The economy didn't jump. It was pushed.
- By Daniel AltmanDaniel Altman teaches economics at New York University's Stern School of Business and is chief economist of Big Think.
Imagine, for a moment, how difficult it would have been to land a man on the moon if half of the U.S. Congress had believed that the sun revolved around the earth. Or consider how the War in the Pacific might have progressed if half of Congress had still thought the world was flat. Or whether polio would have been eradicated if half of Congress insisted that the best cure was bleeding using leeches. Unfortunately, this was the situation the United States in January 2009, when Barack Obama assumed the presidency. The nation was trying to climb out of the deepest economic hole since the Great Depression, but the Republican Party had about as scientific an approach to the economy as medieval alchemists did to the periodic table.
Sometimes, mistaken ideas can be harmless or even humorous. But in a crisis, they can be downright dangerous. By the time Obama took office, Lehman Brothers had failed, and the Treasury was already trying to prop up banks and other financial institutions to prevent a complete collapse of the economy. In addition, the nation had undergone a tremendous fiscal transformation. Back in 2000, the United States had expected to rack up more than $4 trillion in budgetary surpluses over the coming eight years, but the Bush administration enacted tax cuts that brought the tax burden for upper-income Americans down to the lowest levels since the 1940s. These cuts, combined with two expensive wars and a short recession, sent the nation into deep deficits. The new president faced an enormous task to revive the economy — one that he could not complete without Congress’s help. Together, they would have to protect Americans from a prolonged economic slump while attempting to chart a course toward a more fiscally responsible future.
Not everyone in Congress was in a mood to cooperate. Stung by their electoral defeats and facing Democratic domination of both houses, the Republicans did everything they could to slow the new president’s agenda, from filibusters and procedural votes to delayed appointments and partisan bickering. Clearly, the election campaigns of 2010 and 2012 had already begun, and Republicans were determined to stop the new president from keeping his promises. But in the early days of the financial crisis that began in September 2008, the Republicans knew that they had to seem like they were doing something about the economy, too.
So when Obama cast himself as a compromiser ready to temper the legislative proposals of the Democrats in Congress, the Republicans got whatever they could from him — often while Obama’s supporters cried foul — and made sure to water down his proposals as well. It started with the first stimulus package. In January 2009, Obama announced his proposal for a combination of tax cuts and new spending worth $825 billion over the coming decade, including more than half a trillion dollars in the first two years. By this point, the value of the economy’s annual output of goods and services had already shrunk by about five percent, adjusted for changes in prices, since its peak in the fourth quarter of 2007. This was a big hole to fill, easily worth half a trillion dollars a year. The stimulus wouldn’t replace all that had been lost, but it might prevent a bad situation from lasting longer and getting worse.
In the end, Congress agreed to $787 billion in stimulus spread over 10 years. Would it be enough? Some economists already had their doubts. Even Christina Romer, who would soon chair the president’s Council of Economic Advisors, had pushed Larry Summers, a former Treasury secretary and Obama’s top economic advisor, to recommend $1.8 trillion in stimulus to Obama in December 2008. Across the Pacific, China had just announced its own stimulus package of $586 billion over just two years — and that was for an economy only a third the size of the United States that had no deficits problems and was still expected to grow quickly for many years. If the American economy still stood on the brink of a new recession a year or two years hence, the president and Congress would have to consider another attempt. After all, Americans would be suffering the pain of joblessness, foreclosure, and bankruptcy until the economy returned to strong growth.
As they girded for each fight against a president they were determined to defeat, the Republicans fell back on the basic tenets of their economic philosophy. Unfortunately for the American people, those tenets were myths. Each one of the economic concepts that the Republicans held dear simply wasn’t true, as qualified economists from around the political spectrum agreed.
The time is running out to repudiate these myths. The unemployment rate is still at 8.2 percent, and the nation added a scant 80,000 jobs in June. Meanwhile, 49 percent of Americans polled this month by the New York Times and CBS said that they thought Mitt Romney, the presumptive Republican nominee, would do a better job with the economy as president, compared to 41 percent for Obama. If Romney were to follow Republican orthodoxy, however, his economic policy would be dangerously reliant on these five myths:
Myth 1: Government spending doesn’t help the economy to grow in the short term.
