Arnold Kling  

Larry Summers, Neo-Galbraithian

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He sets out criteria for a stimulus package.


Investments in an array of areas -- including energy, education, infrastructure and health care -- offer the potential of extraordinarily high social returns while allowing our country to address some long-standing national challenges and put our economy on a solid footing for years to come.

This does not sound like a short-term plan to stimulate the economy. It sounds like a long-term plan to stimulate bigger government. It is economic policy according to John Kenneth Galbraith.

From a stimulus perspective, the timing of this public-sector investment strategy is off. Relatively little of the spending is likely to take place in the first three quarters of 2009, and most of it is likely to take place after the recession has ended. Furthermore, there is no exit strategy. When will the pace of government investment be cut back? I would not hold my breath waiting for government officials to say, "It looks like we have run out of good projects. It's time to cut back public investment and increase private investment."

Instead, I would like to see an immediate and permanent cut in the payroll tax. In the short term, let the deficit go up. In the long term, finance the payroll tax cut by phased-in increases in fuel taxes and in the age of government dependency (known as the retirement age).

The cut in the payroll tax would quickly attack the short-term job creation problem on both the demand and the supply side. It also would be more reliably helpful to the broad middle class.


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COMMENTS (17 to date)
dearieme writes:

On the "First, do no harm" principle, cutting payroll tax and increasing fuel duties is a pretty fair bet, since it would have been a good idea from the early seventies onwards. As for increasing the retirement date, ours (in Britain) has already started the march from 65 to 68.

MattYoung writes:

We do not have a debate on getting the economy going, but a debate on subsidizing the old expectations while the new expectations take root.

What the Keynesians want to do is live a little more in the past until they can liquidate their mis-allocated funds.

Maniel writes:

Arnold,

I concur with your analysis. There is a presumption that federal government should fix the private economy and address local issues by "investing" money that I might otherwise have saved or spent (in the real economy).

Energy is an issue for the private markets, and beyond protecting the environment, government should stand clear. Why must the feds spend $50B on education when we send our kids to the school down the street (which could really use that money)? Whose infrastructure - how will the winners be chosen? Whose health care - will I be receiving a personal trainer from Washington at your expense? Will we soon see Fannie Nurse or Freddie Doc?

El Presidente writes:

If you think it will be hard to rein in spending on projects, try raising taxes once we've lowered them below their efficient level. Contrary to Libertarian dogma, the efficient level of taxation is above zero (and an absence of enforcement and collection activity is not, as Mr. Henderson would have us believe, a good thing).

People do not trust the financial services and banking industries to invest their money and provide a return. I know of no reason to believe that cutting payroll taxes would fundamentally alter our economy in a way that would create more incentive to invest in the long run, or that increasing the volume of investment over the quality will benefit us. Will it raise our average annual growth rate? That is, in effect, what would need to happen if cutting payroll taxes were to bring about sustained economic recovery. If not, any benefit will be short-lived. What would be the opportunity cost of such a plan?

Municipal and state governments don't currently have enough money to pay for required maintenance on existing infrastructure. How long do you suppose that can go on before it seriously impacts baseline private investment?

You may not like the prospect of increased government investment spending, but your suggested alternative is fatally flawed because our rates of taxation are insufficiently progressive to stabilize our economy without variability in government spending. It would be better to resume public investment in a responsible way; not going for broke but fixing what's broken, and building inward instead of outward.

Raising property taxes (relative to income and capital gains taxes) would help in the long run because it would restore some balance in our taxation of the factors of production and change our current tendency to use more land relative to capital and labor, which requires more infrastructure, more transportation time, more energy consumption, more environmental degradation, etc. Let's change our marginal rate of technical substitution (MRTS). That's an opportunity for improving economic efficiency. When will you advocate doing something about that without eviscerating the government we'll need to make it happen? My guess: never.

MattYoung writes:

El presidente has either his sign wrong or his phase wrong on the effect of lowering payroll taxes.

Lowering the payroll tax, would, in the short term, cause more people to enroll in government entitlements, not less. Government entitlement sign up would expand, but in the long term we would have to address the imbalance by making social security flexibly adapt to changing expectations about retirement.

El presidente is correct about property taxes, raising them will force us to use less property for the same output. I see that effect today in Fresno California. As housing prices drop, and owners fail to get a re-assessment, they tend to crowd into inner city housing more to share the property tax burden, probably a good thing.

However, the state of California and the federal government were at odds for a long time, the federal government wanting us to invest in housing with reduced financing costs and the state wanting us to crowd into apartments with high property taxes. It was the feds who won that battle, not Jarvis.

dearieme writes:

I suppose Summers wants to become a sort of "big, swinging dick" of government spending.

