[Previous] [Main Index] [Next]

Sunday, August 24, 2003


The following discussion was prompted by a selection from The Center on Budget and Policy Priorities, a Washington Think Tank, that Professor Brad DeLong --- an economist at UC Berkeley, with an unusual grounding in economic history that he draws on for his views on contemporary economic problems and trends --- posted on his web site on August 22, 2003. The buggy prof then replied at length in the comments-forum on the posted selection, plus Professor DeLong's own brief supporting commentary at the end.

Note the title above, which ends in a question mark.

The short answer: there may be some reasons to worry about the Bush Jr. deficits, particularly if they were to initiate an era of high government deficits that lasted, say, a decade or more. For all that, it seems unlikely they will. Before national debt as a percentage of GDP rose above the high point of the Reagan-Bush Sr. era, around 60% of GDP, corrective measures would probably kick in: either GDP growth would rise fast enough to generate new revenue to offset some or most of the deficits; or taxes would be raised to collect more tax revenue, something that happened in 1990 under President Bush Sr. and then at the start of President Clinton's administration in 1993; or government spending would be cut back in some areas to reduce the overall burden; or some combination of these first three alternatives would follow.

For the time being, however, they aren't worth worrying about and should be welcomed. Why? For two reasons essentially:

[1] As at the start of the 1980s, so today the US economy faces a major problem of high unemployment --- 6.3% now, almost 10% then (plus 10% annual inflation!) --- and large unused industrial capacity, now operating only at about 75% of full capacity. As the buggy prof argued in a mini-series of 4 articles published on this site between July 20th and July 26th, we need to find a way to kickstart aggregate spending in this country --- personal consumption, business investment, and government consumption and investment --- in order to close the output gap between actual GDP growth (averaging 2.4% annually over the last 23 months) and the new long-term growth trend of the economy. The latter seems to be about 3.5% or even more, thanks to big improvements in labor productivity that emerged in the latter half of the 1990s and have been sustained ever since. That long-term improvement in our future economic growth, welcome as it is, creates a major problem of short-term growth: it has increased the output-gap between a full-employment economy and current GDP growth. Hence the desirability of the large federal deficits for the time being.

[2] We can disagree whether the three Bush tax cuts since 2001 --- which will likely contribute about $180 billion this year to the projected $400 billion deficit by the end of December --- were wisely designed from a viewpoint of equity. What we're interested in is their impact on GDP growth in the present and near-future, say through 2005. On that count, they already seem to be stimulating current economic growth . . . and at an increasing fast clip: durable goods orders alone rose 1.0% last month compared to June, and shipments rose noticeably too. In fact, almost all the economic news the last two months has been cause for optimism. No less important, the latest Bush tax cut contains a significant, highly innovative twist that no other fiscal stimulus package, here or abroad, has ever flirted with: a legal end, projected to kick in automatically in later years, to many of the existing tax reductions. . . including the accelerated tax depreciation rate, lowered now to encourage investment. The aim here is to ensure that the current fiscal deficits will not rise endlessly into the future and raise national debt as a percentage of GDP beyond tolerable levels.

(Whether tax rates would actually be upped in the future as the law requires is another matter, regarding which there's lot of skepticism. The argument is that raising taxes is generally unpopular with the electorate, and so Congress and the President in 2010, say, could simply pass new legislation. Possibly so. But Bush-Sr. raised them in 1990, much to the discomfort of the Republicans, and Clinton raised them again in 1993, so the skepticism is hardly ironclad. Much more likely, Republicans hope to find ways to cut back on government spending as a deficit-reducing measure. There certainly is room for such reductions, but the new defense burdens and medicare coverage of medicines have already led the Congressional Budget Office to revise its earlier spring projections of a fairly optimistic sort about future deficit trends after 2005. It's hard to believe Republicans will oppose big cut-backs on these two costly, but popular commitments . . . or any at all.)

What follows here? A four-part argument:

1) The CBPP selection, and DeLong's follow-up;

2) Then the buggy prof's first lengthy rejoinder . . . with its cautionary notes that when an economy like the US faces high unemployment (still 6.3%) and serious excess capacity --- right now, US industry is operating only at 75% full capacity: a record for the last couple or three decades --- then huge fiscal stimuli are needed to kickstart faster GDP growth and lead to more capacity usage and new jobs. The argument concentrates on the similarities with the start of the 1980s, and looks at the large Reagan deficits of the period . . . and what subsequently happened. In line with the earlier buggy article of August 8th, 2003, Is Economics A Science, the buggy argument at the DeLong site ends with a list of problems that economics as a discipline encounters as a guide to policymakers grappling with real-world economic problems, themselves politically charged.

