Russell Roberts's Blog, page 1477

Congressional Testimony on the Stimulus

(Text of my opening remarks before the Subcommittee on Regulatory Affairs, Stimulus Oversight and Government Spending of the House Committee on Oversight and Government Reform, February 16, 2011.)

Thank you Chairman Jordan, Ranking Member Kucinich, and distinguished members of the Subcommittee.

Over the last two years, the American Recovery and Reinvestment Act of 2009 has injected over half a trillion dollars into the US economy in hopes of spurring recovery and creating jobs.

The results have been deeply disappointing. Job growth has been anemic while our deficit has grown, limiting our future policy options. Fourteen million workers are unemployed. The unemployment rate among African Americans is over 15%. This is an American tragedy.

What went wrong? Why were the predictions so inaccurate?

There have been two explanations. One is that the economy was in worse shape than we realized. The only evidence for this claim is circular—the standard Keynesian models under-predicted unemployment.

I prefer a simpler explanation: the models that justified the stimulus package were flawed. Those models were broadly based on the Keynesian notion that the road to recovery depends on spending. In the Keynesian worldview, all spending stimulates. Somehow, subsidizing university budgets in the Midwest or paying teachers in West Virginia helps unemployed carpenters in Nevada. That may be good politics. It's lousy economics.

This isn't the first time the Keynesian worldview was wildly inaccurate in predicting the impact of changes in government spending. Look at the beginning and end of WWII.

Keynesians frequently argue that the military spending on WWII ended the Great Depression.

Certainly unemployment fell to nearly zero because of the war. But did the war create an economic boom? There was a boom for the industries related to the war. But there was little prosperity for the rest of the country. The war was a time of austerity. Government spending didn't have a multiplier effect on private output. It came at the expense of private output.

What about the end of the war, when government spending plummeted?

Paul Samuelson, a prominent Keynesian, warned in 1943 that when the war ended, the decrease in spending combined with the surge of returning soldiers to the labor force would lead to "the greatest period of unemployment and industrial dislocation which any economy has ever faced." He was not alone. Many economists predicted disaster.

What happened? Government spending went form 40% of the economy to less than 15%.  And prosperity returned to America. Unemployment stayed under 4% between 1945 and 1948. There was a short and mild recession in 1945—while the war was still going on. But the economy boomed when government spending shrank and price controls were removed.

We are told that the failure of the current stimulus proves it simply wasn't big enough to get the job done. But it is equally plausible that the opposite is true—that government intervention in the economy prevented the recovery.

The truth is that our knowledge of the complex system called the economy is woefully inadequate and may always remain that way. We ask too much of economics. Even our best attempts to measure the job impact of the stimulus spending make this clear. In November of 2010, the CBO estimated that the stimulus had created between 1.4 and 3.6 million jobs. Not a very precise estimate.

But even this estimate was more of a guess than an estimate. The CBO estimates didn't use any of the actual employment numbers after the stimulus was passed. Instead the CBO based its "estimates" on pre-stimulus relationships between government spending and employment, relationships that failed to predict the magnitude of our current problems.

The CBO's results and those of other forecasters using multi-equation models of the economy are not science but pseudo science–what the economist F.A. Hayek called scientism—the use of the tools and language of science in unscientific ways.

So where does that leave us?

Let's get back to basic truths.

When you're in a hole, stop digging. Stop running deficits of over 1.5 trillion dollars. Act like grownups and get your fiscal house in order. Stop spending 25% of what we produce. Stop wasting my money and giving it to your friends. Stop passing legislation that makes it hard to figure out what the rules of the game are going to be. Get out of the way. Make government smaller and give us a chance to do what comes naturally—seeking ways to make profit, avoid loss and work together. That is the only sustainable path to prosperity.

Thank you very much.

Food, Famine, and Globalization

Over in today's "Room for Debate" at the New York Times, Raj Patel – whose entry is entitled "So Much for Market Efficiency" – writes that

Over the centuries, societies developed the tools of grain stores, crop diversification and 'moral economies' to guarantee the poor access to food in times of crisis.  Global economic liberalization discarded these buffers in favor of lean lines of trade

… an effect that presumably is causing, or at least exacerbating, today's food crisis.