El Presidente writes:

MattYoung,

Lowering the payroll tax, would, in the short term, cause more people to enroll in government entitlements, not less.

How would lowering payroll taxes without reducing government spending increase enrollment in government entitlements in the short run?

Greg Ransom writes:

we spend the most and get the least out of K-12 of any major country.

Yes. Lets dumb more down that rat hole.

And while we're at it, lets lower teacher retirement to age 30, and triple their pensions.

That ought to fix everything.

tjames writes:

El Presidente - I take issue with a couple of your statements.


You said "People do not trust the financial services and banking industries to invest their money and provide a return."

I am thinking the millions of us who have freely chosen to keep our money invested with such institutions, even in the face of the current bear market, will ignore your advice in this regard.

Furthermore, why should I be more trusting of a goverment that has invested somewhere north of $1 trillion in these very institutions, and is further contemplating investing in "toxic" securites precisely because they fail to provide any return and are, in fact, at risk of losing substantial amounts of the money put into them? With government investment, I don't get to back out - my participation is involuntary, through taxes, now and in the future.

You said "Municipal and state governments don't currently have enough money to pay for required maintenance on existing infrastructure."

Each new infrastructure project that gets built will add additional fixed costs to municipal and state budgets for this maintenance. How exactly is building more infrastructure helping this particular situation? Is it replacing older & less cost effective infrastructure? I am thinking adding lanes to bridges and roads isn't going to make them cheaper to maintain. Are you asserting these governements will derive enough added benefit to offset the increase in costs? OK, that means each of these projects needs to go through a cost benefit analysis to show it is worth it to these local goverments. Color me skeptical, I don't trust the goverment to do all that good a job in this regard, and anyway, that will take too long to be considered much of a stimulus.

Maybe what we really need isn't spending on new infrastructre, it's a giant nationwide maintenance catchup project for the infrastructure we already have. Somehow, I am thinking that is not what is being talked about in many, if not most cases, of the stimulus spending. I think far too often, "stimulus" is a label attached to many pet projects as a way to get them funded, regardless of whether or not they have anything at all to do with the crisis at hand.

Anyway, one of Arnold's original points is that this takes time to get going, whereas a tax cut is immediate. Furthermore, the decision about what to invest the money in rests with each of us that gets a break, rather than with pols and the politically connected.

I do agree with one of your points though about raising taxes. It seems frightfully hard to do, which is why I have some reserve about a tax cut now that gets paid for by later increases or legislative changes in the retirment age. I am not sure the political will can ever be mustered on the back end to make this situation balance.

Maybe a limited duration tax holiday? I don't know.

The Cupboard Is Bare writes:

As I look towards the future, I envision an America where the majority of employees are working for the government. Everyone will be uttering the same timeworn phrase, "The salary stinks, but the benefits are great."

All evidence of the free market will be gone. The only place where you'll be able to see an American Capitalist will be in the "Culture Halls" of the American Museum of Natural History.

But other than that, everything is going to turn out just fine. :\

El Presidente writes:

tjames,

I am thinking the millions of us who have freely chosen to keep our money invested with such institutions, even in the face of the current bear market, will ignore your advice in this regard.

Maybe they just don't know what else to do. Please don't tell me you think there is broad profitability in equities at this moment, or that people have a generally positive view of the financial services industry in light of accounting fraud, security ratings fraud, material "misstatement" of financial information to shareholders, options backdating, ponzi schemes, the collapse of hedge funds, enormous bankruptcies and fire sales, bailouts, and a 50% decline in the Dow.

You may not trust government to do much better, but we may not have much of a choice anymore. Lies have devalued the currency of fractional reserve banking (trust). Now we must have accountability and investment in things we can see, touch, and experience instead of more financial "products". You can trust government that invested in AIG and others because that government has the ability to make good on their debts. That is their unique advantage. However, you should not trust them blindly any more than we should have trusted Enron blindly.

OK, that means each of these projects needs to go through a cost benefit analysis to show it is worth it to these local goverments. Color me skeptical, I don't trust the goverment to do all that good a job in this regard, and anyway, that will take too long to be considered much of a stimulus.

That is absolutely correct. They do need cost benefit analysis based upon municipal and regional level CGE models, not merely impact analysis using static multipliers (i.e. IMPLAN). I am working on it at this very moment. There are a number of shorthand policy guidelines that we can use until we have CGE models in place in more jurisdictions, but we certainly need to move that direction.

