Austerity, Stimulus, and Hidden Agendas

Nothing better exemplifies our gridlock over the future of 21st century government, as well as how to recover from the Great Recession, than the false dichotomy of austerity versus stimulus.

The austerity thesis, reduced to its simplest form, suggests that government has been living beyond its means for some time, only exacerbated by the actions that accompanied the recent economic downturn. Sequesters, tax increases, and spending cuts become the order of the day.

The stimulus hypothesis, reduced also to simplest form, suggests that more government spending and lower taxes puts money in people’s pockets and helps cure a country’s economic doldrums. Once the economy is doing better, government spending will naturally fall and taxes rise.

The debate then plays out largely over deficits: do you want larger or smaller ones?

But reduced to this form, the debate is a fallacy, for several reasons.

First, one must define larger or smaller relative to something. Last year’s spending or taxes or deficits? What’s scheduled automatically in the law? The public debate often glosses over these issues. Which is more expansionary when keeping taxes at the same level: an economy whose growth in spending is cut from 6 to 4 percent or one whose growth is increased from 1 to 3 percent?

Second, a country’s ability to run deficits depends on its level of debt. A recent debate over whether at some point higher debt starts to slow economic growth doesn’t change the fact that lenders want to be repaid. People won’t loan to Greece now, but they still find the U.S. Treasury securities a safe haven for their money.

Third, and by far the most important, what timeframe is involved? Is the Congressional Budget Office pro-austerity or pro-stimulus when it concludes that sequestration hurts the economy in the short run, but is better in the long run than doing nothing about deficits? No one on either side suggests that debt can grow forever faster than the economy. Everyone implicitly or explicitly believes that to accommodate recessions when debt grows faster there are times when debt must grow slower.

So where’s the rub? Here you must understand the emotional systems, usually veiled, that lie behind those on both sides trying to force the problem to an either/or solution.

Start with hardline austerity advocates. Many of them don’t just want smaller deficits. They want smaller government—or, at the very least, they want to prevent the government from taking ever larger shares of the economy, even given changing demographics. Essentially, austerity advocates don’t trust their pro-stimulus adversaries, some of whom can almost always find an economy going into a recession, in a recession, coming out of a recession, or attaining a lower-than-average growth rate and, therefore, needing some form of stimulus. Austerity advocates have learned from long experience that once government spending is increased, it’s hard to reduce. So they feel they have to get what deficit reduction they can now that the public’s attention to recent large debt accumulations is creating pressure to act.

Now for many the hardline stimulus advocates, their support for additional temporary government intervention cannot be entirely disentangled from their sympathy for a larger future government. Else why not agree to cut back now on the scheduled acceleration of entitlement programs, particularly fast-growing health and retirement programs? That would bring the long-run budget, at least as currently scheduled, back toward balance. It would simultaneously please many of their austerity opponents and allow for more current stimulus.

The hidden agendas are complicated further by inconsistencies on both sides. Many hardline austerity advocates, at least in the United States, don’t want cuts to apply to defense spending. For their part, many hardline stimulus advocates would be glad to pare growth in tax subsidies.

Regardless, the dichotomy falls apart once one realizes that a solution can involve a slowdown in scheduled growth rates in spending and a higher rate of growth of taxes, accompanied by less short-run deficit reduction and an abandonment of poorly targeted mechanisms such as sequesters.

Consider the buildup of debt during World War II, the last time we saw U.S. levels above where they are today. Debt-to-GDP fell fairly rapidly after the war all the way until the mid-1970s. While the growing economy certainly helped, tax rates that were raised substantially during the war were largely maintained afterward, and spending had essentially no built-in growth (actually huge declines when the troops came home). Just the opposite holds now even with recovery: there are limited tax increases to pay for past accumulations of debt or wartime spending, and spending is scheduled to grow long-term, even after temporary recession-led spending and defense spending on Afghanistan declines.

Both sides—pro-austerity and pro-stimulus—want desperately to control an unknown future, either by not paying our current bills with adequate taxes or by maintaining built-in growth rates in various programs, mainly in health and retirement. The false dichotomy between austerity versus stimulus has fallen by the wayside, and what we see through the veil are two sides in mutual embrace trying to control our future, whatever the cost to the present.


