Growthology

Why Do We Expect a "Normal" Recovery?

The thrust of all debates over economic policy and government debt these days seems to be that this recovery ought to look like previous recoveries. We are insistent that unemployment fall faster, jobs be created more rapidly, consumption rise quickly, and economic growth pick up steam. All desirable outcomes, unquestionably. But we keep ignoring the factors that made the "Great Recession" of 2007-2009--and, accordingly, also the subsequent recovery--an outlier in terms of recent historical experience.

This is only natural, of course; our only comparative frames of references are other recessions since 1948 and, in terms of personal experience, the recessions of 2001, 1990-1, and the early 1980s. But this recessions was clearly of a different order, for a variety of reasons. For starters, the expansion that preceded it was one of the weakest--if not the weakest--since World War Two, as measured by job creation, per capita income, and the employment-to-population ratio.

Of the growth that did take place, we obviously know now that a significant portion of it was distorted by all things housing bubbled-related: construction, real estate, finance, etc. The plural of anecdote is not data, but I find Paul Kedrosky's parable of the highway ladder debris amusingly illustrative. Looking at Statistics of US Business data from 1998 to 2006 reveals that, of the net increase in the total number of firms of 442,000, fully one-quarter of that growth was in Construction (NAICS two-digit industry code). The only larger share went to the Professional, Scientific, and Technical Services (PSTS) sector, which includes businesses in R&D testing, ad agencies, computer design services, engineering services, law offices, accoutants, payroll services, and so on. Overall, a good sector in which to experience growth; yet, both the Construction and PSTS sectors are comparatively small job creators because average employment per firm is nine and ten, respectively, compared to the all-sector average of about twenty.

We keep wondering why job creation isn't automatically bouncing back to expansionary levels, and blaming sluggish job figures on fleeting factors like discretionary government policy. But because job creation in the prior expansion was low and because the driver of job creation--consumption--was built on sand (i.e., housing bubble), we shouldn't expect it to come roaring back. The employment-to-population ratio barely budged from 2002 to 2007, a historical first. The Federal Reserve of San Francisco, moreover, has calculated that personal consumption took a hit equivalent to about $175 per month per person as a result of the recession and is nowhere near returning to pre-recession levels. This is due, in part, to the completely unsustainable level of consumption the US enjoyed in the last decade. We shouldn't expect a return to that.

This points to the deeper factor underlying the slow recovery: this recession was marked by a financial crisis. And, as Reinhart and Rogoff have convincingly showed, post-financial crisis recoveries are very, very slow. Combine that with deep-seated challenges facing the American economy--geographic asymmetries, skills mismatches--and you can't help feeling that this is going to take a while.

How this Recovery Measures Up

Good slide deck from the Economic Cycle Research Institute (ECRI) on comparing the indicators in this recovery to past recoveries. Of particular interest is the "stair-stepping down" of the intensity of expansions over the past fifty years (slide 12).

Waging Politics Through Graphics

For those of you who haven't seen it, this is a recently released graphic being pushed by the Obama Administration to illustrate the recession it inherited and the impact of the stimulus:

 Source.

Although it doesn't quite embody the "golden age" of data visualization that Paul Kedrosky likes to say we're living in, it is a very clever graphic--a "brilliant image" says Ryan Avent. That said, it's not without problems--Drew Conway provides a nice angle.

Has the Great Recession Ended?

This is the question of the moment for many economists and analysts and policymakers, although the relevance of the answer will vary widely across the country. Will someone who has been unemployed for seven months or longer (which is now the average duration) celebrate when the National Bureau of Economic Research (NBER) officially dates the end of the recession?

In a recent research note, William Hester of Hussman Funds examines the four primary indicators tracked by the NBER Business Cycle Dating Committee: Industrial Production, Real Manufacturing and Trade Sales, Real Personal Income Less Transfer Payments, and Nonfarm Payrolls. Many readers won't be surprised to learn that the first two indicators have bounced back nicely, in line with prior recoveries:

Source: William Hester, Hussman Funds 

The Manufacturing and Trade chart is similar, although with not quite the same "V" shape as Industrial Production. Personal Income has risen in the last several months, but so far is merely flat-lining rather than rising. But as you can guess, it's the employment situation that will continue to weigh on the economy:

Source: William Hester, Hussman Funds 

Yikes. Hester points out that the trend of NonFarm Payrolls thus far tracks quite closely the "jobless recovery" that followed the 2001 recession. That recession was said to be over in November 2001, but employment didn't recover for about two years and the bear market persisted for another year. As Hester notes, "it would go against precedent for [NBER] to declare the end of a recession with the mixed signals that are currently in place."