3) Then the follow-up replies to the buggy comments left by others at the DeLong site. Prof bug leaves it up to you to reflect on the quality of those rejoinders.

4) And finally the even longer Prof Bug rejoinder to them and the DeLong posted article.



From the Center on Budget and Policy Priorities:

$401 Billion vs $455 Billion: Good News, Bad News, Or No News?,/03: In early July, we issued a projection of future deficits. Our analysis explained that official budget projections paint too rosy a picture because they omit costs that are likely or nearly certain to occur. For example, CBO's March "baseline" projection reflected laws in place at that time. CBO consequently assumed that the various tax breaks enacted in 2001, 2002, and 2003 would expire on schedule.

Likewise, CBO omitted relief from the Alternative Minimum Tax after tax-year 2004 and did not include the likely enactment of a Medicare prescription drug benefit. Our report concluded that if these and other likely costs occur, deficits over the ten-year period from 2004 through 2013 will total $4.1 trillion, will not fall below $325 billion in any year, and will reach $530 billion, or 3.0 percent of GDP, by 2013.

Other analysts, such as Goldman Sachs, the Concord Coalition, and the House Budget Committee minority staff, have published similar estimates.

Significantly, our $4.1 trillion ten-year projection included a deficit estimate of $403 billion for 2003 and $446 billion for 2004. CBO's current estimate of $401 billion for 2003 is virtually identical to -- and thus reinforces -- the projections we issued in early July. Similarly, on June 17, Goldman Sachs projected a $425 billion deficit for 2003 and a $4.5 trillion deficit over the ten-year period 2004-2013, while the Concord Coalition earlier projected a deficit of about $420 billion for 2003 and $4.0 trillion over the decade. These projections, as well, indicate that a deficit below $455 billion in 2003 should not be interpreted as good news for the future...

In short --- [this is Brad Delong speaking] --- it now appears that OMB July figures both overstate the short-term deficit and seriously understate the long-term deficit. The OMB estimates understate the long-term deficits because they omit some costs that are very likely or nearly certain to occur in years after 2004.

Posted by DeLong at August 22, 2003 08:19 AM | TrackBack



1) We should all, I believe --- yes, even Democrats like myself --- be more cautious about the long-term trend of federal deficits. Similar catastrophic warnings were issued throughout the 1980s after the Reagan tax-cuts; and eventually --- contrary to conventional political wisdom --- Congress was willing to twice increase taxes in the 1990s, first in the Bush Sr. administration and then in the Clinton era.

2) Whether those tax rises made much difference in the subsequent bursting growth of GDP and labor productivity after 1993-1994 --- along with the totally unpredictable decline in unemployment to around 4.0% without new inflationary pressures --- isn't clear. What we do know is that faster GDP growth in the 1990s not only steadily reduced the federal deficit from an all-time high as a % of GDP in 1992, but eventually changed the deficit into a surplus.

3) There were always some liberal economists --- especially Robert Eisner, the former head of the American Economic Association, and an old-fashioned Keynesian economst --- who supported the Reagan deficits and warned the critics on the left and right that they were unduly pessimistic about the predicted bad effects of those deficits. He was convinced above all --- a lonely voice even in liberal circles --- that the estimated level of natural unemployment at around 6.0%, an estimate clung to throughout the mid- and late-1990s by most of the economics profession, was way overdone and bluntly wrong.

Eisner proved right. Even if there was some crowding out of net business investment in the 1980s as a result of the fiscal deficits, it didn't happen as much as the critics had predicted. Even if the crowding out in loanable funds markets was largely blunted by a huge inflow of foreign capital, the resulting trade deficits began to reverse themselves after 1985 --- US exports essentially doubled in the next 5 to 6 years --- and we now know that there is no direct causal link between the size and even direction of federal deficits on one side and trade deficits on the other.

Tersely put, the US current account mounted rapidly in the early and mid-1980s with rapidly growing fiscal deficits, then began to reverse itself noticeably even with those fiscal deficits continuing to soar. More unpredictably too, the current account deficits surged to new heights in the late 1990s despite the federal deficit turning into surplus for a few years.