Growth in Income and Health Care Costs

Worried about the stagnation of income among middle-income households? Or about the growth in health care costs? The two are not unrelated. In fact, middle-income families have witnessed far more growth than the change in their cash incomes suggest if we count the better health insurance most receive from employers or government. But is that all good news? Should ever-increasing shares of the income that Americans receive from government in retirement and other transfer payments go directly to hospitals and doctors as opposed to other needs of beneficiaries? Should workers receive ever-smaller shares of compensation in the form of cash?

The stagnation of cash incomes in the middle of the income distribution now goes back over three decades. Consider the period from 1980 to 2011. Cash income per member of a median income household, which includes items like wages and interest and cash payments from government like Social Security, only grew by about $4,300 or 27 percent over that period, when adjusted for inflation. From 2000 to 2010, it was even negative. Yet according to data from the Bureau of Economic Analysis, per capita personal income—our most comprehensive measure of individual income—grew 72 percent from 1980 to 2011.

How do we reconcile these statistics?  By disentangling the many pieces that go into each measure.

Growing income inequality certainly plays a big part in this story: much of the growth in either cash or total personal income was garnered by those with very high incomes. So the growth in average income, no matter how measured, is substantially higher than the growth for a typical or median person who shared much less than proportionately in those gains. But personal income also includes many items that simply don’t show up in the cash income measures. Among them is the provision of noncash government benefits, such as various forms of food assistance.

Health care plays no small role. In fact, real national health care expenditures per person grew by 223 percent or $6,150 from 1980 to 2011, much more than the growth in median cash income. If we assume that the median-income household member got about the average amount of health care and insurance, then we can see how little their increased cash income tells them or us about their higher standard of living.

Getting a bit more technical, there’s a danger of over-counting and under-counting health care costs here. Some of the median or typical person’s additional cash income went to extra health care expenses, so the additional amount he/she had left for all other purposes was even less than $4,300. However, individuals pay only a small share of their health care expenses; the vast majority is covered by government, employer, or other third-party payments. So, roughly speaking, typical or median individuals still got well more than half of their income growth in the form of health benefits.

The implications stretch well beyond middle-class stagnation. Employers face rising pressures to drop insurance so they can provide higher cash wages. For instance, providing a decent health insurance package to a family can be equivalent roughly to a doubling of employer costs for a worker paid minimum wage. The government, in turn, faces a different squeeze: as it allocates ever-larger shares of its social welfare budget for health care, it grants smaller shares to education, wage subsidies, child tax credits, and most other efforts. Additionally, the more expensive the health care the government provides to those who don’t work, the greater the incentives for them to retire earlier or remain unemployed.

In the end, the health care juggernaut leaves us with good news (that our incomes indeed are growing moderately faster than most headlines would have us believe) as well as bad news (that health care remains unmerciful in what it increasingly takes out of our budget).

Cumulative Change in Income & Health Expenditures


When Policy Meets Statistics: The Reinhart and Rogoff Study on Excessive Debt

Knowing how many of us economists toil away in obscurity on most research, I’m always intrigued by what catches the press’s and public’s attention. Take, for example, the significant attention paid to a 2010 study by Harvard economists Carmen Reinhart and Kenneth Rogoff that concluded that countries with debt levels above 90 percent of GDP began showing slower rates of growth. When Thomas Herndon, Michael Ash and Robert Pollin, scholars at the University of Massachusetts at Amherst, recently had trouble replicating Reinhart and Rogoff’s results, the debate played out in national news outlet.

Unfortunately, this discussion quickly devolved from substance to politics to arguments ad hominem. Without getting into the extent to which I or others can validate Reinhart and Rogoff’s (R&R’s) original findings, I offer six cautions for anyone witnessing this or a similar statistical debate with significant policy implications: (1) statistics should never be interpreted as showing more than simple but potentially useful correlations; (2) healthy skepticism is required for all social science research, which seldom gets replicated for validity; (3) all empirical economic work is based on history that will not repeat in the exact same form; (4) research can certainly contradict conventional wisdom but not reason; (5) arguments ad hominem, particularly by those with their own agendas, are unhelpful; and (6) be careful with labels and straw men.

