links for 2009-07-24
Lunch with Neel Sinhababu

Barry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

Barry Eichengreen said he never understood the math of the stimulus:

All Stimulus Roads Lead to China: Now that the “green shoots” of recovery have withered, the debate over fiscal stimulus is back with a vengeance. In the US, those who argue for another stimulus package observe that it was always wishful thinking to believe that a $787bn package could offset a $3tn fall in private spending. But unemployment has risen even faster and further than expected. Combine this with the continued fall in housing prices, and it is understandable that consumer spending remains depressed. The banks, having been recapitalised only to the extent necessary to keep them afloat, still have weak balance sheets. Their consequent reluctance to lend constrains investment. Meanwhile, state governments, seeing revenues fall as a result of lower taxable incomes last year, are cutting back like mad. If there was a case for additional stimulus back in February, that case is even stronger now...

And then I think Barry takes a misstep:

But the case against additional stimulus is also strong. The US federal deficit is an alarming 12% of GDP, and public debt as a share of national income is already projected to double, to 80% of GDP. The idea that the US can grow out of its debt burden, as did Finland and Sweden following their financial crises in the 1990s, seems unrealistic...

At a 3% per year average inflation rate, the trend growth rate of nominal GDP in America is somewhere between 6% and 7%. The U.S. Treasury can currently borrow at 3 years for a nominal interest rate of 1.62%, for ten years at a nominal interest rate of 3.72%, and for 30 years at a nominal interest rate of 4.58%. When the growth rate of your economy is greater than the interest rate you have to pay, that is the definition of "grow[ing your way] out of [your] debt burden--as long as you can keep your budget in primary balance: keep non-interest spending at or less than your revenues so that your net nominal debt issues are zero.

Is the U.S. in primary balance? Almost--if you take the CBO's "Alternative Fiscal Scenario" as your baseline, which you should, it wouldn't take much in the way of tax increases to get us there by 2012. We should, I firmly believe, put those tax increases in place now: pass legislation with standby triggers so that if we are not in primary surplus by 2012 the surtaxes kick in. And doing so does not seem unrealistic to me at least.

CBO Extended Baseline:

CBO Alternative Baseline:

U.S. Treasury - Daily Treasury Yield Curve

The fact is that the approporiate fiscal policy for the U.S, right now is to pass: (a) a bigger stimulus over the next two years, (b) a standby tax increase to return the federal budget to primary surplus by 2012, and (c) devout and lengthy prayers that confidence in the dollar doesn't collapse and send interest rates on U.S. Treasuries above the economy's growth rate--in which case the situation changes from its current value of "dire" to "catastrophic."

But Barry appears to think differently:

[M]ore deficit spending will only stoke fears of higher future taxes and inflation... encourage the reemergence of global imbalances... not reassure consumers or investors.... [T]he politics all point in one direction. The US Congress lacks the stomach for another stimulus package.... Disappointment over the effects of the TARP has already destroyed popular – and Congressional – support for more public money to recapitalise the banks. So, even those who find the economic logic of arguments for fiscal activism compelling must acknowledge that the politics are not supportive. A second stimulus simply is not in the cards...

Or does he? I suspect that Barry agrees with me on what the appropriate fiscal policy for the U.S. is, he just believes that it is politically unrealistic to argue for such a policy. I believe that Barry is committing a common fallacy what I call the Samwickian fallacy, after Andrew Samwick's explanation of the failure of the Bush administration Council of Economic Advisers to argue for the imposition of a carbon tax:

Republicans and Gas Taxes: [Politics] sets the framework for all policy outcomes--not the CEA--even on economic issues. CEA... works to generate the best outcomes within that framework. And if the President is not interested in a gas tax, then it becomes a very short conversation...

The Samwickian fallacy is the claim that economists should censor themselves and not argue for the best policies when those policies are not politically attainable, but should instead argue for the best politically-attainable policies. That, I think, mistakes the economist's role. First of all, economists are lousy at figuring out what is and what is not politically attainable. Second, to make powerful and convincing arguments that policies that are not politically attainable are in fact best for the country and the world is the best way to stretch the boundaries of the politically attainable.