4) Meanwhile, as Eisner and some others noted, whatever the supply side hype surrounding the Reagan tax cuts and deficits at the time, the huge jump in US GDP growth that followed --- together with the leap in the US current account --- most likely saved the global economy from a new Depression: call it, if you prefer, a sustained sharp recession and slump. Estimates in the mid-1980s found that well over half the revived growth of Germany and Japan --- which of course then had beneficial spillovers to the EU and Pacific Asia --- could be traced back to their export-led growth into the booming US economy.


5) So where are we now in 2003?

--- Similar pessimism surrounds the long-term projections of soaring US federal deficits way into the future. That pessimism seems excessive and overdone. Job-wise, we are back in the early 1980s as far as excess capacity in the economy goes, and we need to find ways to accelerate national spending in order to reduce the output gap between actual GDP growth and the new, much higher potential output.

--- Beliefs that crowding out in loanable funds markets will be caused by US fiscal deficits seems overdone too. There may be some, but it hasn't occurred in the standard textbook way from the early 1980s on. Whether that's due to an influx of foreign capital, or whether the Ricardo-Barro theory is at work here, or whether there's just no clear correlation, are matters that just are unresolved.

--- Beliefs that the inflow of foreign capital as something bad or undesirable as a way to compensate for the insufficiency of US national savings --- given our investment levels --- seem overdone too. What exactly is wrong with incurring liabilities to foreigners if they are voluntarily willing to leave their capital in the US, rather than sell off dollars and have the dollar decline steadily in currency markets? As long as the rest of the world seems to prefer export-led growth, at least one major country, the US, has to run continued current account deficits to accommodate them.

The trick is to ensure that the added national savings that follow from the capital inflows --- the counterpart of our current account deficits --- are largely used for sustaining higher levels than otherwise of national investment. That might not have been the case in the 1980s (though recent new estimates of national investment and savings have adjusted the decline in net investment downward somewhat); but it definitely was the case in the 1990s, when net national investment soared. (See Benjamin Friedman, figure 1, p. 17. Note that though net private domestic investment did rise sharply in the first 2 - 3 years of the Reagan recovery in the early and mid-1980s --- something to be expected when the economy is coming out of a very deep recession --- it dwindled steadily throughout the 1980s and at the start of the 1990s. By contrast, it rose sharply throughout the 1990s throughout the rest of the decade.) And to repeat, there is no observable correlation between federal deficits and trade deficits.

These matters, I add, are explained in a mini-series on the US trade deficit just published on the buggy professor web site: http://thebuggyprofessor.org, starting August 19th and continued in three parts through August 22nd.


Is Macroeconomics Theorizing Much Of A Helpful Guide?

More generally on a theoretical plane --- here I speak as an outsider, a professor at UC Santa Barbara in political science, not an economist --- it seems there are lots of cocksure proclamations from various sides in the financial and economics professions about macroeconomics and policymaking that haven't a solid foundation.

-- Does crowding out occur? What are the statistical studies that convincingly show this?

-- Is the Barro update of Ricardo sound? Lots of the studies, here and abroad, show some rise in private savings as government deficits rise, but lots don't.

-- Is net national investment the best way to measure national investment and hence savings? Why not gross investment, especially since the new machines used these days as replacement capital for older machines --- say, computers and their software --- seem to embody more recent technologies and hence possibly to raise the level of productivity more than otherwise?

And, for that matter, if we now include in net national investment new roads built by the government at any level, why isn't a private household that buys a vehicle for use on those roads to travel to work regarded as investment too, rather than consumption? It is certainly a durable good, and it is indispensable to getting work done on the job as part of the larger productive process.

-- How much, for that matter, does business investment depend on the levels of real interest rates compared to all sorts of other influences, such as optimism about the growth of the economy and above all future sales prospects in their industries?

-- Why do numerous economists keep predicting some sort of catastrophe from large persistent current account deficits? These doom-doom predictions have been going on since the mid-1980s, and yet doom never occurs. Maybe the entire way of relating national income stats to trade stats needs to be thought through anew, especially since national income accounting was pioneered at a time, decades ago, with largely a closed economy in mind. Only in the 1950s was there, if I remember correctly, efforts to bring in the trade side (exports and imports) by James Mead and others. Might it not be time to see what all this means in an era of increased globalization and multinational activity and all sorts of investment flows across borders that the original and updated work of the 1930s - 1960s never came fully to terms with?

