"who represent competing strains of Democratic economic thought": I'm A Sort Of Non-Competative Strand

Yesterday Free Exchange commented on the post by Robert Rubin and Jared Bernstein about interest and debt, and how they are viewed in the Democratic Party. My party. Now, you might well ask where I fit in, but I've about 600 posts now trying to answer that, so let's move on:

"ROBERT RUBIN and Jared Bernstein are two left-leaning economists (both of which have advised Barack Obama) who represent competing strains of Democratic economic thought. Mr Rubin, Treasury secretary under Bill Clinton, was known as an economic centrist—pushing free trade and fiscal responsibility. Mr Bernstein is a more progressive economist, who has emphasised international labour standards and a robust social safety net.

Today, the New York Times published an opinion column co-written by Mr Rubin and Mr Bernstein. It lays out the broad areas of agreement between the two men which, one assumes, hints at what might emerge from an Obama administration. It's not particularly scary stuff—short-term stimulus, infrastructure investment, long-term fiscal discipline, sympathetic labour policies, and a trade policy that seeks to protect workers but not jobs or industries. A change in direction, to be sure, and one that deserves vigilant oversight, but not a new social democratic state."

Now, I didn't respond to this column because I also didn't see it as particularly scary or even interesting. It dealt at the level of nostrums. I'm more on Rubin's side, but I actually am concerned about Bernstein's concerns.

"What's most interesting to me are the areas where the two authors are forced to concede disagreement. One of these issues—the effect of long-run deficits on interest rates and economic growth—is one of the most contentious areas of debate for lefty economists. The authors write:

One of us (Mr. Rubin) views long-term fiscal deficits — in combination with a low national savings rate, large current account deficits and foreign portfolios that are heavily over-weighted in dollar-dominated assets — as a serious threat to long-term interest rates and our currency and, therefore, to our economic future. The other views these economic relationships as much weaker.

This is the view that shaped Clintonian deficit reduction. It also angered many Democrats, who would have preferred that increased revenues be used for a health insurance solution or public investments. Mr Rubin's position strikes me as fairly orthodox. The thing is, I'm not sure that it makes sense in light of recent events. A lot of people expected a dollar run to precipitate crisis. Instead, crisis precipitated a dollar boom."

Again, here I'm on Rubin's side. But I see the problem.

"And now, Calculated Risk is arguing that declining American deficits might result in higher long-term interest rates. Why? A reduction in the current account deficit would trim growth in foreign central bank investment in dollar-denominated assets, pushing up interest rates. In short, so long as Bretton Woods 2 held up, American deficits meant low interest rates. Only when that financial system comes apart can we expect Mr Rubin's conditions to obtain.

Mr Rubin was right about interest rates given that he was in a certain financial equilibrium, but he was wrong about which equilibrium he found himself in. Given Bretton Woods 2, and the resulting ability to borrow cheap, America should have borrowed heavily and ploughed Chinese capital into long-term domestic investments. By instead running a surplus, Mr Rubin simply made easy credit available to the private sector which, understandably, poured that credit into heavy consumption and investment in non-tradable sectors (like housing!) which weren't rendered comparatively unattractive by Chinese currency policies."

I saw the Calculated Risk post as well, and it bothered me. ( but see Setser here )

"So which should America choose moving forward? For the moment, the risk of a dollar collapse seems low, and the need for deficit spending appears high. Beyond that, we must see whether China will continue to finance American borrowing, or if China will allow domestic spending to flourish by letting the RMB appreciate. Increasingly America is learning that neither its monetary policy or its fiscal policy is as independent of international forces as it believed."

So, this really is food for thought. I agree with:

1) Risk of dollar collapse is low ( I also agree with 'seems' )

2) That's why I accept some deficit spending in the short term and a stimulus plan.

Where to go from here. Let me utter some nostrums:

1) A banking system based on Bagehot's Principles

2) Reducing government spending

3) Lower debt

4) A slight budget surplus or debt in normal times

5) Lower taxes, and fairer and more efficient taxes

I fear:

1) Inflation

But I have to admit, all these gyrations are making things hellishly complicated.

However, this post by Bob McTeer seems to echo more or less the same view, although I would disagree with him on some specifics:

"The most important near-term thing you could do to reassure financial markets and quell the turmoil is to announce early that you don't intend to eliminate President Bush's marginal tax-rate cuts. If you can't go that far, keep the adjustments as small as possible and announce your intentions to be moderate early. A little bad news early is better than great uncertainty and expecting the worse. ( I'm fine with small adjustments )

You have an education job to do. You must be able to articulate clearly how high tax rates on capital (capital gains, dividends, corporate taxes, the death tax, etc.) diminishes the demand for labor and keeps wages from rising. ( I agree )

While tax-rate increases are bad anytime, they are particularly bad in a recession. The timing couldn't be worse for a tax increase. ( I tend to agree, but the debt bothers me more )

Energy limitations must be attacked on all fronts: drill, drill, drill, nuclear, clean coal, wind, solar, and so forth. Don't push for energy independence; push for less energy dependence. ( I sort of agree, but have more environmental concerns )

Everyone knows that exports create jobs, but few focus on imports, which represent the gains from trade. Help educate people on the benefits of low prices via imports. ( I agree, basically )

Don't overdo the regulatory reaction to the current financial crisis. Another Sarbanes-Oxley is the last thing we need." ( I agree )

In other words, while things are in flux, let's stick to our general principles, while confronting reality and bending them where necessary. But like Becker and McTeer, I agree that we don't want to kill the goose that laid the golden egg.