The Republicans knew that opposing any kind of stimulus just to undermine the Democrats and the president would turn them into villains in front of the voters. They had to accept some kind of stimulus, but they preferred tax cuts to new spending. Tax cuts gave money back to the people who earned it, and they also took money away from the government, which would eventually cause the government to shrink. Their patron saint, Ronald Reagan, put it this way: “People are tired of wasteful government programs and welfare chiselers, and they’re angry about the constant spiral of taxes and government regulations, arrogant bureaucrats and public officials who think all of mankind’s problems can be solved by throwing the taxpayers’ dollars at them.”
Faced with the Democrats’ proposal for a $900 billion stimulus combining tax cuts and spending, Sen. Jeff Sessions, a Republican from Alabama, said, “we need to resist this package with every strength that we have. Indeed, the financial soul of this country may be at stake.” The Republicans called the Democrats’ spending wasteful and began to propose alternatives. “We need to make tax cuts permanent, and we need to make a commitment that there’ll be no new taxes,” said John McCain, the Arizona Republican.
Most first-year students of economics learn about how government spending and tax cuts can affect the economy. When the government spends a dollar, it buys goods or services from a vendor; this is new economic output. The vendor then puts the government’s money in the bank, which may in turn lend out a portion of the money. When that portion of the money is spent, it generates more economic output, and so on. This is called the multiplier effect. Tax cuts have a multiplier, too. When people get money back from the government, they may save some and spend the rest. The part that they spend generates new economic output, and the cycle begins again.
Mathematically, the multiplier for a dollar of spending should be higher than the multiplier for tax cuts unless the saving rate is zero, which has often been true in the United States in recent years. But Republicans were essentially arguing that the multiplier for government spending was lower or even zero — in other words, that the spending was so wasteful that it would just shift economic activity from one area of the economy to another.
Economics textbooks did not agree, and neither did a diverse group of the nation’s best economists. At the University of Chicago’s Graduate School of Business, the Initiative on Global Markets launched a forum to poll economists on some of the biggest issues in economic policy. It brought together a panel of more than 40 top academics from both sides of the political divide, including members of the Council of Economic Advisers from the presidencies of George H. W. Bush, Bill Clinton, George W. Bush, and Obama. As four panelists wrote in an editorial for Bloomberg News, they wanted to dispel “a common belief that economists can’t agree on anything important.” The forum, they said, “provides an introduction to the half-century of fact-based research that informs the scholars’ opinions.”
In 2012, the panel was asked about the stimulus bill that the Democrats pushed through Congress against the Republicans’ vocal opposition. Each panelist could agree or disagree with the following statement: “Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill.” Ninety percent of the panel said they agreed or strongly agreed. Then they were asked if the benefits of the stimulus would end up exceeding its costs — not an essential aspect of a stimulus package, since the goal of stimulus is to borrow growth from the future to smooth out a rough spot in the present. Still, 46 percent agreed or strongly agreed, and most of the rest said the result was uncertain; only 12 percent disagreed or strongly disagreed. Not only did the stimulus successfully lessen the pain and duration of the downturn, which was its main purpose; it also had a decent chance of being a net gainer for the economy in the long term.
How could that be? Looking at data going back to the 1950s, economists from the University of California at Berkeley found that during recessions, every additional dollar spent on goods and services by the government yielded between 1.5 and 2.1 dollars of economic activity. For investments in infrastructure and other forms of public capital, the effects were bigger: 2.8 to 3.4 dollars of economic activity for every dollar spent. The effects were large, the economists wrote, because during recessions the additional spending was very unlikely to crowd out any consumption or investment by the private sector.
When judging the effectiveness of stimulus in the short term, you simply couldn’t take the Republicans at their word. One reason was their own hypocrisy. Eric Cantor, who became the House majority leader in 2010, was a case in point. In March 2009, he appeared on ABC News to deny the notion that government spending could bolster the labor market. “It can’t create jobs,” he said. “It can’t create wealth.” Yet seven months later, he wrote to the Department of Transportation asking for budget money to do just that. His letters said that a $74.8 million high-speed rail project would “create 281 jobs during each year of construction” and that $60 million in loan guarantees for shipbuilding would generate “thousands of jobs in the shipyard and supplier base for two to three years.”
Myth 2: Cutting tax rates eventually leads to higher tax revenue.
Among Republicans, one of the great justifications for preferring tax cuts to increases in spending is that the tax cuts supposedly pay for themselves. Reagan said that if the government reduced taxes, people would “be more industrious; they’ll have more incentive to work hard, and money they earn will add fuel to the great economic machine that energizes our national progress.” The results were “more prosperity for all — and more revenue for government,” he said. “A few economists call this principle supply-side economics. I just call it common sense.”