As for the length of time, how much time should we waste before we begin to do this? Stimulus? Perhaps not in the short run. Good policy? You had better believe it. No amount of stimulus we have available will do more than mitigate our present hardship. Not even payroll tax cuts, which would come at a very steep future cost. So, let us know when we can begin planning and building more efficiently and how long you'd like to wait to reap the rewards of more efficient governance. I'm persuaded that we need to look beyond the immediate crisis if we are going to avoid jumping out of the frying pan and into the fire.

Maybe a limited duration tax holiday? I don't know.

I would be inclined to agree if not for our recent experience with temporary tax cuts that were supposed to expire and economic stimulus payments that did not have a proportional effect on demand. Believeing the cut is temporary causes people to treat it less as income (higher MPC) and more as a change in their wealth (higher MPS). It is only the prospect of permanence, the notion that this is a sustained change in the flow of income, that tends to shift spending in the way necessary to resume our previous course. That would simply be too expensive.

Methinks writes:

Bare Cupboard,

Everything is going to turn out fine for those who want to work and innovate. They will move to Asia and tell their kids and grandkids about how the United States used to be the land of hope and opportunity.

Dan Weber writes:

Please don't tell me you think there is broad profitability in equities at this moment,

This is a critical and fundamental misunderstanding of how markets work.

Markets have no first derivative. There is no such thing as a stock that is "doing well right now." It may have done well in the past, or be expected to do well in the future, but there is absolutely nothing to say about it "at the moment."

People who are waiting for the markets to get better before investing in it will miss the upturn.

El Presidente writes:

Dan Weber,

Markets have no first derivative. There is no such thing as a stock that is "doing well right now." It may have done well in the past, or be expected to do well in the future, but there is absolutely nothing to say about it "at the moment."

People who are waiting for the markets to get better before investing in it will miss the upturn.

Understood. Investment is based on expectations. That is my point. Investors generally have adaptive expectations. What looks promising right now? What can investors hang their hat on when investment requires handing their money over to others whom they cannot trust and cannot hold accountable? The fact that blue-chips are having a terrible time getting financing should be a clue that people do not believe the future looks rosy. Why would they think that? Are they wrong?

Mike Rulle writes:

Arnold---I wrote a similar commentary on Summers but instead focused on the "marketing language", which needless to say I found appalling. Here it is.

"Well, at least he doesn't call it a 5 year plan, as was de rigueur for the the old Soviet Union-- "Obama's Down Payment"--WaPo--12/28" . How does this article by renowned economist Larry Summers irritate me? Let me count the ways. I realize Summers is on record for maximum deficit spending to get the economy growing again. I have already quoted many economists who admit this is a policy prescription with weak empirical support, as are most macroeconomic theories. But that is a discussion for another time.

"I object here to the manner in which this is being "sold". First the title. Obama's down payment? This is a taxpayer funded enterprise, so lets at least get that straight. Second, it is classic "industrial policy" where the Government chooses what money should be spent on--without taxpayer approval of course. He mentions "energy", "health care", "infrastructure", "libraries, "laboratories" "classrooms" and "education". A lot for the teachers unions it seems. Great. Third, the mission is high "social returns". Instead of those other dreary measures, "economic" returns, which can actually be measured, "social returns" are in the eye of the beholder. They can always be deemed "successful". Fourth, even though economic returns are not emphasized, they are still "investments", not "earmarks". Finally, these investments are "long term" and Washington will be held "accountable". Summers did not outline the "accountability" plan."

Dan Weber writes:

That is my point. Investors generally have adaptive expectations. What looks promising right now?

You are asking questions that cannot be answered. If something "looked promising" to the market, it would have already gone up, and would no longer "look promising."

This applies during bull markets just as much as during bears. Except during a bull market everyone thinks they are a genius.

El Presidente writes:

Dan Weber,

You are asking questions that cannot be answered. If something "looked promising" to the market, it would have already gone up, and would no longer "look promising."

You are making my point for me. Virtually nothing is going up, therefore, by your reasoning, nothing has looked promising. Expectations of future returns are depressed. Do you suppose there is a reason(s) for that?

Adaptive expectations are formulated by adapting to the recent past (thus the name, right?). Rational expectations are the variety you are speaking of. If we are assuming that investors have rational expectations, then the current dearth of growth is all the more damning. Whether investors have a hangover or have become fatalistic, something will need to change their mind for them to want to increase investment. I do not see that push coming from the financial services industry because it has lost nearly all credibility. As much as we may cringe at the thought of government filling the void, what else can?

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