Bigger government is needed for the US economy - OSO's New Deal

This graph from Calculated Risk has been worrying me for a while:

The most noticeable thing about this particular recession is just how long it has taken for unemployment to recover - or not recover as the case is. But this is not an isolated case. The 2001 recession took ages for unemployment to recover, as did the 1990 recession. Obviously something has happened to the US economy that has prevented quick employment recovery even while GDP recovers.

I'm still trying to work out what that is. I have at theory but that will come in another posting.

What is obvious though is that the market is just not creating enough jobs. While the cause might be debatable, the result is not.

But what is needed to fix this is not just another round of stimulus packages. What is needed is a structural expansion of government spending. In essence, the US government needs to spend more.

Of course readers of this blog might wonder if I have changed my mind from recent times when I advocated austerity. The problem is that the word "austerity" has ended up becoming synonymous with spending cuts - which is the favoured position of conservatives. While I have advocated spending cuts in the area of military spending I came to the conclusion that the only way the US could ever hope to cut enough spending to make any difference would be to destroy Medicare or Social Security (and I don't use the word "destroy" lightly - you'd be looking at cuts of over 50% to make any difference). The alternative is to raise taxes - and that is the option I have always promoted. I still define this as "austerity" since it causes pain, but it is not the preferred description of the word in these times.

What I have done, though, is change my position on the market's ability to recover properly. I would've been happy for Obama to cut military spending and raise taxes in order to run a small deficit (at the least) but do little else while the economy stumbles, falls and eventually recovers from my austerity package. Now I realise that the economy wouldn't recover - at least not quick enough to make any difference.

So here's my big government solution:

More government spending.

I would create the following long term or permanent programs:

  1. Universal Health Care. This would involve "Medicare for all" and would probably increase the size of government by 4-5% percent of GDP. So you're looking at an increase in government spending from around 25% of GDP to around 29-30% of GDP. This would naturally have the effect of Keynesian stimulus but the result would be healthier citizens - something that would boost the productivity of workers. The increase in spending relative to GDP would be permanent.
  2. Building a renewable energy infrastructure. This would involve the eventual shutting down of all coal and gas powered power stations and the building of renewable alternatives to replace them. Developing nuclear reactors based on the Thorium & Molten Salt technologies would be acceptable but I can't get over the sheer availability of deep geothermal power: they would be expensive to develop and build but once they're there they will last for many decades. To fast-track the building of these, a renewable energy sector would take at least 10 years to complete. But as we can see from the military buildup during world war 2, all it takes is the will to do it. This would radically reduce America's carbon emissions. An upgrading of America's electricity grid would also accompany this. You're looking at adding another 1-2% of GDP being spent on this over a ten year period.
  3. Mandate and support an electric car industry. This would involve a legal framework preventing the sale and registration of carbon-emitting cars by a certain date (say 10 years in the future) but would also need substantial government investment in battery technology. The Nissan Leaf, the first real "electric car" sold to the market, still has only a short range. Inventing batteries that hold more power is essential if electric cars are to effectively replace their petroleum or lpg powered competitors. Spending on this program would also build a nationwide network of recharging stations to ensure that no electric car is out of recharging range. Not only would such a program reduce carbon emissions, they would also reduce America's dependence upon oil and mitigate the problem of Peak Oil. Add another 1% to GDP being spent on this over a ten year period.
  4. Set up a national water grid. This would involve potable water being distributed over all states and towns throughout a national network of water pipes and purification plants. This would ensure that any future droughts in the US (brought on by global warming) would not affect town and urban water supplies. It would theoretically mean water sourced from Seattle finding its way to Texas through this proposed water grid. While this would require a huge amount of work, a lot of the work would simply involve connecting up disparate water infrastructure and bringing standards up to a national level. You could probably add 0.1% to 0.5% of GDP on this over a ten year period.
  5. Provide a national child tutoring strategy. This would involve the hiring of personal tutors to deliver numeracy and literacy skills to the nation's Kindergarten,1st and 2nd grade students. Each student would receive one hour of personal tutoring per week at the school they attend during the school year. While this will not have any immediate economic benefit apart from increasing the money velocity, it will eventually produce adults who are better educated and more likely to succeed at employment and less likely to end up in jail. All economic benefits. I'm not sure how much this would cost but you'd be looking at at least 0.1% of GDP being spent on this program on an ongoing basis. Additional tutoring, say in 3rd grade and above, would increase this effect even further.

Less money on Defense

America does not need to spend huge amounts on national defense. Of course it is important that some level of defense spending exist to defeat any potential attacker, but I am convinced that the most bloated, most inefficient and most corrupt sector in government spending is in defense contracting. Reducing military expenditure may not even reduce America's military strength, it will make the whole contracting system better.

In fact I would suggest a change in the way the whole contracting thing works. Rather than contracting out to companies who design weaponry and other military items, the government should actually do this themselves. Let's say we want to build the fictional B-5 supersonic stealth bomber. Instead of contracting out the design to Boeing, the design is actually made by government employees working in a government building somewhere. Once the design is complete, they then contract out the parts building to the defense companies - and ensure that common parts can be made by many different manufacturers in order to reward the productivity and profitability that would arise in a competitive environment. The B-5 could even be manufactured by different aerospace companies, with Boeing manufacturing some, Northrop Grumman some more, and Lockheed Martin the rest.