It is Barack Obama's, Rahm Emmanuel's, Nancy Pelosi's, and Harry Reid's job to figure out what is politically attainable. It is our job to figure out what it would be best to do. It's not at all clear to me that a combination of (a) more stimulus now, (b) standby taxes later, and (c) health and climate-policy reforms that promise to improve the country's fiscal balance after 2012 will not be very politically possible come September--if those of us who know enough to know that such policies are best for the country and the world spend the rest of the summer strenuously arguing for them.

Barry, however, despairs and seeks to persuade not the U.S. government but the government of China to do what is economically good for the U.S and the world:

If there is going to be more aggregate demand, it can come from only... emerging markets like China. The problem is that China has already done a lot to stimulate domestic demand, both through government spending and by directing its banks to lend. As a result, its stock market is frothy, and it is experiencing an alarming property boom. Through May, property prices were up 18% year on year. Understandably, Chinese officials worry about bubble trouble. The obvious way to square this circle is [for China] to spend more on imports... purchase more industrial machinery, transport equipment, and steelmaking material, which are among its leading imports from the US. Directing spending toward imports of capital equipment would avoid overheating China’s own markets, boost the economy’s productive capacity (and thus its ability to grow in the future), and support demand for US, European, and Japanese products just when such support is needed most. This strategy is not without risks.... But these are risks worth taking if China is serious about assuming a global leadership role.

The question is what China will get in return.... China is worried that its more than $1tn investment in US Treasury securities will not hold its value.... It therefore wants to see a credible program for balancing the US budget once the recession ends. And, tough talk notwithstanding, the Obama administration has yet to offer a credible roadmap for fiscal consolidation. Doing so would reassure American taxpayers worried about current deficits. Just as importantly, it would reassure Chinese policymakers.We live in a multipolar world where neither the US nor China is large enough to exercise global economic leadership on its own. For China, leadership means assuming additional risks. But for this to be tolerable, the US needs to relieve China of existing risks. Only by working together can the two countries lead the world economy out of its current doldrums.

The problem is that China's economy is only one-quarter the size of America's. It is a generation too early for global macroeconomic stabilization policy to be made in Beijing and Shanghai rather than Washington and New York. To call for China to assume the role of the Hegemon in the world economy is even less realistic than to call for the government in Washington to live up to its responsibility to boost demand in the short run and lay out a convincing roadmap for fiscal consolidation in the medium run.

UPDATE: Andrew Samwick is unhappy:

In, that you would misquote one post from my blog and attribute such a recommendation to me is contemptible.

The full paragraph you are quoting is:

The word "emerging" is in quotes, referencing a theme of the article, which is that it is much easier for people who have worked inside a Presidential administration to advocate for politically unpopular ideas when they are on the outside. That's true but only to a point. It's not that Greg Mankiw ever said anything other than what he now says about the gas tax while on the inside. It's that the President sets the framework for all policy outcomes--not the CEA--even on economic issues. CEA, like every other part of the administration, works to generate the best outcomes within that framework. And if the President is not interested in a gas tax, then it becomes a very short conversation.

You make three errors:

  1. You misquote me. You substitute the word "Politics" for the words "The President." You are correct that economists may be lousy at determining what is politically attainable when considering all of the political institutions in the argument you are making in your post. You are not correct that economist serving as CEA chair is necessarily lousy in determining what is politically attainable when the President, after taking part in the conversation, has decided that a particular policy is off the table.

  2. The sentence before the one you misquote indicates that I do not claim that Greg censored himself in his internal conversations about policy while CEA chair.

  3. Even if you believe that sentence indicates that he did censor himself in his internal discussions about policy while CEA chair, I have not in any way made the normative statement that this is what "should" happen.

I apologize. I do think that economists of both parties in and out of government censor themselves too much in the interest of presenting positions that they think are palatable to their political masters. But I do not think the Bush administration CEA was culpable of this mistake to a significantly greater extent than the CEA under other administrations. (The Bush OMB, Treasury, and NEC, on the other hand...)