Reagan’s belief has been passed down lovingly to each new generation of Republican leaders. For example, when asked about George W. Bush’s tax cuts, the Republican leader in the Senate, Mitch McConnell, said “there’s no evidence whatsoever that the Bush tax cuts actually diminished revenue.” He continued: “They increased revenue, because of the vibrancy of these tax cuts in the economy.” And he said that this “was the view of virtually every Republican on that subject.”
It was not, however, the view of every economist. To be sure, there was a theoretical foundation to Reagan’s belief. If tax rates were zero, the government wouldn’t collect any revenue. If tax rates were one hundred percent, the government wouldn’t collect any revenue, either, because no one would work for free. In between, however, there had to be a curve where revenue would peak at some level of tax rates. Reagan thought the United States was on the right side of the curve, and cutting rates would bring the nation closer to peak revenue. It wasn’t true in the 1980s; his tax cuts led to the biggest budget deficit, proportional to revenue, that the country had ever seen. It wasn’t true in the 2010s, either.
The Chicago Initiative on Global Markets asked its panel what would happen to tax revenue over the coming decade if income tax rates went up by one percentage point for the top earners. Reagan and McConnell’s logic would predict a fall in revenue. Ninety-three percent of the economists on the panel said it would rise. Emmanuel Saez of the University of California at Berkeley, one of the world’s top experts on taxes and income distribution, made direct reference to the curve: “Based on best estimates and even with current tax code, U.S. top rate is still significantly below revenue maximizing tax rate.”
Myth 3: Government spending doesn’t help the economy to grow in the long term.
Supply-side economics, as you might expect, is a collection of policies that could help the economy to supply more goods and services. It stands in contrast to demand-side economics, often associated with the British economist John Maynard Keynes, which is about spurring consumers and businesses to buy new goods and services. The Republicans’ favorite supply-side policies are tax cuts and deregulation, which are two ways that the government can get out of the way of the private sector. But they’re not the only ways that the economy can raise supply in the long run, nor are they the only ways government can be involved.
For economists, the classic role of government is to correct failures in the market. These often occur when the private sector can’t provide something that all of society wants and needs. No American has enough incentive to buy an aircraft carrier, but by banding together through government we can buy enough of them to defend ourselves. The same goes for some of the economy’s most important needs: infrastructure, universal education, and basic research in the sciences. Investing in these critical pillars of our economy pays huge dividends in the future. Reports from the United States and United Kingdom have found evidence that a dollar spent by the government on basic research in physics, chemistry, biology, and related fields pays back as much as 50 percent more in economic growth.
Yet Republicans have often lumped these investments in with every other kind of spending. Their reaction to the stimulus package in 2009 was no different. A report by McCain and his Republican colleague in the Senate, Tom Coburn, singled out several scientific projects for disdain. They compared one project, dubbed “Facebook for Scientists,” to propaganda, even though its purpose was to make collaboration between researchers easier. Bizarrely, they named a research project mapping cancer patients’ responses to chemotherapy under the same heading. In another section of the report, a study on primates of how addiction was related to chemicals in the body was labeled “Monkeys Get High For Science.”
Of course, science was becoming something of a bugaboo for Republicans. When Jon Huntsman, the Utah governor who ran in the Republican primaries for president, tweeted that he believed scientific evidence about global warming, he was forced to backpedal by doubters in his own party. (He had even acknowledged the bizarre positions of other Republicans by ending his tweet, “Call me crazy.”) If the Republicans were true supply-siders, they would see government investments in scientific research as a fundamental engine for economic growth.
Myth 4: Smaller government is always better.
Clearly this is not the case when it comes to investing in infrastructure, education, and research. But the financial crisis of 2008 made clear that government had a meaningful role to play in regulation, too. Not only did the federal government fail to oversee trading in the derivatives markets that led to the collapse in subprime mortgages, it didn’t even record data on what was happening in those markets. Nor did it monitor the activities non-bank financial institutions, such as insurance companies and hedge funds, that were just as important as banks in these markets. Big government clearly was not the problem here.
In the midst of the financial crisis, reminders of the perils of too-small government were coming in from around the world. China, with its primitive regulatory apparatus, was being blindsided on an almost monthly basis by scandals surrounding its exported foods, drugs, and consumer products: poisonous toothpaste, melamine-tainted milk, defective blood-thinners, and toys covered with lead paint. These were the same kinds of scandals that convulsed the United States a century earlier and led to the modern regulatory system we have now. Did the Republicans want to go back to the early 1900s?