Patel is wrong.  Until three hundred years ago the poor (and most people were poor) had no "guaranteed" access to food; famine was frequent and routine throughout the world.  This horrible reality was reversed only by economic liberalism and expanding trade.  As Jagdish Bhagwati notes on page 100 of his 2004 book In Defense of Globalization,

medieval famines in Europe were moderated by the increasing opening of trade routes and integration precisely because food moved to famine-stricken high-price areas, dampening prices, moderating the food scarcity and improving its accessibility to the poor.

The people who today are hungry and starving are not those of us living in globalized, liberal economies; it is, rather, the poor souls cursed with the misfortune of living in countries whose governments follow the advice of the likes of Mr. Patel and 'protect' their citizens from "global economic liberalization."

Patel's entry is marred also by this confusion.  See if you can spot it before you read what I write after the block quote from Patel:

Global economic liberalization discarded these buffers in favor of lean lines of trade. Safety nets and storage became inefficient and redundant – if crops failed in one part of the world, the market would always provide from another.

Climate change turns this thinking on its head. A shock in one corner of the world now ripples to every other. The economic architecture that promised efficiency has instead made us all more vulnerable. Little has changed in this crucial respect since the last food crisis. But this isn't simply a rerun of 2008.

How does climate change change the fact that a crop failure in one part of the world, by causing prices there to jump, will cause an increase in the volume of crops shipped to that part of the world (assuming trade routes are relatively free) and, hence, cause prices elsewhere also to rise?  How does climate change change the fact that regions suffering crop failures are especially in need of food imports – and will get them if prices are free to rise and if trade is free?  Indeed, if weather patterns are becoming more unpredictable, then all the more reason to have the insurance of being part of a global network of food supplies.

I hope Patel reads this entry by Michael Roberts, also in today's "Room for Debate."

Some Links

Boston Globe columnist Jeff Jacoby challenges the artificiality of racial categories.

In my most-recent column in the Pittsburgh Tribune-Review, I discuss inflation.

Josh Wright questions Paul Krugman's assertion that there is a bias toward "a doctrinaire free-market view" in major, scholarly economics journals.  Unless understanding that trade-offs are prevalent makes someone a doctrinaire free-marketer, my sense of the contents of major economics journals squares with Josh's.

Writing in Barron's, Chapman University's Tibor Machan explains businesses' moral obligation to pursue profits.

Steve Horwitz on wartime prosperity.

Denver Post columnist David Harsanyi explains that democracy is not identical to – and, indeed, can be the enemy of – freedom.

And the Baltimore Libertarian challenges The Donald (the real Donald, not yours truly) on trade.

Brooks on Cowen on Stagnation

Here's a letter to the New York Times:

David Brooks appropriately devotes today's column to my GMU Econ colleague Tyler Cowen's important new book The Great Stagnation ("The Experience Economy," Feb. 15).  Mr. Brooks offers the intriguing hypothesis that what accounts for the relatively 'stagnant' measured economic growth since the mid-1970s isn't so much the absence of remaining "low-hanging fruit" (as Tyler argues) but, instead, a shift to less-materialist values.

I have a different hypothesis: what has stagnated isn't the economy but, rather, economists' and statisticians' capacity to measure economic activity and its contribution to human well-being.

As Mr. Brooks notes, Americans today demand more unique and nuanced experiences.  Unfortunately, though, the economic value of experiences – unlike that of more corn, more cows, and more cars – is difficult to measure using mid-20th century national-income-accounting categories.  But we are demanding these experiences not because we're becoming less materialistic or less wealthy.  We're demanding these experiences precisely because, rather than stagnating, our economy and our wealth continue to grow so impressively that they are outstripping last-century's economic categories and measurement techniques.

Sincerely,

Donald J. Boudreaux

GMU Econ Bloggers

I agree with my brilliant young colleague Bryan Caplan's explanation of why so many GMU economists blog.

Calling Bill Bryson

I'd like to interview Bill Bryson for EconTalk. Does anyone know how to reach him? Please send me an email russroberts at gmail dot com.