As to Rubin and Bernstein, I'm not that bothered by either of them. I see them as sensible people. I've no fear of some massive economic shift. There will be tinkering, but tinkering can often be wise.

"I could come up with a pretty good list of tax rate cuts financed by spending cuts that would increase economic growth."

A very succinct and potent discussion of the connection between cutting taxes and economic growth by Gerald Prante on the Tax Policy Blog:

"If Bernstein's standard for "high" economic growth is that a tax cut pay for itself, I would agree that no major tax rate cut at today's tax levels is going to promote that much of economic growth. (I'm referring to major federal taxes, as I'm sure there is somewhere out there in a state that lower tax rates would pay for itself...say on a cigarette tax or something where there is huge border activity. Also if you consider certain prohibitions to be implicit taxes, repealing them and in effect cutting tax rates would pay for themselves.)

But Bernstein's position seems to be like many on the left, which is a lexicographic preference for government always getting bigger, and he's trying to act as if it's a free lunch. It's very similar to the view of those on the right who say that government is a waste and should be starved of all revenue. The fact of the matter is that the optimal size of government > 0, but it's optimal size is not 100 percent of the economy (and there would be substantially lower economic growth if that was the case).

There are some government spending items currently in existence that are not worth their costs to taxpayers. Then again, there are some hypothetical government spending items that do not exists right now that would be worth additional tax dollars. The secret is finding which spending items are worth their costs and only funding those, and raising the necessary revenue in the best possible way that meets various criteria (such as equity and efficiency).

It is one of the paradoxes for those who seek to rally support for starving the beast (even if it worked say at the state level under a balanced budget rule). You are starving a beast because you view the beast as too wasteful and not looking out for the best interest of the taxpayer. But whose to say that when you starve it, it's going to devote its now more limited resources to the best interest of the taxpayers. It may starve you in return of the services you and those who you seek to garner support from value most (since you already believe that it doesn't look out for your own interests), thereby not getting rid of the programs at the margin that aren't worth their costs to taxpayers but instead getting rid of the programs that are worth their costs."

Any tax must be looked at and judged by the conditions of the economy, what the money is needed for, the level of debt, etc. Even if you believe in limited government, there is no getting away from analyzing the effects of particular taxes and whether or not they are worth it, even to you. In our complicated economy, it's a hellishly hard thing to do, but there's no way around it. There's not even an easy way to judge simplifying taxes or tax rates, without discussing what you need the money for, and whether the simplification gets you to where you want to go.

Any tax or government expenditure needs to be examined on its own.

On The Stimulus

Matt Yglesias with a post about the stimulus, featuring an interesting paper by Jared Bernstein. Here's my comment on the paper:

1. Don the libertarian Democrat Says:
   October 26th, 2008 at 11:44 am

   “This example brings us to the final crucial area that the last stimulus package did not address, which is infrastructure investment. I urge this body to strongly consider including funding for infrastructure projects in a second package.’

   I believe that this should be the major thrust of the new stimulus package. Declining oil prices can be seen as giving the consumer a bit of a stimulus.

   I do not disagree with his proposals about unemployment, etc., except that I don’t consider them purely part of the stimulus, but a social cost we must pay to help people through the downturn.

   The aid to states here:

   “This time the states’ budget needs are considerably larger, and various analysts of such conditions have suggested that $50 billion, split between Medicaid and block grants, could be usefully absorbed by states to offset the effects noted above.”

   Might make sense on its own, but as a stimulus it should happen quickly, precisely because the infrastructure part of the plan, while essential, might take some time to implement. Some part of the stimulus needs to get going very soon to actually qualify as a stimulus.

More On McCain's Plan On Mortgages

I guess this is piling on, but Jared Bernstein and Gene Sperling consider the McCain mortgage buyout plan and say basically what I've been saying:

But today we learned of a detail that makes his plan significantly different -- and much worse. The McCain plan uses taxpayer dollars to buy distressed mortgages at their full, face value from the banks and lending institutions that are currently stuck with them. Only then, after we the taxpayers have fully absorbed the cost to the lender of these troubled loans, does the homeowner get the benefit of the lower principal.

That's right folks...it's private profits and social losses. Instead of an effort to safeguard taxpayers as Senator Obama has called for and the Frank-Dodd bill goes to great lengths to do, this plan takes from taxpayers to provide unjustifiable subsidies to financial institutions - even those who engaged in deceptive or outright fraudulent practices to induce people into homes they could not afford.

What responsible plans like Dodd-Frank do, by contrast, is to include the following critical provisions: First, if lenders want into the plan, they have to agree to "take a haircut," i.e., write down the principal on the loan. This step spreads some of the economic pain around between the lender and the government (taxpayer), who in return for the write down, guarantee that the mortgage will be repaid. Second, Dodd-Frank requires that homeowners who benefit from a lower mortgage and more stable monthly payments share some of the upside benefit with taxpayers when the values of their homes recover. Together, these steps ensure mutual responsibility - that lenders, borrowers and the government each share in the process of stabilizing the housing market while protecting taxpayers to the maximum possible extent. Or then we can go with a "Resurgence Homeownership Plan" and just write checks to financial institutions and hope it trickles back to the rest of us."