Economists Get Their Experiment

THE ECONOMICS DEBATE

While few economists see this Administration's proposed budget as anything but a severe departure from prudent norms, we still have enough economists who support it. One would have thought the Zombie bank and stimulus spending failures of Japan in the 1990s and the Reagan success of the 1980s would have been sufficient to try another way. But apparently not. In dollar terms, Japan GDP growth was, for all practical purposes, flat from 1994-2006 EconStats: Japan GDP . The 80s was so successful in the US, the media, staring in horror at the "amiable dunce's" success, had no choice but to dub the 80s the "Decade of Greed". It is pretty funny when you think about it.

What is the Obama administration's economic rationale?  CEA head Christina Romer summarizes her support for the fiscal side of the plan and gives her reasons. It is a bit depressing to tell you the truth. Economist's View: Christina Romer Answers Criticisms. Even the best of thinkers are willing to make leaps of faith when it suits their analytical and political belief system. Romer strikes me as an honest person. Her general points from an economic perspective seem plausible and perhaps correct. But she uses 2 different standards in support of the spending plan when comparing it to tax cutting proposals.

Romer and her economist husband, Paul Romer, have made the point that "anti-Keynesian's" have missed what she calls the "omitted variable" problem. This simply means that when studying past stimulus programs, economists have left out variables in their studies which may have had a legitimate negative impact on the economy, thus masking the true positive impact of stimulus spending. One would think that any well trained statistical economist would understand this and attempt to adjust. One of the problems, of course, is there are not many such situations to study. Both Romers claim economists underestimate the effect of stimulus action in a systematic way accordingly.

The irony of her view is that it was derived from her empirical work on tax cuts, not spending increases. I sincerely doubt many economists can make a legitimate commentary supporting or disputing the results of her 1994 study, let alone me. There are far too many subjective judgments and statistical assumptions made. It is unclear to me this study is even replicable. Still, my point is she believes they adjusted for omitted variables and believe a 1% tax cut results in a 2-3% increase in GDP. This means tax cuts have a multiplier of 2-3. This is almost double what is being forecast per 1% of spending in this stimulus spending package. So why not do tax cuts? She does not provide affirmative reasons.

She states (in her talk last week) that to do a similar study on the spending side, versus the tax cutting side, "adjusting for omitted variables" would be an order of magnitude more difficult and maybe not feasible. Yet, she believes it is justifiable to expect that the "omitted variable problem" exists in stimulus spending studies despite it not being empirically verifiable. It is not "nuts" or "dishonest" to extrapolate from her tax study to spending, but it is without doubt a less sound conclusion. If we have one real empirical study that puts a 2-3% multiplier on tax cuts and an unverifiable model which puts a 1-2% (but maybe more) multiplier on spending, why do the latter instead of the former? Then there is the Japan and Reagan evidence to also consider. My guess, if given her druthers, she would have chosen more tax policy stimulus. She does believe spending works, so she can support it, even if tax breaks may work better.

Having said all this, lets put the economics debates to bed. Secretly, I'm sure, the economists are thrilled. They will be able to study one of the great social experiments in American History for decades. Even if we all end up in the Mad Max Thunderdome, the remaining economists can debate whether or not it would have been even worse were it not for the stimulus program.

THE REAL DEBATE

But is this stimulus debate really about "objective" economic analysis? Of course not. It is driven exclusively by ideology and politics. The economists are the consultants brought in to rubber stamp a decision already made by Pelosi/Reid/Obama. Obama's vision is to have government become a larger part of our economy. He also wants to redistribute the wealth from the top "2" percent to the other 98%. All I can say to that is "good luck". Income will disappear, or not be earned to begin with, before it gets redistributed to that extent. Guess who will be left holding the tax bag? The other 48% of Americans who actually pay taxes--recall 50% do not pay income tax (they of course pay social security and medicare--but at least in theory you are supposed to directly benefit from that). The projected deficit really is shocking. Here is a graph from USA Today.

  

This deficit is the largest percent of GDP since the peak of World War II in 1945. The Congressional Budget Office prints a lower number. The difference is the CBO excludes the TARP funds and accounts for it differently. Under that theory, we could argue we have no deficit at all since all deficits are designed to generate enough economic activity to pay back the short fall.  This deficit is 12% of GDP. The last time we had a negative 6% GDP quarter before 2008 Q4 was under Reagan in Q1 of 1982. The highest his budget deficit reached was 6% of GDP. We can say all we want about this crisis beginning under Bush, which it did. But Obama's non stop phony insistence this is the worst crisis since the great depression has been used to justify this ideological shift. Why not do what Reagan did? He cut taxes and the deficit began to decline until it reached zero under Clinton. Because Obama is a "Statist" by instinct and philosophy.

So we are in new territory and there will be no parsing of the results. This proposal seems insane despite Romer's optimistic reasoning. This does not even address the social policies or the bank policies that come with this mess---1) the proposed confiscatory tax rates for the evil top 2% of earners---ever wonder how much of a disincentive this will be for those rare individuals who have the ability to create job creating businesses? ; 2) the absurd Cap and Trade alternative energy proposal--which many otherwise rational people support---will raise the cost of energy for everyone; 3) the Government run health care proposals which will surely use its monopoly power to wipe out the private market insurance competition; 4) the obsessive desire to support home sellers over home buyers by trying to prop up home prices through mortgage subsidies for individuals; 5) the slot machine mentality that pours good money after bad as they increase ownership of banks; 6) the continuity of confusion with the Bush administration on what to do about the financial sector over all.

I suppose I could go on, but it is pointless to debate these issues. It is done. The results will be what they will be. I am not happy about it---but who knows? Maybe this is just the same as doubling down. Sometimes you win. When you lose, of course, it is kind of all over. Obama is approaching that kind of bet with his policies. He is counting on, as Charles Krauthammer said, "China growth rates" to save us---growth rates that even China no longer projects.

As I have said many times before---it still shocks me that a severe, but localized, housing bubble in the West and Florida could have brought such chaos to this world. Historians argue about "the Great Man" theory of history. I don't know about that, but the "Great Incompetents" theory of history looks like a promising field.