Buying Loco

Here's a letter to the Richmond (Indiana) Pal-Item:

State senator Allen Paul of Indiana's District 27 observes that "Hoosiers in Senate District 27 have found that cities like Indianapolis and Cincinnati have large, national businesses who often submit lower contract prices to gain the upper-hand in area projects" ("'Buy local' moves to full Senate," Feb. 15).  To address this alleged problem, Sen. Paul introduced a bill that would, as the senator says, "help ensure local businesses and their products are considered in public works project contracts" – even if local governments can get lower prices from businesses outside of their locales.

In other words, Sen. Paul seeks legislation that would (to use your word) "encourage" local-government officials to bribe local businesses for political support while simultaneously forcing local citizens to over-pay for school construction, road repairs, and other government projects.

Such 'buying local' is also 'buying loco.'

Sincerely,

Donald J. Boudreaux

(HT Nicolas Martin)

Budget puzzle

In fiscal year 2007, the federal government spent $2.7 trillion. In 2010, the federal government spent about $3.7 trillion. Obama is proposing to spend that amount next year. Data from here.

That's an extra TRILLION dollars in three years. Yet I keep reading that only 20% of the budget is "discretionary," a silly word that seems even sillier in the face of these numbers.

The implication is that most of that increase of a TRILLION dollars was in so-called non-discretionary spending.

Does someone have the data that shows what categories of spending increased to account for the increase of a TRILLION dollars?

The brave Republicans are trying to cut $100 billion. That sounds like a big number. Compared to $3.7 trillion it's a very small number.

So what would be so hard about going back to the level of nominal spending in 2007 of $2.7 trillion? Why isn't that proposal on the table?

Rent Extraction

Some U.S. furniture makers and their lawyers have found a reliable way to extract cash from Chinese competitors deemed by U.S. officials to have "dumped" their products in the U.S., selling them at unfairly low prices.

Each year since 2006, they have asked the Commerce Department to review the U.S. duties paid by Chinese manufacturers on imports of wooden bedroom furniture. Many Chinese firms, fearing a steep rise in duties, agreed within months each time to pay cash to their U.S. competitors in return for being removed from the review list.

The above are the opening paragraphs from this story in the Feb. 15 Wall Street Journal.

What's going on here is properly called extortion.  The academic name for it is "rent extraction" – brilliantly identified and explained by Northwestern University law professor Fred McChesney in his 1997 Harvard University Press book Money for Nothing – reviewed here.  Fred's book – in the finest tradition of public-choice scholarship – explains how persons and groups with the ability to arbitrarily alter the rules of the game can bribe productive others, holding these productive others hostage to the demands of the bribers.

And so it is in the case discussed in the WSJ report.  In order to gain for a time the unhampered privilege of exporting their wares to the U.S. – that is, in order simply to be able to offer American consumers potentially attractive deals – Chinese producers pay American rivals not to exercise their (the American rivals') "right" to challenge these Chinese exports in American tribunals.

This is but one lesson for those who have a romantic notion that government is a noble institution that chiefly operates for the benefit of ordinary men and women.

A Question about Corporations and Financial Markets

In today's New York Times, Felix Salmon writes:

A private company's stock isn't affected by the unpredictable waves of the stock market as a whole. Its chief executive can concentrate on running the company rather than answering endless questions from investors, analysts and the press.

There's much less pressure to meet quarterly earnings targets. When the stock does trade, the deals can be negotiated quietly, in private markets, rather than fall victim to short-term speculation from the high-frequency traders who populate public markets.

Question to readers more familiar with the literature on finance, financial markets, and corporations: Has there been rigorous empirical research on the extent to which corporate executives focus on quarterly earnings to the detriment of their firms' long-run profitability?

Popular belief seems to have it that such obsession with the short-run is the order of the day for publicly traded corporations (at least in the U.S.).  Whether or not – and to the extent that – this popular belief is true is an empirical matter.

On one hand, the more well-functioning are markets, the more likely will this afternoon's share prices reflect the long-run, future consequences of this morning's executive decisions.

On the other hand, to the extent that market aren't perfect (which is surely 'at least somewhat') companies whose executives focus on their companies' long-run profitability irrespective of what that focus does to short-run earnings and share prices will fare better over the long-run than will companies whose executives focus inordinately on short-run performance measures.  Does the evidence tell us that, even when there is reason for executives to believe that short-run share prices don't adequately reflect the future prospects of their companies, executives (1) generally or (2) sometime or (3) seldom to never keep focused on the future?

Anyone know what the evidence says?