This past Wednesday, Larry Summers and Paul Krugman both spoke at different events and both warned of a lost economic decade–or decades–in the United States. While I am loathed to accept anything spewing from the frothy mouth of Larry Summers, he was uncharacteristically cogent in his remarks. Mr. Krugman continued–much to his credit–to pound the drum for decreased austerity, increased stimulus, and more proactive programs to spur employment. Mr. Krugman is widely regarded as championing policies that hang precariously the fringe of mainstream economic thinking, while Mr. Summers has long been a technocratic proponent of free markets.
“For the first time in 75 years, we are experiencing a protracted recession due to a lack of demand,” Summers said during a speech to the Center for Global Development in Washington. “It’s now been about five years since the recession began and it appears the stagnation will be with us for another long interval.”
“There is not enough demand,” Krugman said during an appearance at the Economic Policy Institute, where he gave a talk to promote his new book, End This Depression Now. “We focused a lot – too much – on the financial sector’s problems. Yet that is long since gone and we still don’t have a steady recovery. That tells us the crisis was far more about household debt.”
Summers chose to focus on fixes to income inequality through progressive taxation as medicine for the demand problems in the United States, while Krugman focused on retracing the cuts in government spending at the federal and state level in order to increase expendable income, employment, and certainty. Both men are correct. Summers is correct in that if the United States is to allow the tax system to remedy income inequality rather than to implement tight regulation and limits on executive pay and compensation, then individual–namely wealthy individuals–and corporate tax revenues must necessarily increase. He also points out, falsely I believe, that much of the job losses caused by technological innovation in the manufacturing sector are to blame for much of the income inequality, and that nothing can be done to reverse that trend. Krugman is correct in that it was wholly irresponsible to react to a short term protraction in government revenues by slashing millions of public sector jobs. By failing to recapitalize state and municipal coffers, the federal government has exacerbated the huge demand problem and contracted government tax revenues. Krugman also points out that the long slog of short term fixes to the tax code and stop-gap measures on infrastructure funding have created an uncertain contracting environment for federal and state agencies, leading to the cancellation and procrastination of major improvement and repair projects. In doing so, the government has further dragged down consumer spending, employment, and government revenues.
The two had also squared off last November in a debate sponsored by the Munk Debates, sponsored by the Canadian Aurea Foundation. In this prior exchange, it appears that Krugman got the best of Summers.
Economically speaking, the Nobel laureate largely had the better of the technocrat. We’re already four years from the beginning of the U.S. recession, and we’ve certainly been going nowhere over that time — the question isn’t whether the economy is lost, so much as whether there’s something which can help it back onto its feet in the next few years. As Rosenberg said, if you look at employment, or the stock market, or median income, or house prices, all of them are back to where they were years ago. Things might improve in the future, but they sure aren’t healthy right now. And Japan is proof that economies can stagnate more or less indefinitely — it’s now, as Krugman pointed out, 19 years into its “lost decade”.
Summers on the other hand not surprisingly offered boasting support for the economic achievements of his former boss Barak Obama. He also went as far as to voice some support for the idea of income inequality.
But here’s the thing: Summers really is a formidable debater. He met Krugman’s gridlock argument head-on, saying that Barack Obama’s legislative achievements in 2009-10 were greater than those in any two year period since 1965-66, or possibly even 1933-34. And in his concluding remarks, he declared that “things are never as bad as you think they are when things are bad”, adding optimistically — and accurately — that in politics, “the transition from inconceivable to inevitable can be very rapid”. Summers’s optimistic sentiment went down well with the well-heeled Toronto crowd: people who are wealthy and healthy and happy, like the Munk Debate audience, tend to be attracted to arguments saying that there’s no need to feel guilty or fearful.
Summers also tried to defend inequality, at least in part, by saying that “suppose the United States had 30 more people like Steve Jobs” — that, he said, would be a good thing even as it increased inequality. “So we do need to recognize that a component of this inequality is the other side of successful entrepreneurship; that is surely something we want to encourage.” This might have been received better had Summers not earlier praised America, while pointing to Bremmer, as “the only country in the world where you can raise your first $100 million before you buy your first suit and tie”.