  1. Correlation versus causation. It’s long been stressed that statistical tests never prove causation, not simply because they can’t but because researchers make many choices and assumptions, often of statistical convenience. This doesn’t mean statistics are useless. Just accept that any result merely shows that A and B seem to occur together even after trying to account for other influences under a huge range of never-fully-tested assumptions.
  2. Skepticism. A growing body of “research on research” shows that few social science experiments, and even many medical studies, are replicated. Also, positive results get published; negative results usually do not. R&R’s study was replicated mainly because it got an unusual amount of attention.
  3. History. The past never repeats itself exactly—or, as Heraclitus warns, “You could not step twice into the same river.” That historical interpretations are contained and sometimes couched in data analyses doesn’t mitigate this well-known caution.
  4. Reason versus conventional wisdom. The R&R debate mainly revolves around two reasonable notions. One is the simple arithmetic conclusion that debt can’t rise forever relative to national income, along with the related economic conclusion that higher levels of debt can and have been shown in many places to have consequences for investment, interest rates, ability to borrow, and how government revenues are spent. The other is that institutions, times, places, and circumstances matter greatly, and they affect how one should interpret past data, such as those presented by both R&R and their critics.
  5. Ad hominem arguments. R&R published some of their work with the Peterson Institute for International Economics, so some of those who attacked R&R may have considered the authors guilty by association because of Peter George Peterson’s concern about deficits and his contributions to that Institute. Peterson’s own “guilt” on budget issues seems to be that he became rich on Wall Street, although he favors higher taxes on what he calls “fat cats” like himself. Still, while many of those who engage in these attacks themselves fail to represent their own or their institution’s sources of funding, let’s be honest. Much social science research is funded in ways that doesn’t necessarily bias how the research is done, but rather what is researched in the first place. So, unless one fully engages and thoroughly analyzes every study, even the careful academic reader must often try to determine trustworthiness in other ways, such as whether the researchers report results only consistent with some special interest or political party.
  6. Labels and “straw men.” While we all use labels and straw men at times to set up the stories we tell, they at best simplify greatly. In this case, R&R are identified as advocates of “austerity” and their opponents as “Keynesians” advocating stimulus, both of which are nothing more than labels. Most budget analysts I know worry about deficits but vary widely in whether they would engage in more short-term stimulus or in how strongly they believe that a path toward long-term balance even requires austerity. For instance, is reducing some rate of growth of spending, no matter what its level, austerity? Is the Congressional Budget Office an advocate of austerity or Keynesian when it asserts that sequestration hurts the economy in the short run, but has long-run benefits relative to doing nothing about deficits?

The bottom line: use extreme caution no matter which economist you read or believe.

Full disclosure: I have spent most of my career at the Urban Institute or the Treasury Department, brief periods each at the Brookings Institution, American Enterprise Institute, and the Peter G. Peterson Foundation (which differs from the Peterson Institute for International Economics). I also serve or have served on many advisory groups and boards for such organizations as the Committee for a Responsible Federal Budget and the Comptroller General of the United States. As a consequence, je m’accuse of being among the many economists limited more than I would like by what research is supported by those institutions or their funders.


Lost Generations? Wealth Building Among the Young

The young have been faring poorly in the job market for some time now, a condition only exacerbated by the Great Recession. Now comes disturbing news that they are also falling behind in their share of society’s wealth and their rate of wealth accumulation.

Signe Mary McKernan, Caroline Ratcliffe, Sisi Zhang, and I recently examined how different age groups have shared in the rising net wealth of the U.S. economy. Despite the recent recession, our economy in 2010 was about twice as rich both in terms of average incomes and net worth as it was 27 years earlier in 1983. But not everyone shared equally in that growth.

Younger generations have been particularly left behind. Roughly speaking, those under age 46 today, generally the Gen X and Gen Y cohorts, hadn’t accumulated any more wealth by the time they reached their 30s and 40s than their parents did over a quarter-century ago. By way of contrast, baby boomers and other older generations, or those over age 46, shared in the rising economy—they approximately doubled their net worth.