So what do you think? Is the Great Recession over? If it is, does it matter? Don Peck has a very disheartening piece in the newest Atlantic predicting a "long shadow" that will stretch across the economy for several years to come and will even produce a "slow motion social catastrophe," wrecking marriages, cities, and quality of life for whole swathes of the United States.

It's a perpetual temptation for every generation to declare its time to be historic, for everyone to perceive themselves as living through some sort of inflection point. Such time-centrist sentiment often proves unfounded, but occasionally the signals are so overpowering that you can't help wondering: is this the moment when everything changed?

Would a Jobs Credit Work? A Response to Pozen

(Bob Litan)

Main Street is impatient with the pace of the recovery. Yes, the stock market has rebounded smartly from its March lows; and yes, government statisticians tell us that total output of goods and services actually increased at an annual rate of 3.5% in the third quarter, most likely marking an official end to the Great Recession. But on Main Street, unemployment has now passed 10%, and many more Americans are discouraged from looking for work, or engaged in part-time jobs unable to upgrade into full-time work.

No wonder then that policy makers in both political parties are frantically searching for ways to reverse the monthly job losses and start putting more Americans back to work. One idea that has attracted a lot of attention is a temporary tax credit or a partial or total suspension of the payroll tax to encourage employers to begin hiring again.

Robert Pozen, a thoughtful and experienced financial expert, recently provided some useful analysis of this idea, and came up with a highly targeted job creation proposal designed to provide the largest bang for the policy bucks (to minimize the impact on the uncomfortably large federal deficit). The notion is to provide a 15% tax credit, up to $100,000 per employee, for employers making net additions to their payrolls, but require that half of the new workers come from the ranks of the previously unemployed.

However, this proposal would limit the credit only for already established employers – those in business prior to some cutoff date (Pozen suggests September 30th of this year). The rationale for excluding all new firms from eligibility is to prevent existing firms from breaking themselves up or forming new subsidiaries or affiliates simply in order to qualify for the credit.

What sounds like a minor detail – the eligibility cutoff – would actually be a big mistake--for it reflects a fundamental misreading of which firms are most likely to hire new workers and sustain the recovery after the stimulus measures wind down and are eventually withdrawn.

A new Kauffman Foundation study documents that over the past three decades, until this recession, new firms (those one to five years old) have been responsible for much or all of the net new jobs created in our economy. Remarkably, even in the teeth of the recession, through 2008, the number of new business starts, as measured by another Kauffman study, has actually increased modestly. What we don’t know is whether the constraints on business credit or other impediments will deter these new firms, as well as those recently created, from continuing the historical pattern by being the prime source of net job creation now and in the years ahead. What do know, though, is that excluding new firms from receiving any job tax credit will certainly break that historical pattern – hardly the outcome anyone wants.

Fortunately, there is much more straightforward way to prevent the kind of gaming that Pozen worries about: in calculating the employment benchmark for determining whether a firm has added to its payrolls, the tax authorities should include all subsidiaries and affiliates in which a firm has an equity interest above a certain threshold (such as 10% of  an entity’s equity).

Meanwhile, policy makers should continue to look for other ways to boost the formation and growth of new companies, which are not only likely to be source of new jobs but of the next wave of new products and services that will restore optimism about our economic future.

Some examples: Establish a “job creator’s” visa for immigrants who launch new companies and hire workers; fix bank capital requirements so that they are less likely to discourage business lending in economic downturns (by making the requirements less pro-cyclical); allow shareholders to determine whether their companies should adhere to all or a portion of the requirements of the Sarbanes Oxley Act that make it more expensive for high growth companies to go public and thus expand on their rather than to sell out; and encouraging the development of a truly free market in the licensing of technologies developed by our universities using federal research funds, which would accelerate the commercialization of innovations that will reshape our future. (The House Financial Services Committee recently voted to extend the exemption of small companies from Sarbanes-Oxley's section 404(b). The measure still needs to pass the full House and Senate and does not affect the requirement that these companies comply with section 404(a).)

Agree or disagree, as you may, with some of these specifics. But the source of America’s remarkable job growth, our new firms, is not in dispute. As we all seek to dig our way out of our current economic hole, we cannot leave our entrepreneurs out of the solution, because they are the solution.

--Bob Litan

Where Have All the Loans Gone?

Last week the Obama Administration announced the expansion of a few Small Business Administration (SBA) loan programs, raising the cap on 7(a) loans, increasing the size of "microloans," and offering more aid, via TARP, to community banks. Questions will persist about the efficacy of SBA loan programs for new and small companies, as well as the effect of TARP restrictions on community banks, but two things are immediately clear. 

First, business loans have plummeted during this recession (via Econompic):

Worse, they show absolutely no upward trend in recent months:

(Source: John Mauldin.)