A healthy mix of both men’s proposals is required to lift the United States economy from a potential ten or more years of stagnant growth and high unemployment. Marginal tax rates must be increased across the board with a heavier weighting toward the top earners in order to grow government revenues and allow it to send stimulus into the economy. The government must also borrow while interest rates are at historic lows in order to prop up state and local governments to constrict the public sector job bloodletting. The Federal Reserve must abandon attempts to prop-up the banking sector and force equity to flow through the large financial institutions and into the hands of the public. The Federal Reserve must also set aside fears of higher interest rates and inflation as cause for inaction and focus on increasing employment, as no evidence exists to support the fears. The government, in conjunction with the business community, must implement job training and education programs in order to fill needs that currently and will exist, and prevent the millions of long-term unemployed from creating a drag on the economy for decades. Germany for example, has a wonderful dual education-job training system that through agreements with for-profit business has been able to maintain extraordinarily low unemployment throughout the recession.
Consumer spending accounts for 70% of the United States economy. It doesn’t take a Harvard business degree to conclude that if real wages continue to drop and income inequality continues to increase, that the economy will be unable to sustain growth going forward. Without disposable income, there is no money to spend on the goods and services that are so vital to maintaining the growth that has been enjoyed in the United States for generations. The United States has a lower debt to GDP ratio that the United Kingdom, France or Japan, and just marginally higher than that of Germany. Contrary to public consciousness, the United States is not on the eve of some public debt crisis. However, it certainly will be if it continues to reduce government revenues by embarking upon policies that guarantee high unemployment and lower tax rates.
Until recently, consumers had been deleveraging responsibly since the outset of the financial crisis. Fears of economic and employment uncertainty have encouraged the people to pay off debt and attempt to save more than they had in the recent past. Lax lending standards and easy credit tightened considerably following 2008, and it is only now beginning to loosen for the average citizen. It is downright fantastic that Americans have seen fit to pay down high interest rate credit cards, auto loans, and refinance their mortagges when able. However, every dollar now spent to pay down debt is not being spent in the larger economy. It isn’t responsible policy to continue to expect the middle class and the poor to live life on the economic edge in order to provide the consumption necessary for growth. Without government stimulus and spending to make up the difference, while the government also fails to offer a counterweight to reductions in spending due to unemployment, the economy flounders, and will continue to do so until structural changes are made.
Neither Democrats or Republicans are promising any large scale recapitalization of state and municipal budgets, or increased spending on infrastructure. The Democrats fear being labeled as irresponsible spenders in the current political atmosphere of cut-now-ask-questions-later, and the Republicans are hell bent on destroying the economy while President Obama is in charge. Certainly if Mitt Romney is able to capture the presidency this November, he will be left with no choice but to allow the economy to crumble further into dust under the policies proposed by Paul Ryan and his fellow economic Darwinists in the Congress, or save his own hide by corralling his party and releasing cash into the economy. If President Obama is reelected, he will face much the same obstructionism he currently faces, with little chance of convincing Republicans in the Congress to offer him a lifeline unless public sentiment is such that the conservatives have no electoral choice.
It is a recipe for decades of stagnant growth and continued reductions in government programs, infrastructure spending, school funding, park and wildlife preservation, government efforts to maintain clean water and a safe food supply, higher education funding, and funding for advanced projects such as high speed rail, solar, wind, and geothermal power. It will also exacerbate crime and overload the prison system. Medicare, Medicaid, and Social Security will have to be cut. The only means through which this situation can be avoided is by following the advice–gulp–of both Mr. Summers and Mr. Krugman. Taxes must be made more progressive and the government must borrow and spend to provide the economy with life support until it can breathe on its own. Structural changes must be made to the means through which we train and educate future workers. Income inequality must be addressed through the tax code, or alternatively, strict regulations must be put in place to limit worker-to-executive pay ratios.
To do otherwise practically guarantees that future Professors Krugman and Summers will be holding graduate seminars in exclusively private universities in order to study the United States and its lost century.