Older Generations Accumulate, Younger Generations Stagnate

Change in Average Net Worth by Age Group, 1983–2010

Change in Net Worth by Age Group

Source: Authors’ tabulations of the 1983, 1989, 1992, 1995, 1998, 2001, 2004, 2007, and 2010 Survey of Consumer Finances (SCF).
Notes: All dollar values are presented in 2010 dollars and data are weighted using SCF weights. The comparison is between people of the same age in 1983 and 2010.

Households usually add to their saving as they age, while income and wealth rise over time with economic growth. If these two patterns apply consistently and proportionately, then one might expect to see, say, a parent generation accumulate $100,000 by the time its members were in their 30s and $300,000 in their 60s, whereas their children might accumulate $200,000 by their 30s and $600,000 by their 60s.

This normal pattern no longer holds for the younger among us. However, this reversal didn’t just start with the Great Recession; it seems to have begun even before the turn of the century. The young increasingly have been left behind.

Potential causes are many. The Great Recession hit housing hard, but it particularly affected the young, who were more likely to have the largest balances on their loans and the least equity relative to their home values. If a house value fell 20 percent, a younger owner with 20 percent equity would lose 100 percent in housing net worth, whereas an older owner with the mortgage paid off would witness a drop of only 20 percent.

As for the stock market, it has provided very low returns over recent years, but those who hung on through the Great Recession had most of their net worth restored to pre-recession values. Bondholders usually came out ahead by the time the recession ended as interest rates fell and underlying bonds often increased in value. Also making out well were those with annuities from defined benefit pension plans and Social Security, whose values increase when interest rates fall (though the data noted above exclude those gains in asset values). Older generations hold a much higher percentage of their portfolios in assets that have recovered or appreciated since the Great Recession.

As I mentioned earlier, however, the tendency for lesser wealth accumulation among the younger generations has been occurring for some time, so the special hit they took in the Great Recession leaves out much of the story. Here we must search for other answers to the question of why the young have been falling behind. Likely candidates for their relatively worse status, many of which are correlated, include

  • a lower rate of employment when in the workforce;
  • delayed entry into the workforce and into periods of accumulating saving;
    reduced relative pay, partly due to their first-time-ever lack of any higher educational achievement relative to past generations;
  • their delayed family formation, usually a harbinger and motivator of thrift and homebuilding;
  • lower relative minimum wages; and
  • higher shares of compensation taken out to pay for Social Security and health care, with less left over to save.

When it comes to conventional wisdom and media attention to distributional issues, there’s a tendency simply to attribute any particular disparity, such as the young falling behind in wealth holdings, to the growth in wealth inequality in society. But the two need not be correlated. Disparities can grow within both younger and older generations, without the young necessarily falling behind as a group.

Whatever the causes, we should also remember that public policy now places increased burdens on the young, whether in ever-higher interest payments on federal debts they will be left or the political exemption of older generations from paying for their underfunded retirement and health benefits. At the same time, state and local governments have given education lower priority in their budgets; pension plans for government workers now grant reduced and sometimes zero net benefits to new, younger hires; and homeownership subsidies post-recession increasingly favor the haves over the more risky have-nots.

Maybe, more than just maybe, it’s time to think about investing in the young.


Henry Ford, the American Experience, and Why and How the Distribution of Income Affects Growth in the Modern Economy

One hundred years ago Henry Ford dropped the price of his Model T to $550.  Having adopted new and successful engineering and assembly techniques, the company’s sales expanded exponentially, approximately tripling between 1911 and 1914 alone.  Henry Ford bragged that his car would be “so low in price that no man making a good salary will be unable to own one.”

On the American Experience (January 29, 2013) PBS covers the biography of Henry Ford.  That story has application to our own time in explaining how the distribution of income affects economic growth.

Ever since the Industrial Revolution, economies of scale—mass production with lower cost for the last items produced than for the first—have been the primary engine of income growth for nations and workers.  Ford’s talent at mass production not only made him extraordinarily rich, it helped increase the effective incomes of workers throughout the country since their earnings could go farther.  While massive rewards did accrue to entrepreneurs, inventors, and those gaining temporary monopolies, the rising tide lifted all boats; it even leveled out the gains as the forces of competition limited how much leading capitalists could garner for their efforts of yesteryear.