Any expansion of capital for businesses, even from the SBA, should theoretically help in some way. Credit is the oxygen line of new firms and they have been courting asphyxiation in this recession. 

Second, new and young businesses are the primary source of net job creation in the United States, yet this fact of economic life has for the most part been lost on policymakers (and media) obsessed with restarting the hiring process at large, established companies. Any recognition, therefore, of the importance of new firms and their access to capital can only be a good thing.

These steps aren't a silver bullet, mind you, and officials in Washington and every state capital continue to cast around for anything that will address (or appear to address) the dire employment situation this country faces. Nonetheless, President Obama's announcement is a step in the right direction and it comes on the heels of the creation within the Department of Commerce of a new Office of Innovation and Entrepreneurship. New firms are the drivers of job creation, and now Washington is finally turning to them.

The Macro War

I have refrained from commenting on Paul Krugman's lengthy critique of macroeconomics which was published earlier this month in the NYTimes Magazine.  I am not sure if I have anything useful to add. It is an important essay that is part of the conversation economists will be having for years to come (which I am calling the "Macro War"). It is quintessential Krugman being Krugman: brilliant, funny, nasty, and a puzzling blend of revelation and overstretch. And forgive me for protesting, but if I see the baby co-op story in print again, I'm submitting Krugman to the authorities for unfairly regurgitating the same pop material to pad his pubs.

If you are genuinely interested in the macro war, do not miss an alternative critique recently published by Northwestern 's distinguished professor Robert Gordon. I highlight five sections here: the entire abstract, three clips on growth vis-a-vis macro, and his assessment of Krugman. It is amazing. (Thanks to Greg Mankiw for the pointer).

Is Modern Macro or 1978‐era Macro More Relevant to the Understanding of the Current Economic Crisis?

ABSTRACT
This paper differs from other recent critiques of “modern macro” based on DSGE models. It goes beyond criticizing these models for their assumptions of complete and efficient markets by proposing an alternative macroeconomic paradigm that is more suitable for tracing the links between financial bubbles and the commodity and labor markets of the real economy.
The paper provides a fundamental critique of DSGE and the related core assumptions of modern business cycle macroeconomics. By attempting to combine sticky Calvo‐like prices in a theoretical setting that otherwise assumes that markets clear, DSGE macro becomes tangled in a web of contradictions. Once prices are sticky, markets fail to clear. Once markets fail to clear, workers are not moving back and forth on their voluntary labor supply curves, so the elasticity of such curves is irrelevant. Once markets fail to clear, firms are not sliding back and forth on their labor demand curves, and so it is irrelevant whether the price‐cost markup (i.e., slope of the labor demand curve) is negative or positive.
    The paper resurrects “1978‐era” macroeconomics that combines non‐market‐clearing aggregate demand based on incomplete price adjustment, together with a supply‐side invented in the mid‐1970s that recognizes the co‐existence of flexible auction‐market prices for commodities like oil and sticky prices for the remaining non‐oil economy. As combined in 1978‐era theories, empirical work, and pioneering intermediate macro textbooks, this merger of demand and supply resulted in a well‐articulated dynamic aggregate demand‐supply model that has stood the test of time in explaining both the multiplicity of links between the financial and real economies, as well as why inflation and unemployment can be both negatively and positively correlated.
     Along the way, the paper goes beyond most recent accounts of the worldwide economic crisis by pointing out numerous similarities between the leverage cycles of 1927‐29 and 2003‐06, particularly parallel regulatory failings in both episodes, and it links tightly the empirical lack of realism in the demand and supply sides of modern DSGE models with the empirical reality that has long been built into the 1978‐era paradigm resurrected here.

(Krugman critique mentioned)

The malaise of modern macroeconomics has recently been the subject of strikingly vitriolic accusations. The Economist (p. 70) quotes Paul Krugman’s LSE Lionel Robbins Lecture of 10 June 2009 as stating “most macroeconomics of the past 30 years was spectacularly useless at best, and positively harmful at worst.” More recently Krugman (2009) has amplified this criticism in a long and overly argumentative denunciation of modern macroeconomics. In notably similar language that might have inspired Krugman, Buiter (2009) wrote three months earlier that “the typical graduate macroeconomics. . . training received at Anglo‐American universities during the past 30 years or so may have set back by decades serious investigations of aggregate economic behaviour and economic policy‐relevant understanding. It was a privately and socially costly waste of time and other resources.”