Higher Taxes - especially for the rich and corporations

Alongside this substantial increase in spending should be a substantial increase in taxation. I don't believe that deficits don't matter and there is a need for the debt to be paid down. Since we can no longer rely upon the market to provide enough economic growth to increase tax revenue,  the government will simply have to step in, increase spending and increase taxation. In fact I would argue that the increase in taxes should be substantially higher than any increase in spending. I would advocate not only an increase in spending (outlined above) but an increase in taxes so high that a budget surplus is created. It is expected that any economic pain generated by this increase in taxation would be matched by the economic gain of the increase in government spending (above)

There are many ways to achieve this - one way is to increase the highest marginal tax rate. Another is to introduce a Tobin Tax.

My preferred method of taxing the financial market would be to create a market capitalisation tax: public companies being taxed incrementally on a daily basis according to their market capitalisation (share price multiplied by amount of shares). In fact I would adjust the tax according to the average p/e ratio in order to punish over-investment - if the p/e ratio of the whole sharemarket is too high, then there will be an increase in the market capitalisation tax. If the p/e ratio falls down low, then the tax would also be lowered. This system would not only generate income for the government to balance its finances, but would also act as an "automatic stabiliser" for the financial industry - punishing the market if it approaches unsustainable investment bubbles, encouraging the market if it there is not enough investment.

OSO's New Deal

Of course once the spending I have outlined above runs out over ten years (with the exception of Medicare and the tutor system), we would also assume that government debt would have been paid off by the increases in tax revenue. What then? Well I'm happy, once America has reinvented its energy, transport and water infrastructure, for taxes to drop. Hopefully the success of my "New Deal" would see so much economic and social success that Norquisters, Randians and Supply Siders would descend into obscurity. It would also force political conservatives to be more centralist, where they can be far more effective at promoting non-extremist conservative policies and ideas (conservatism does, after all, still have many considerable strengths once the extremism is removed from it).

So what are the chances of this occurring? Probably none. Rather, I expect the coming downturn to turn people against Obama and vote for a crazy Republican in 2012, ensuring a Republican controlled congress as well. What they would do from there is anyone's guess, but I doubt that any polices they do enact will do anything except make things worse.


Noni Mausa said...

"What then? Well I'm happy, once America has reinvented its energy, transport and water infrastructure, for taxes to drop..."

One slight quibble -- I am inclined to think that there is a tax "tipping point" below which private influence will inevitably bring us back where we are now. Kimel's work puts that top marginal tax rate at somewhere above 60%.

Neil Cameron (One Salient Oversight) said...

Hi Noni. Nice to read a comment from you again.

I don't think the answer is in simply raising the marginal tax rate to 60% and then things might be better. It's also a question of what the government does with that money. It's also a question of WHY the free market isn't performing well enough under the current ultra-low tax regime.

My theory is that the economic changes since the early 80s - what is known as neoliberalism in some circles - has made a huge assumption: that the free market can provide more economic growth and prosperity if it is allowed to expand and capital controls are removed.

I think most of the industrialised world is in the midst of an investment bubble that is many decades in the making. It's the same as tulipmania, except the prices haven't risen as quickly nor have they crashed as quickly.

With money being ploughed into the marketplace and generating increased investment prices, what happens to that cash, except for it to be reinvested back into it. Asset prices rise while p/e ratios skyrocket. And this has gone on for decades, and it has affected almost every western industrialised nation.

So what happens is that eventually the economy slows. Nothing of value is actually being produced as more and more money is being thrown into a gigantic investment bubble. Economic growth drops. Less money is invested in labour intensive industries.

And the question is why? It's because the free market will always throw money at whatever will profit them most. And yet the returns that are made are illusionary since they rely entirely upon a continuing asset price bubble. Ponzi scheme indeed.

But getting around to your original point - IF the market wasn't investing in this gigantic investment bubble and if they actually did care about important things like revenue and p/e ratios, they wouldn't be creating this bubble.

In short I would see financial regulation as being the key here. Governments all over the world need to rein in the excesses of the free market.

And this doesn't have to mean high taxes (though it might have to).

Rodger Malcolm Mitchell said...

Slowly, ever so slowly, the debt-hawks will come to understand Monetary Sovereignty and realize that federal deficit growth is absolutely necessary for economic growth.

When that happens, the debt hawks will say, "I knew it all the time."

Rodger Malcolm Mitchell

Noni Mausa said...

Yes, obviously regulation is the problem, but that takes us back around to the problem of the influence that loose money has on the electoral and regulatory functions.

It is not possible to legislate and regulate if you are not elected, and now it's practically impossible to get elected, much less re-elected, unless you have access to haystacks of cash and the influence that comes with it.

Ugh, these circular problems make my head hurt.

To make things worse, what's different today than in the 30s is that most Americans cannot live without a paper income. They are hostages, so to speak, of the paper economy.

My parents' generation could hunker down by moving in with uncles, parents, or friends in a rural setting, planting or hunting or keeping a few chickens. Hardly a blissful way to live, but do-able.

And urban people, bachelors or other unattached folk, could rent rooms in boarding houses, an option which appears to have dried up due to zoning and licensing laws. As recently as 1965 my aunt ran a boarding home for poor veterans and other men down on their luck, a huge house where she had 6 to 10 at any time, feeding them well and keeping a sharp eye on them (my mental image includes a rolling pin here, not sure if any real rolling pins were involved.)

Though we seem, and are, better off than 50 years ago, we are also enmeshed in a financial system where access to a steady stream of cash is necessary, and where that stream's valve is controlled by and large by actors whose interests do not coincide with the well-being of the majority of Americans.

When the river from which those streams derive is controlled by only a few hands, the result is a nation of "free-range hostages." Not a free country by my standards.