Sunday, August 11, 2013

Neoliberal Orthodoxy

In Forbes on 8/04, Peter Ferrara in his Op-Ed, compared Obama's recovery to Reagan's. Our President, predictably, came up way short. The column was a full-throated statement of the neoliberal (read Conservative) economic orthodoxy. Here are excerpts:

Taxing or borrowing a trillion dollars out of the private sector to spend a trillion dollars in the public sector is not going to increase jobs or economic growth overall on net.  At best, it will just shift jobs from where the market directs to where the government directs.  More likely, it will be a net drag on the economy, because the market spends money more productively and efficiently than the government...

But jobs and middle class prosperity are not created by government spending, which just takes more productive jobs and spending out of the private economy.  In a capitalist economy, economic growth, jobs, middle class prosperity, and opportunity for the poor are created by capital investment driven by decentralized markets, which aggregate the choices and revealed preferences made by hundreds of millions of consumers and workers, to increase production of the goods and services desired by those consumers, most efficiently as driven by decentralized market competition.  The effective knowledge aggregated by decentralized markets is far greater than any centralized collection of so-called experts can even conceive...

Obama has increased government spending, deficits and debt, which only drains the private sector of the resources to create good middle class jobs, and economic growth and prosperity.  And he has cheerled a weak dollar Fed monetary policy that only chases off investors who don’t want to invest in dollars that the Fed is depreciating over time.

To summarize:

  1. Government spending is "taken out" of the economy through taxes or borrowing and therefore cannot create net new jobs or economic growth.
  2. Jobs and growth are created by private capital investment in a decentralized, free and efficient marketplace.
  3. Government attempts to replicate this from the center will fail.
  4. Government deficits and debt "drain" the private sector of resources needed for jobs and growth.
  5. The Fed's easy money policies will cause inflation (i.e., investors are driven off, markets tank, yields rise, creating inflation) and will debase the currency.
The only thing missing from the list is the need for "expansionary contraction", i.e., austerity. But I have no doubt this is on Ferrara's full list. 

This is what economists call Neoliberalism. It is Conservative and Republican orthodoxy. It has England and the Eurozone in its thrall, and, unfortunately, way too many Democrats, including (on a bad day) our President.

And it's almost entirely wrong, from an empirical point of view. #1 is wrong. #2 is partly correct (private investment is a key source of job creation, just not the sole source). #3 is partly correct (the Government should not try to replicate the "wisdom" of the marketplace, but there is much that Government can do well). #4 is wrong. #5 is wrong. And the unlisted austerity is also completely wrong.

Take note, my conservative friends, I am not only claiming that I disagree with your policy framework; I am saying that the neoliberal framework is just plain wrong. I am not an economist by academic training: it is not my vocation, but it has, through study in the last three years, become my avocation. Over the next few weeks, and as a regular part of my posting, I will present the framework I am certain is correct. It is rooted in Keynes, carried forward by Minsky and Godley, and brought into its most complete form by the Post-Keynesian School, called Modern Monetary Theory. More on the key ideas and leading lights to come.

For now, let me devise a short list to counter the six points in the neoliberal list. And here they are:

  • There are four spending streams in the economy that contribute to GDP and directly create income streams for people in the US: consumption (C), investment (I), government (G), and net exports (X-M), giving us
                                                                GDP = C + I + G +(X-M)

  • All spending streams matter. All contribute to National Income (Y). In fact, 
                                                                     Y = C + T + S
                                                    National Income = Consumption + Taxes + Savings

  • Since GDP spending = National Income, then GDP = Y, so
                                                              C + T + S = C + I + G + (X-M) , then simplify, so
                                                                 (S-I) + (T-G) + (M-X) = 0
                                              Net Private + Net Government + Net Foreign = 0
                    This is the Sectoral Balances model, showing how spending/income flows from
                    the government, private, and foreign sectors must balance, or equal zero. So
                    private sector saving (S > I) must be balanced by government deficits (T < G), when
                    the current account balance is negative, as it almost always is in the US.

  • Spending creates and equals income (GDP = Y). My spending is your income. Your spending is my income. Our spending is our income. All spending contributes to GDP, or economic growth. All spending is demand for goods or services. All spending contributes to creating jobs. Saying that only private investment (I in the above formula) creates jobs or growth is absurd. Conservatives try to argue that when government spends, consumers and businesses withhold an equal amount to account for future tax increases - but this position has no empirical backing.
  • The next Conservative argument is that government spending takes resources out of the economy, and in effect "trades" or "replaces" private spending. Under this approach, there is a finite pool of savings in the economy to be spent by either business or government, but not both. The spending of government overrides or "crowds out" private spending. And this gets to a central point in MMT's analysis: the government always spends by creating new money, and since it is a sovereign currency issuer, there is no "savings pool" limit to what they can spend. In many, possibly most cases private industry will also use new money to finance their investment spending, as they borrow from banks, taking on new loan commitments that create new demand deposits, or new money. There is no finite loanable funds or savings pool. In fact Investment helps create GDP, which then generates Savings, not the other way round. 
  • As we saw in the Sectoral Balances analysis, government deficits are essential for the US, since we are a deficit current account country, and only a deficit that balances the Net Exports negative, and then adds some more spending, will be sufficient to allow the private sector to Net Save. Under Clinton, when we ran surpluses, the private sector became a significant net borrower(S-I is negative), leading to over-indebtedness and ultimately the 2008 GFC. In all cases, however, government deficits supply resources to the economy, and are never a drain.
  • The Fed's easy money stance will have no impact on inflation, until unemployment is eliminated and the economy moves towards its limits. Inflation is also not created by QE, since the excess banking reserves created when the Fed buys back securities do not get into the real economy. Banks do not loan reserves. They make loans to creditworthy customers, creating new demand deposit money, and adjust their reserve balances later. As for currency debasement, there is effectively no evidence that this has been happening since the GFC.
  • Neoliberal economists and Conservative politicians argue for austerity (cutting government spending) by saying only this will revive the "job creator's" confidence, causing him to loosen the pursestrings and begin investing heavily in the economy. This is the "confidence fairy" argument. It is in the process of deeply wounding Europe. We have been fortunate that only a mild form of this therapy has been tried here in the US. Austerity is LOUSY economics. And as we watch Japan move into solid growth, I predict we will finally have a powerful anti-austerity example, a country who will have been unafraid to reembrace Keynesian fiscal stimulus.
That is plenty for now. More soon.

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