(Three sections that mention growth are below)

The adjective “business cycle” in front of the phrase “modern macro” represents an important qualification to the scope of this paper. Much of modern macro escapes its critical overview, including such broad areas of modern macro progress as growth theory, search and matching models of unemployment, theories of why prices and wages are only partial flexible, and attempts to use modern versions of production functions and factor input measurement to develop empirical counterparts to longstanding 1978‐era macro constructs such as potential GDP growth and the GDP gap.
...
Viewed more broadly, a more basic similarity between the 1920s and the period between 1995 and 2006 was the view that permanent prosperity had arrived, and that the good times should be allowed to roll. The underpinning of this benign environment was the parallel upsurge in productivity associated with the invention of new “general purpose technologies” (GPTs, Bresnahan and Trajtenberg, 1995). In the 1920s productivity was boosted by the delayed payoff of the invention in the late 19th century of two revolutionary GPTs, electricity and the internal combustion engine. Many of the reasons for the delay in the application of electricity to manufacturing in the analysis of David (1990) apply as well to the internal combustion engine which required technical development and highway construction fully to transform transportation and distribution. Likewise, in the late 1990s the invention of the internet together with other delayed applications of the computer, including bar‐code scanning, boosted productivity growth for several years after the collapse of the late 1990s investment boom itself. More rapid productivity growth held down inflation and in this decade allowed the Fed to justify its maintenance of low interest rates.
...
The required condition for continued full employment is the opening of a gap between the growth rate of nominal GDP and the growth rate of the nominal wage (Gordon, 1984, p. 40) to make room for the increased nominal spending on oil. If nominal wages are flexible, one option is for the growth rate of wages to become negative, allowing the growth rate of nominal GDP to remain fixed. At the alternative extreme with rigid wages, to avoid a decline in nonenergy output an accommodating monetary policy must boost nominal GDP growth by the amount needed to “pay for” the extra spending on oil, but this will lead to an inflationary spiral if expectations respond to the observed increase in the inflation rate. A third alternative, and the one that actually occurred in the 1970s, was a combination of wage rigidity with a partial response of nominal GDP growth, pushing down both real non‐energy spending and employment.

The Stimulus Sun God

Six weeks ago, Michael Cembalest, CIO of J.P. Morgan Global Wealth Management, sent out his regular "Eye on the Market" newsletter, which included a stunning chart. Comparing the current economic "rescue mission" with past recessions (as of April 22), Cembalest displayed monetary and fiscal stimuli, with the Sun deities representing the present policy response:

All you can really say about this is, wow.

Cembalest began the newsletter by recalling that "ancient sun worshippers were mostly unaware of the astronomical forces at work guaranteeing that the sun would rise every day, whether they offered a sacrifice or not." This could probably apply to most economic policymakers, who often seem to think that, but for their efforts at managing and steering the economy, all growth and activity and innovation would come to a halt and we would all pitch into poverty.

Depression Index

Our very own Tim Kane has a nice empirical piece up at Real Clear Markets today. Tim makes crystal clear just how stark things are right now in the economy.

Nice work, Tim!

Unsticky Wages? Not so fast.

Over at BusinessWeek, there's a discussion of whether a company should cut pay or lay off workers in a time of distress, with management tending to always prefer laying off workers to cutting the sacrosanct base salary.

There may be a skill effect going on here. In an era/economy dominated by low-skill jobs, a firm could more easily boost productivity by threatening to lay off or actually laying off workers. But in a knowledge economy, many of the workers feel a part of the team and eliminating part of the team can lead to diminishing returns. Just imagine if the Beatles had cut Paul McCartney (or even George Harrison.)

 

BW cites Dan Ariely, the go-to guy for behavioral economics after he wrote the magnificent book, Predictably Irrational, which is also the title of his pretty informative blog. 

Dan Ariely, a behavioral economics professor at Duke University who sees value in cutting pay vs. jobs, notes that salary is what economists call a "positional good," meaning people care more about how much they make relative to their peers than the absolute level of what they take home. That's why Wall Street bankers get angry if their bonuses don't match what rivals are pocketing a few blocks away, and why distressed U.S. autoworkers who have given up years of hard-won benefits take some solace in the knowledge that they still many more than many other industrial workers.

A skills shift? Just maybe there's a clue in this article about Professor Ariely in Haaretz. (Professor Ariely is Israeli.)  

Ariely and his colleagues ran several experiments, among everyday people in India and among American students, in which participants were given a cognitive challenge - such as a memory game or a puzzle - as well as technical tasks requiring little thought, such as fast-paced typing. The researchers promised participants bonuses of varying sizes for good performance. They discovered that when it came to the cognitive tasks, which demanded mental effort, participants who were offered the largest bonuses performed less well than those in the two other groups, which were promised smaller ones. When the task was a purely mechanical one, however, the financial incentive did prove effective. [Emphasis mine.]

This is all interesting stuff.  But Let's not be so fast to say job losses are less frequent in the new (more altruistic?) economy when the facts say the fastest rising rate of unemployment in the U.S. since the 1930s is happening right now.