The American people certainly didn’t. A poll by NBC and the Wall Street Journal found that in some areas, citizens wanted more regulation, not less. In fact, the “more regulation” votes outnumbered the “less regulation” votes by four-to-one for the financial industry and the oil industry, and by two-to-one for big corporations and the health care industry. The American people were speaking with a clear voice, but John Boehner, who was poised to become Speaker of the House after the Republican victories in November 2010, didn’t seem to hear it. “The new majority here in Congress will be the voice of the American people,” he said after the election. “We’re going to continue and renew our efforts for a smaller, less costly and more accountable government here in Washington, D.C.”
It was an especially odd thing to say for someone who should have known that the federal government had changed very little in the previous five decades. At the start of the Great Recession, Washington’s non-defense spending represented about the same share of the overall economy as in 1959, the first year for which figures are available:
Figure 1: Federal non-defense and state and local government spending, share of economy
What had changed was the spending of state and local governments, whose share of the economy had grown by more than a third since the 1960s. And of course, Social Security and Medicare represented huge liabilities in the nation’s future. Yet the other parts of the federal budget — some crucial to long-term growth, like the Department of Transportation, and others to the orderly functioning of the economy, like the Justice Department — were peculiar targets for Republicans’ rhetoric.
Myth 5: The economy is meritocratic, so people earn what they deserve based on talent and effort.
In a meritocracy, if you’re poor, it’s either your fault or just bad luck. If you were smarter or worked harder, chances are you’d be rich. There’s nothing fairer than a meritocracy, if you don’t mind some advantages going to people who were simply born with a greater ability to make money. A true meritocracy provides equal opportunities for everyone, and, if you have equal opportunity, why should you also have redistribution? Why take from the wealthy to support the strugglers, when the strugglers are only struggling because of their own deficiencies or laziness?
The only reason would be to counteract occasional bad luck by providing some kind of temporary social insurance. That’s about as far as Republicans are willing to go. Unfortunately, their underlying assumption is wrong. The American economy is not a true meritocracy. Plenty of opportunities still go to people because of their connections and their families’ existing wealth, rather than because of their ideas or their work ethic. Plenty of our most talented, hard-working people don’t have time to start a business or develop new inventions, because they have to work two or three jobs just to put dinner on the table. Thousands of Americans still suffer discrimination every day because of their age, gender, race, or religion, whether they’re trying to get a job or a loan to buy a car or a house. And the people who want to change the system are shut out of the political process because they can’t afford a big campaign. At the same time, the way around these obstacles — the education system — is becoming harder to access because of self-segregated school districts, rising college tuition, and class stratification. As a result, the children of the rich tend to stay rich, and the children of the poor stay poor, no matter their abilities.
The United States may be one of the more meritocratic countries in the world, but it is not a true meritocracy. When an American doesn’t have a job, or can’t pay for food, that doesn’t mean he or she is lazy or inept. Yet Republicans showed little sympathy for Americans down on their luck in the aftermath of the recession. Every time the Democrats tried to extend unemployment benefits in the deepest downturn since the Great Depression, the Republicans balked. And as millions of Americans slipped into poverty and even hunger, with state budgets being slashed and social services disappearing at the moment of greatest need, the Republicans turned the other way.
With their economic philosophy based on so many mere myths, perhaps it isn’t surprising that the Republicans have a dismal economic record. In the past six decades, economic growth was highest — 3.9 percent annually, adjusted for changes in prices — when Democrats controlled the House, Senate, and presidency. When the Republicans controlled all three, growth averaged only 3.0 percent. That may not sound like a huge difference, but consider this: a drop of one percentage point in the economy’s rate of growth implies a shortfall in job creation of about one million jobs per year. Of course, economic policy sometimes needs time to take effect. But even if you give the Republicans a long runway — say, five years from the period when they control the government — the effect of their policies on economic growth is actually negative. Extending the runway to 10 years only makes their record look worse.
On the strength of this evidence, perhaps the Republicans who faced the aftermath of the Great Recession might have reconsidered some of their most dearly held economic ideas. But no — they fought harder than ever, and the American people have suffered for it.
Alicia P.Q. Wittmeyer is assistant managing editor for online at Foreign Policy. Her work has appeared in the Los Angeles Times, the Washington Post, and Forbes, among other places. She holds a bachelor's degree from U.C. Berkeley, and master's degrees from Peking University and the London School of Economics. The P.Q. stands for Ping-Quon.| Argument |