Henry Ford’s fight with unions to the side, he did recognize from the start that workers needed to earn enough to buy his products.  I’m not suggesting that the cart of workers’ incomes leads the horse of profits, but rather that they move forward together.  Ford at least knew that he and some of the other rich people he tended to detest could use only so many cars themselves; if the everyday citizen couldn’t buy them, he could never get rich.

So how did we move toward a society where today profits seem to be rising but workers’ incomes remain stagnant?  The main answer, I believe, is that while economies of scale have expanded extraordinarily since Ford’s day, the necessary purchasers of the new products lie within a global economy.  The growth of U.S. workers’ incomes is less necessary for the producers of new goods and services to become wealthy.

Consider how many modern-day Henry Fords produce goods and services with limited physical content: pharmaceutical drugs, electronic software, technology, movies, and other forms of entertainment and information.  These “industries” provide much of the growth of the modern U.S. economy.

Many products within these growth industries can be produced at almost no cost for the next or marginal purchaser.  How much does it cost Hollywood producers to let one more person watch a movie?  For the drug manufacturers to produce one more pill?  For Microsoft or Apple to make software available to one more person?  Almost nothing in many cases, other than marketing.  As economies of scale expanded as we moved through the 20th to the 21st century, so, too, have the possibilities for growth when more people have enough money to buy these new products.  If the costs of a pill or movie can be shared among 10 million people, rather than 1 million, then the world economy can expand quickly when 9 million more people can afford to buy the product.

These economies extend beyond production to transportation, storage, and similar costs.  It doesn’t cost much to “transport” a movie to Monaco, a pill to Paris, or software to Sofia.

Modern capitalists seek their buyers within a world population of 7 billion, not a U.S. population of 300 million.  When creating products with extraordinary economies of scale that are easily transportable, at low weight or even with the click of a mouse button, the new American entrepreneur still wants purchasers whose incomes rise enough to buy these new goods and services.  It’s just less necessary that those purchasers reside in the United States.

Does this mean that income becomes increasingly unequal?  It depends partly upon whom you count and what type of measure you use. Almost no one could have guessed even a few decades ago the rise of hundreds of millions of middle-class people in China and India.  At the same time, it’s also possible that incomes will rise initially for U.S. and Indian entrepreneurs and for workers in Bangalore, but not for large portions of the population in either the United States or India.

I am not arguing that all the consequences of this world order are sanguine.   But only by defining its characteristics can we identify our opportunities.

First, consider how substantial economies of scale make higher growth rates possible when incomes rise across the board.  Productivity just doesn’t rise as quickly when we build and subsidize McMansions for the few rather than employ workers to provide goods and services with greater economies of scale for the many.

Similar calculations can affect welfare policy.  It may not cost us very much directly to give lower-income people the ability to buy goods and services with large economies of scale.  For instance, if we give a household $1,000 that it uses to buy a television subscription that at the margin costs a cable company only an additional $100 to provide, then the net cost to the non-welfare part of society may also be only $100 despite the transfer of $1,000.  At the same time, if the $1,000 subsidy at a $100 marginal cost of production results in plus $900 to a monopoly cable company and minus $1,000 to the taxpayer, then both the welfare recipient and the taxpayer may have reduced incentive to work.  Private income (before welfare) also becomes more unequal.

Or consider antitrust policy.  Tying it to its 19th century moorings may be inadequate for a 21st century economy.  International competition may lessen any concern over having only four major American automobile manufacturers, but what about the concentration of accounting practices among the Big Four? Did the breakup of Arthur Andersen for its accounting indiscretions promote or reduce competition?

What about our current multi-tiered pricing of drugs, higher at home and lower abroad?  Without any compensating mechanism, does this increase net output from the United States but at an unfair cost to U.S. consumers?

To answer all these questions, we need to concentrate correctly on causes, not inveigh interminably on impressions.  One conclusion from Henry Ford’s day still stands out in my mind: promoting greater growth means both a favorable climate for entrepreneurship and a sharing of its rewards broadly with workers.