Sticky Facts

Then again, the facts don't seem to back up the flexible pay argument. The best measure of compensation, according to a friend at the BLS, is the ECI (employment cost index).

Total compensation costs for civilian workers increased 0.3 percent from December 2008 to
March 2009, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  This follows a 0.6 percent increase for the September to December 2008 period. In March 2009, wages and salaries also rose 0.3 percent, while benefits rose 0.5 percent.

The ECI is a really useful fact-based piece of reality to keep in mind as you are assaulted by news and opinion that Americans are suffering from lifestyle declines.  It is awfully hard to square that with the ECI's report of compensation growing at 2/3 a percent every quarter! Maybe the ECI is a slightly lagging indiciator, but there's no denying a deceleration down to just 1/3 a percentage point last quarter.

Who wants to bet the ECI goes negative?  I'll wager $10 to anyone (or up to 50 anyones) that ECI growth remains positive during 2009.

Entrepreneurs Stay Strong

A new Kauffman Foundation study finds that entrepreneurial activity increased in 2008. The press release and the study highlight the variable trends beneath the aggregate figures, but here's what jumped out at me: immigrants continued to found new businesses at higher rates than natives.

Most of the noise in the econo-blogosphere around immigration has concerned H1B visas and the turning away of high-skilled immigrants. But as I've noted before, we can't ignore the lower-profile immigrant entrepreneurs.

As an aside, it will be interesting to note the detailed NAICS breakdown of new firms once all the data becomes available. Our study has the general industry categories (e.g., construction, services) but not the more detailed information.

The Next Economic Wave

A recent Time magazine article pointed out that many people see the recession as a good opportunity to start a new company: "At no other time in recent history has it been easier or cheaper to start a new kind of company. Possibly a very profitable company. Let's call these start-ups LILOs, for 'a little in, a lot out.' These are Web-based businesses that cost almost nothing to get off the groundyet can turn into great moneymakers."

Indisputably, the Internent has fundamentally changed the dynamics of not only starting new companies but also starting up in a recession. If it's cheaper and easier now with this technology, perhaps Web-based firms offer one promising route out of the recession and onto a long-term growth trajectory.

The Internet, obviously, is relatively new. But the underlying story--about startups and recessions and economic growth--is an old one. The very nature of technological change and economic growth is the rise and fall of successive waves of entrepreneurs. The early New England textile manufacturers became an elite whose names (Cabot, Lowell) still today signify distinguished pedigree. Part of the reason Los Angeles became the center of the film industry was that many of the entrepreneurs were driven out of New York by the established (such as they were) companies and individuals. We can replay the same story with FM radio, software, search engines, etc. 

A generation of entrepreneurs becomes the next generation's elite, the position of whom is then challenged by newer entrepreneurs. Henri Pirenne knew this; Joseph Schumpeter and his intellectual cousins, the Austrian economists and German historicists, knew this. We are apparently rediscovering it today.

Research we have been working on the Kauffman Foundation, soon to be released, will confirm this broad theme. Recessions don't seem to matter all that much to entrepreneurs--they act as their own economic stimulus package. The most pertinent policy question, then, concerns what actions we should take or not take such that we don't squash the next emergent economic wave.

From the "Sentences We Never Thought We'd See" Department

Strong banks will be allowed to repay federal bailout funds, but only if such a move passes a test to determine whether it is in the national economic interest, the Financial Times reported on Sunday, citing a senior U.S. administration official.

Link here (emphasis added).

Short-term Backstop, Long-term Transformation

Out here in suburban Kansas, enrollment at the local community college has been increasing: Johnson County Community College (a fantastic institution, by the way) is experiencing its highest totals ever for a spring semester. The most popular fields of study? Health and entrepreneurship.

That, in and of itself, is unsurprising: higher education often sees a spike in times of recession. Yet in a larger sense, JCCC and other similar institutions around the country may augur a broader shift in the higher education landscape. At least, I hope they do. Enrollment at JCCC is now around 20,000, comparable to some of the country's best state universities--include continuing education, and the number rises. The school expects to benefit, too, from the Johnson County Education and Research Triangle.

In the early decades of the twentieth century, the "high school movement" transformed the relationship between the citizenry, the education system, and the emerging industrial economy. Undoubtedly, a similar transformation is taking place today--community colleges like JCCC, the increasing use of technology in education, completely new ways of teaching, etc etc.

The nature of these transformations is such that, while the federal government will play an unavoidably large role (just given its size and sway in education these days), we won't even be able to coherently outline the future of education until it's already upon us. The only things we can say for sure is that it will be a far more structurally diverse system than today, and it will be much more substantive than simple calls for more money.

