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Tens of thousands of people marched to the U.S. Capitol on Sunday, carrying signs with slogans such as “Obamacare makes me sick” as they protested the president’s health care plan and our so-called “out-of-control spending”. The marchers were chanting “enough, enough” and “We the People.” Others, channeling their inner Joe Wilson, screamed “You lie, you lie!” while waving U.S. flags and the now omnipresent images of Obama as Hitler, Obama as the Joker, along with the usual placards decrying the “march to socialism”.
And the reaction against the expansion of the state is by no means restricted to America. According to the London Sunday Times, voters are overwhelmingly in favor of cutting public spending rather than tax rises to close the budget “black hole”. Sixty per cent want to shrink the size of the state to curb the £175 billion deficit amid mounting government disarray over the public finances. Naturally, there is also growing support for this line of thinking in the financial community, despite having successfully received tens of trillions of dollars, even for deeply insolvent financial institutions. The large banks and brokers lobbied for special treatment and got it.
To the extent that government spending is being used to prop up these economic zombies, I sympathize with the prevailing orthodoxy about wastage of our money. However, the fasct remains that the principle opposition to increased government spending is predicated on the simplistic notions about fiscal activism. We need to get past the deficit myths and wrongheaded notions of “national solvency” so that we can move forward in other areas. In the words of economist Bill Mitchell of the University of Newcastle, Australia:
“Within a modern monetary economy, as a matter of national accounting, the sovereign government deficit (surplus) equals the non-government surplus (deficit)…In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending. The sovereign government via net spending (deficits) is the only entity that can provide the non-government sector with financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment.”
A seemingly growing populist drive toward a return to fiscal orthodoxy follows a stream of similar pronouncements from Wall Street, the Fed, the European Central Bank, the OECD, all of whom are legitimizing a campaign against further public spending and mobilizing support for “exit strategies” as they confidently pronounce the end of the recession. Implicit is the view that somewhere along the line ongoing government involvement in the “free market” reaches a tipping point where fiscal “intrusions” no longer act as a stabilizing force, but serve to impede the natural tendency of the market to equilibrate to recovery. The major hypothesis is that anytime the government is involved in the economy, eventually things go bad. But markets do not self-regulate in ways that avoid major financial upheavals and activist government is required as a counterbalancing force.
President Obama himself has legitimized this line of thinking himself, committing himself to the goal of “fiscal sustainability” (whatever that means) as a medium term policy objective. He said as much last Wednesday again during his speech on health care. Having failed to understand what got us into the crisis, and equally having failed to appreciate the extent to which government spending actually prevented an economic catastrophe along the lines of the Great Depression, our policy makers who are championing this move toward neo-liberal fiscal orthodoxy are almost certain to drive us into the next recession if they take these demands to shrink government too aggressively.
Deficit hawks fail to understand that not all debt is created equally. As James Galbraith, L. Randall Wray and Warren Mosler have argued, there is no legitimate analogy to be drawn about the budgets of the government, which issues the currency, and the budgets of the non-government sector (households, firms etc) which uses that currency. The former does not have a financial constraint and can spend freely whereas the latter has to “finance” all spending either through earning income, drawing down savings or liquidating assets.
Although the global debt problem is very serious, the focus on growing government deficits and the need to rein in fiscal expenditures is profoundly misplaced, particularly in the U.S., where (relative to Europe and Japan), the government debt is low, relative to the size of the economy. Additionally, as a matter of national accounting, deleveraging in the private sector cannot happen without an increase in the government’s deficit (the government’s deficit equals by identity the non-government’s surplus. Consequently, if the US private sector is to rebuild its balance sheet by spending less than its income, the government will have to spend more than its tax revenue; the only other possibility is that the rest of the world begins to dis-save massively—letting the US run a current account surplus—but that is highly implausible). In addition, if the government deficit does not grow fast enough to meet the saving needs of the private domestic sector, national income will decline, and, given the size of the private sector’s debt problem, a full-blown debt-deflation process will emerge.
