stocks paying lower taxes than middle-class Americans, whose income is derived from wages and salaries; something peculiar and indeed offensive about having those whose income is derived from inherited stocks paying lower taxes than those who put in a 50-hour workweek. Skewing the tax rates in the other direction would provide better incentives where they count and would more effectively stimulate the economy, with more revenues and lower deficits.

Yeah, that's one of things about lowering capital gains tax rates to levels below marginal income tax rates: one ends up paying more taxes on income derived on work than on income derived from either the sale of stock or from the dividends earned from a trust fund. Now that's irrational: to tax work more than non-work.

Stiglitz suggests we spend on infrastructure, give federal aid to states, and reject Bush-McCain economics:

Spending money on needed investments—infrastructure, education, technology—will yield double dividends. It will increase incomes today while laying the foundations for future employment and economic growth. Investments in energy efficiency will pay triple dividends—yielding environmental benefits in addition to the short- and long-run economic benefits.

The federal government needs to give a hand to states and localities—their tax revenues are plummeting, and without help they will face costly cutbacks in investment and in basic human services. The poor will suffer today, and growth will suffer tomorrow. The big advantage of a program to make up for the shortfall in the revenues of states and localities is that it would provide money in the amounts needed: if the economy recovers quickly, the shortfall will be small; if the downturn is long, as I fear will be the case, the shortfall will be large.

These measures are the opposite of what the administration—along with the Republican presidential nominee, John McCain—has been urging. It has always believed that tax cuts, especially for the rich, are the solution to the economy’s ills. In fact, the tax cuts in 2001 and 2003 set the stage for the current crisis. They did virtually nothing to stimulate the economy, and they left the burden of keeping the economy on life support to monetary policy alone. America’s problem today is not that households consume too little; on the contrary, with a savings rate barely above zero, it is clear we consume too much. But the administration hopes to encourage our spendthrift ways.

But monetary policy has lost its traction. And we face a liquidity trap, meaning public sector spending is really the only lever left for effective action.