Fix Housing, Not Homeowning

Steve Malanga thinks Americans haven't learned from the housing bust:

Even now, in the midst of our current woes, members of the Congressional Hispanic Caucus caution against reining in affordable housing lending because, “We need to keep credit easily accessible to our minority communities,” as Congressman Joe Baca has put it. And both Republicans and Democrats in Congress continue to put forward new programs to subsidize home ownership and kick start the housing market, without wondering whether further subsidies might just spark new foreclosure problems.

Until Congress shifts gears from promoting homeownership into simplifying and/or accelerating foreclosures (e.g. by converting weak mortgage holders into renters), the bottom will be elusive.

Cartoon Keynesiansim = Slamming Amity Shlaes

The Economist (magazine) blog is schizophrenic this week.  On the one hand, it does a drive-by ad hominem attack on Amity Shlaes, calling her "empirically challenged" without actually mentioning any facts she got wrong in her book, The Forgotten Man. On the other hand, the blog has a post today that points out the fallacy in the idea of Keynesian growth. The fallacy of Keynesian growth is the basic idea of The Forgotten Man, by the way, a much bigger story than spending multipliers.

Clearly, the global economy is in a deep recession, and the Democratic monopoly in power in DC is moving boldly to address it. Indeed, the moves have been so bold that Republicans are essentially united in opposition. This isn't just partisanship, as there were many centrist Democrats voting against the recent stimulus bill, and already vocal Democratic defections from other economic plans coming from the White House (witness the quiet multi-month delay in consideration of the Orwellian "Employee Free Choice Act"). These are simple facts. Unfortunately, the heated politics of the worsening recession have boiled over to the economics, and made for some nasty exchanges.

One of the core concepts being debated is whether fiscal stimulus is an effective remedy for recessions. As Harvard economist Greg Mankiw has recently and repeatedly observed, this idea was out of favor among mainstream academic economists in recent years. Unfortunately, the very word "Keynes" has become, in political conversation, an invitation to draw battle lines and simplify discourse entirely. Naturally, we all struggle to make technical economics accessible to the lay reader (i.e. the policymaker), but discussions of Keynesianism are particularly cartoonish. It is unhelpful enough when politicians want to believe that everything Keynes did, said, wrote, researched was somehow socialist. It's even worse when academics (Brad DeLong, are you listening?) play on those same cartoonish sentiments.

Defenders of the stimulus want to confuse Shlaes history book into some kind of wild-eyed hostility to all things wise and wonderful written by Keynes and every great economist since. She's no economist, they thunder! Consider BigPicture which ridiculed Shlaes last November as "economically clueless" and a "no-nothing" (know kidding) for describing a recession as two quarters of GDP decline, which is exactly what Ph.D. economists do all the time as a non-technical rule of thumb. 

Advocates of activist policy are really guilty not just of a war against apostates, but distorting their own prophet's words. They are turning Keynes into a caricature: all spending is good spending! Cartoon Keynesianism sees all politics as a struggle over the size of G, government. This cartoon is offensive and seems like a willful distortion with ulterior motives.

In truth, Keynesian stimulus need not be government spending, it can also be tax cuts. Shocker! I, for one, support the basic Keynesian idea of automatic stabilizers in place and wish we had more built into the tax system. Yet too many voices in the punditry space lump all tax cuts in the capitalism/Republican side and all spending in the socialism/Democratic side. It's insulting to both sides, and worse it marginalizes the more important conversation about growth policy. Here's the honest way economists should be talking about any short-term Keynesian spending plan: "Recovery? Maybe. Growth? No." 

That conclusion, in fact, is from the Economist blog. Quote: "Stimulus can help with recovery, but it can't do much to aid reformation—indeed, it could retard structural transitions."  Keep in mind that not all economists are even that kind to stimulus policies. Research by UCLA economists Harold L. Cole and Lee E. Ohanian in 2004 conclude FDR's policies extended the Great Depression, saying: "We found that a relapse [into another long Depression] isn't likely unless lawmakers gum up a recovery with ill-conceived stimulus policies." A 1999 paper by the economists for the Minneapolis Fed reviewing the Great Depression opens:

[T]heory predicts an extremely rapid recovery that returns output to trend around 1936. In sharp contrast, real output remained between 25 and 30 percent below trend through the late 1930s.We conclude that a new shock is needed to account for the Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly and the distribution of income.

Validation

A lot of good theory works on paper, but is humbled by reality. This is what happened to Old Keynesianism, and is why modern teaching in grad schools is now done under the banner of Neo- or New Keynesianism. The identity Y = C + I + G + NX is simply too crude to tell us anything about how an economy grows. The crudest interpretation, and dumbest, was followed by Washington policymakers for decades and imagines the national income identity can be managed by fiscal policy. Whether such policy is sustainable is irrelevant. And yet, history tells us that constantly pushing G to manage Y causes an uncontrollable price inflation. Uncontrollable in the Keynesian paradigm, that is. The whole framework was superseded by expectations macro and validated by Volcker when he stopped Keynesian inflation of the 1970s with the 1980-82 monetarily induced recession.