Yet today we are still overwhelmed with a chorus of criticism against fiscal activism: we hear constantly that governments are an impediment to the operation of a genuinely “free market” which alone can generate sustained growth and prosperity. The reality is very different on a number of levels. Based on current account and fiscal balance results through Q2, it appears the private sector as a whole is running a net saving position rivaled only once before in the 1973-5 deep recession. At 8 per cent of GDP, the private sector net saving position is probably very near its peak given the rebound in equity prices, stabilizing home prices, and a labor market limping its way back from the abyss. What most commentators fail to acknowledge (Paul Krugman being a conspicuous exception), is that without the automatic stabilizers of fiscal policy, and the turn in the trade balance, the attempt by businesses and households to spend less than they earn would have otherwise been thwarted by a depression sized drop in private income.
Even though private individual and firms face external constraints as they accumulate debt, “household budget” analogies do not hold true for government, as Galbraith, Wray and Mosler argue:
“[I]f we take households or firms as a whole, the situation is different. The private sector’s ability to spend more than its income depends on the willingness of another sector to spend less than its income. For one sector to run a deficit, another must run a surplus (saving). In principle, there is no reason why one sector cannot run perpetual deficits, so long as at least one other sector wants to run surpluses.
“In the real world, we observe that the federal government tends to run persistent deficits. This is matched by a persistent tendency of the nongovernment sector, which includes the foreign sector, to save. Its ‘net saving’ is equal (by identity) to the government’s deficits, and its net accumulation of financial assets (or ‘net financial wealth’) equals, exactly, the government’s total net issue of debt—from the inception of the nation. Debt issued between private parties cancels out, but that between the government and the private sector remains, with the private sector’s net financial wealth consisting of the government’s net debt.”
The reality is – and it is a tyranny of accounting, not a theoretical impediment, since the financial balances of the three sectors must sum to zero – the only way to return to a fiscal surplus, or even a fiscal balance, without taking the private sector back into a deficit spending position, is if the trade balance can be heroically improved. The failure to recognize this relationship is the major oversight of neo-liberal analysis.
Beyond the benign neglect of the dollar depreciation, it is hard to see much in the way of policy measures to achieve either import replacement or export extension in the years ahead. If the fiscal balance is to return to surplus by 2013 – a more aggressive reversal than the CBO depicted in its August Outlook, but consistent with the political tone of returning to fiscal orthodoxy – one can trace out the implications for the private sector financial balance given various assumptions about the trajectory of the trade balance. To get both the fiscal and private sector financial balances to converge at a net saving position of 2 per cent of GDP, the trade balance will have to migrate to a 4 per cent of GDP surplus – something we have never seen before in the US during the post WWII period.
That leaves the emergence of a foreign middle class, and the shift toward domestic demand -led growth abroad as the key elements that could support a better US trade trajectory, which are largely elements outside the control of US policy makers. All of this likely means the path of US fiscal deficit as a share of GDP is probably a better route to full employment and prosperity than the misguided sentiment to cut government expenditures precipitously in a return to financial orthodoxy.
In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending. The sovereign government via net spending (deficits) is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment.
By the same token, the US is no more a “free market” today than the Soviet Union was during the heyday of its empire. The United States is now a species of State Capitalism. The top federal government executives are a partnership of top political and corporate managers who operate a war economy to enlarge their power as their main continuing goal. Less Adam Smith, more Mussolini style corporatism. Today’s unemployment levels that are the hallmark of deep depression are now visible as additional millions “leave” the labor force and are not counted as unemployed by the Federal government even though they are actually jobless. Hence, an 9.7 per cent “unemployment” rate as counted by the Federal government actually refers to a number almost twice as high if we incorporate underemployed and those who classify themselves as independent consultants but who are loathe to describe themselves as genuinely unemployed. Meanwhile, the infrastructure of American society shows decay that can no longer be concealed despite the practiced showmanship of leading public officials.
By the same token, the emphasis on “sound fiscal management”, which allegedly created the platform for vigorous, low inflationary growth, generating jobs and higher incomes is false. Similarly, it is clear that the current reliance on monetary policy (accompanied by the budget deficit phobia) will always fail to deliver full employment and relies on the impoverishment of the disadvantaged for its ability to achieve low inflation.