The defenders of Cartoon Keynesianism want to believe their framework had a similar validating experience, which was the New Deal's curative power over the Great Depression. The simple history taught in most high schools today (and non-economics college courses) is that FDR's expansion of government saved the national economy. That's just not true.

There are four presidential names being bandied about: Hoover, Roosevelt, Bush, and Obama. The cartoon story says that Bush like Hoover wrecked the economy with laissez-faire extremism and that Obama like Roosevelt will tame capitalism's failure with strong government action. The reality is that government spending and budget deficits under President Bush were massive, while Hoover is infamous for raising tariffs in 1930 as well as the top income tax rate from 25 to 63 percent in 1932. So Hoover wasn't really laissez-faire in his policies, and Bush wasn't either. Every president - especially Obama - offers a mixed bag of tricks that defy labels, especially old ones.

So why did Free exchange go after Amity Shlaes?  For starters, it was echoing a long and current piece by Jonathan Chait in the New Republic, whose purpose is to paint modern Republicans as little Hoovers. Except for the little things like tax rates and free trade, which he ignores, choosing to selectively make a case about somebody else making a selective case. My theory is that this is part of a larger reckoning.

Chait wants his readers to think the Amity Shlaes is an outlier (and not the smart kind). But Chait -- perhaps because he also has no economics degree -- makes false claims about consensus in the profession, such as "the essential framework constructed by Keynes--that recessions are caused by a failure of demand, and that at the very least government should not respond to an economic slowdown by paring back its largesse--is no longer in dispute." This is just wrong. It may comes as some surprise that a 1995 survey of economic historians published in the Journal of Economic History said this:

On top of the profession's lack of agreement about the genesis of the Great Depression, there is a disagreement about the effect of the New Deal. In fact, the economists in the sample are almost evenly divided on the question of whether or not when taken "as a whole, government policies of the New Deal served to lengthen and deepen the Great Depression."

The Reckoning

This is important not just to make the point that partisans on the Left (and Right) are mean, dishonest jerks. The global recession is very real, so when even the Economist (magazine) falls into this shallow smear game, I get worried that we are collectively taking our eye off the ball. If your goal is rip-roaring growth, fixing banking, fixing mortgages, or a real cure for poverty, a debate about stimulating the short-run economy is irrelevant. At best, another trillion in G arrests a couple points of GDP decline for a couple years if you believe the macro sim models. Add up all the new plans, and you get annual trillion-dollar deficits for the next decade, according to the Brookings Instituion.

Rather than take on half of the economics profession, or Brookings, or just engage in a serious discussion of growth policy, the partisans have instead decided to target Amity Shlaes for writing a history book two years ago about the New Deal and FDR. Ironically, if you understand her title, The Forgotten Man is not about macro stabilization theory, but about the unprecedented scope of powers that were centralized in 1930s America, running roughshod over the Constitution and the middle class Americans who pay for grand plans. This, too, is fact even for fans of big G. But I guess describing facts makes you an enemy of the state and its toadies.

What is really at stake is a year of budgetary reckoning, which I now believe will become a decade of reckoning. The crisis of big entitlement promises is about to clash with the limits of taxation. Shouting down Amity Shlaes is just a warm-up.

He's at it Again

Have you ever wondered what Deliverance, the Ivy League, debt financing, and DNA have in common? Well, you're in luck: Harold Bradley has the answer.

The Matrix and the Superorganism

On the latest episode of Flight of the Conchords the other night, the prime minister of New Zealand, on a visit to the United States, believes he's living inside The Matrix and, detecting a glitch (deja vu), leaps off a building to escape. This is good TV.

Aside from comic relief, the show's invocation of the Matrix resonated as I read Tim Flannery's interesting review of what sounds like a fascinating book, The Superorganism. In what struck me as a stretch, Flannery sought to analogize the superorganism civilizations of ants to human society, particularly the continued growth of the Internet and global concerns like climate change and economic meltdown.

Humans, perhaps thankfully, are still a long way from building a global superorganism, whether intentionally or not. Even advanced societies do not function in the finely striated ways that ant colonies do, despite the awe-inspiring realization that human societies, like the ants, operate smoothly in the absence of any controlling intelligence.

Yet a reasonable analogy between ants and humans might be the systems that humans build, and I have in mind specifically the global financial system. This seems to be a close approximation of the ant superorganism in that the division of labor is quite deep, the system can often be said to be acting in one unified direction (up or down), there is innovation (ants "invented" agriculture long before humans), and it is marked by behavior in response to discrete signals.

So how does such a superorganism collapse? Here, the story becomes almost entirely human: as Alan Greenspan observed, there was "a flaw in the model that I perceived is the critical functioning structure that defines how the world works." What was the flaw? Every commentator in the economic and financial world has answered this question, but it really comes down to something as old as human civilization: hubris. Probability and risk (really, uncertainty) were distorted, misunderstood, and subsumed within an irresistible superorganism of hubris.

National Public Radio reported the other day that college students, in response to the financial crash and recession, are flocking to a major in economics. This seems understandable, but I can't help wondering: if the current generation of economists utterly failed to suspect something to be a tad askew with the global financial system, will the next generation? (Trained, incidentally, by today's economists.) Given the entirely human traits involved here, perhaps literature or classics or history would be better-advised courses of study? 

Or let's update those staid majors, even. I heard somewhere recently that some college or university now offers a master's degree in the Beatles. Maybe we need one in The Matrix as well.

Power is Power is Power

The McKinsey Quarterly has just published a special edition, "What Matters," and Carl Schramm and I co-author an essay, "The right way to regulate."

I don't know whether or not we actually lay out the "right" regulatory path, but our writing scope was broad and we used it to explore questions of finance, its relation to entrepreneurship, the role of government in the face of complexity, and the raw issue of presidential power. The last topic, radioactive for the last eight years and simmering below the surface in the prior three decades, does not seem to have been much of a public concern of late.

This is entirely appropriate: crises aren't known for bringing out one's inner constitutional scholar. Eventually, however, constitutional issues unavoidably arise and this recession should be no different. We observe in the essay that President Obama, inheriting the aggresive unitary executive philosophy of the Bush-Cheney administration and now assuming radical fiscal authority (the stimulus, the second half of TARP, the next bank rescue plan, the new budget proposal), enters office as pretty much the most powerful president in American history. 

Political inclination matters little here--we observe in the essay that the strong U.S. economic performance over the last two centuries has occurred during a time of continually rising governmental size and power. There's a lot packed into that observation: size can be a poor proxy; policy orientation matters more; pecuniary issues can be relative, etc. So irrespective of how you view the President or how you view the proper government response to the meltdown, the scope of executive power at this point in time is beyond astounding. Breathtaking, perhaps.

As a final note, I want to point out that the McKinsey "What Matters" collection includes a lot of interesting essays that I'll be further exploring in this spot over the next several days. Those in the "Innovation" section look especially tempting for critical analysis.

Does the Long Run Still Matter?

Were we to flatter ourselves, we might say that today's Financial Times Insight column by the legendary Peter Bernstein was a gauntlet thrown down at Growthology's doorstep.

It wasn't, of course, but Bernstein's short essay raises serious questions related to the entire premise of this and many other economics blogs. Has "the possibility of the long run" run away? That's Bernstein's question, and while his specific point pertains to investments, we cannot escape the larger economic growth implications of passages such as these:

"What kind of long run is this mess going to produce? . . . Can capitalism remain a 'going concern' [quoting Bill Gross] after an extended period characterised by massive government intervention into the economy--and bail-outs of firms that would otherwise have failed? . . . Will our society and economy emerge so risk-averse after these experiences that years will have to pass before we return to a system naturally generating vibrant economic growth and a renewed willingness to both borrow and lend? Or will we head in the opposite direction, where faith in ultimate bail-outs will justify the wildest kind of risk-taking? Or will the entire structure collapse from government debts and deficits that turn out to be so unmanageable that chaos is the ultimate result?"

Heartening stuff.

Bernstein's starting point is a comparison between equity and bond yields and the famous observations made by Keynes that only the short-term storms, not the long-run fate of the ocean surface, matter for economists. But the question for us, as Bernstein frames it, is very serious: what should a long-run perspective on economic growth look like in the face of this incredible tempest? It's clear that no one can simply say, well we're concerned with the long term so we should do X, Y, Z, irrespective of how emergency policymaking will or will not impinge on the long term. 

No one can see the future, of course, as Bernstein reminds us: "the unknown today seems more than usually unknown. . . . The long run is an impenetrable mystery. It always has been." So it's somewhere close to impossible for anyone to know or precisely foresee the short and long term balance of crisis response and long run growth prospects. 

Yet we cannot pretend that the immediate future won't affect the long term. I know I'm sounding circular here, but it's an important consideration--to what extent are we foreclosing the possibilities of long-term growth, or to what extent are we expanding those possibilities? Should, that is, the short and long term questions go together? Or should we somehow imagine them to be separate, throwing our hands up in the face of complete and utter uncertainty?