In the “market fundamentalist” era, prior to the current economic crisis, governments began to rely on monetary policy for counter-stabilization. According to the logic, this rendered fiscal policy a passive player. Under the misguided inflation-targeting regimes that emerged in the early 1990s, central banks adjusted short-term interest rates to control inflation and therefore saw the unemployment rate as a policy tool rather than a legitimate target in its own right. Given the erroneous belief that expansionary fiscal policy was inflationary and its use would compromise the primacy of monetary policy, governments began to pursue surpluses and put in place frameworks to punish deficits and penalize workers who obtained high wage settlements, on the grounds that this was inherently inflationary (though this logic is never extended to CEO executive compensation or Wall Street bonuses).
The results have been clear. They indicate that this way of managing the economy cannot possibly be a sustainable long-term strategy. The emphasis we have placed on “financial responsibility” on the government side has actually introduced a deflationary bias that has slowed output and employment growth (keeping unemployment at unnecessarily high levels) and has forced the non-government sector into relying on increasing debt to sustain consumption. The complaints about “private sector debt fuelled” consumption miss the mark: the debt accumulation is a direct consequence of our failure to use fiscal policy in a manner which supports aggregate incomes and job growth. Targeting wages and the use of a buffer stock of unemployed labor have been the preferred methods of controlling inflation, but minimizing economic output below full potential.
This was not, however, the model which gave the US its greatest period of prosperity. In fact, until the mid-1970s, the U.S. consistently paid the highest industrial wages in the world. According to the late Seymour Melman (a professor of industrial engineering at Columbia University), this fact actually helped the U.S. maintain its economic supremacy.
Melman’s concept that explained this unconventional wisdom he called “alternative cost”. The basic idea is this: faced with high labor costs, firm managers will be more willing to mechanize, that is, use more machinery, and more sophisticated machinery, instead of using labor. By using more, better machinery, they increase labor productivity, which leads to higher wages, and they also stay at the cutting edge of technology. Melman compared factories in England and the U.S. after World War II, and found that the English, who paid lower wages, were using more primitive equipment than the Americans. More recently, his theory has been echoed in Suzanne Berger’s new book, How We Compete, in which she argues that employing cheap labor is not the most effective way of responding to global competition. The activities that succeed over time are those that involve conditions – such as long-term working relationships with customers and suppliers and specialized skills – which companies whose main asset is cheap labor cannot match. A company policy of forcing down wages is not a recipe for long-term economic success.
Economic growth has never been strong enough to fully employ the willing workforce and inequalities are rising throughout the Western world not falling. Further, the disparities between wealthy and poor countries have widened. By curbing the role of government and fiscal policy, we risk reverting to an approach which not only established the pre-conditions for the current crisis including the massive build-up of non-government debt and persistently high labor underutilization, but will almost certainly ensure a return to intense recessionary pressures (at a time when we are still experiencing double digit unemployment). To be clear: I am not advocating unlimited government deficits or spending. Rather, the size of the deficit (surplus) should be market determined by the desired net saving of the non-government sector. This may not coincide with full employment and so it is the responsibility of the government to ensure that its taxation/spending are at the right level to ensure that this equality occurs at full employment.
Accordingly, if the goals are full employment AND price stability then the task is to make sure that government spending is exactly at the level that is neither inflationary, nor deflationary but sufficient to create full employment. This is the true “Goldilocks” scenario, much beloved by Wall Street. It can be better achieved through fiscal policy, rather than the preferred approach of the majority, which suggests that the same outcome is engineered via a monetary manipulation of short term rates by the central bank. Fiscal policy is relatively direct – that is, the dollars go into aggregate demand – immediately they are spent. The standard view that government budget deficits lead to future tax burdens is problematic it assumes a financial constraint which in reality is non-existent. The idea that unless policies are adjusted now (that is, governments start running surpluses or that we experience a “deflationary recession”) is a recipe for social turmoil and revolution. The sooner our policy makers understand that, the more likely we avoid repeating the mistakes that got us into this mess in the first place.
MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at MAuer1959@aol.com