-- Is there any evidence that the Federal Reserve will lose autonomous control over monetary policy in order, as the doom-doom critics also say, to keep up the confidence of foreign investors? If so, where is it above and beyond the concern of Greenspan and his fellow Fed members to keep the US economy growing dynamically and offsetting inflationary pressures?

-- What exactly causes foreigners to invest here anyway? You, Brad DeLong, noted some interesting political motives in such inflows not long ago (I replied at length three times, I believe, in that forum), and there may be motives that haven't been fathomed as yet. Certainly, arguments that it's only the real return on interest rates in the bond markets --- compared to the returns abroad, taking into account the trends in the price of the dollar in currency markets at present and in the future --- seem inadequate. Standard views also look at differential inflationary rates, but they have all been done considerably, if not disappeared as a problem, in the EU, the US, and other industrial countries (and even most of Latin America) --- never mind Japan with its steady price deflation of around 1.0% a year since 1997 or 1998. (China too, despite hard-to-believe GDP growth reports, suffers from price deflation as well.)

Or is it the political stability of the US, plus the belief around the world the US is a more dynamic economy for investment, plus the determination of foreign political leaders to enjoy export-led growth (hence if need be to buy dollars in currency markets in order to keep the export-led growth going at home), plus the huge range and depth of US financial investments and our general indifference to foreign ownership, plus . . . well, what exactly?

-- And, to come back to the jump-off point of these comments, why --- given our experience with the Reagan deficits that continued through the Bush Sr. years --- are so many people, including economists, convinced that they augur bad fortune or even doom or catastrophe for the future health of our economy?

I could go on, but the point, I trust, is made. Macroeconomics remains a badly divided discipline, with all sorts of claims advanced by all sides --- Keynesians, New Keynesians, supply-siders, Barro-Ricardians, monetarists, and real business cycle theorists, never mind the problems of explaining balance of payments trends on current and capital accounts and the causal connections --- that seem, as a general thing, to exceed any solid scientific basis. For what it's worth, the buggy professor site has dealt with all this at length in an article published August 8th, 2003: Is Economics A Science?

-- Michael Gordon



Those who are interested in the comments left by diverse people in the forum that followed the DeLong posting --- and all were directed at the buggy rejoinder here --- will find them here



I thank everyone for their comments, including those of Mr. Bakho, the Wizard-of-Duhz, who seems to think that an argument is advanced by insults and various forms of name-calling. Very briefly,

(1) Supply-Side Stuff

----- I. First Anne: She quotes a sentence of mine referring to "supply-side hype", disagrees with the observation in that sentence, then thinks I'm guilty of . . . well, supply-side hoot:

Anne's comment, which begins by quoting the buggy prof:

"Eisner and some others noted, whatever the supply side hype surrounding the Reagan tax cuts and deficits at the time, the huge jump in US GDP growth that followed --- together with the leap in the US current account --- most likely saved the global economy from a new Depression...."

Please. This is mere supply-side all-side nonsense. What a hoot."

I'm not certain what sort of logic this is --- maybe the Wizard of Duhz can clarify it for us --- but it leaves the buggy prof puzzled.

Factually, it's not a hoot. The combined oil price surges of the 1973-74 period and 1979-80 had crippled world economic growth by 1981. Macroeconomic policy had also become erratic: the primary Keynesian policy-guide, the Phillips curve alleged stable tradeoff --- between less unemployment at the margin and more but predictable and stable inflation --- had broken down; and by 1980, the Fed in this country and the European and Japanese central banks were all following very tight monetary policies even as unemployment kept rising and inflation too. (Japan was doing better on that latter score, but not much.) The term "sclerotic Europe" was even run on the cover of Time or Newsweek in 1983 as the US economy itself was recovering. Subsequent analysis showed that about 50-67% of the German and Japanese revival in GDP growth after the US revival in 1983 --- GDP was a bursting 7.3% real growth for the year --- could be traced to the recovery of the US economy, thanks to their huge export drives to us . . . with all the multiplier effects on their own GDP and that of their neighbors through the trade sector that followed.

---- II. SZ, on the other hand, believes the credit for the achievements --- and presumably problems --- of the Reagan era should go to Paul Krugman and Larry Summers. Go figure.


2) What Happened to National Investment in the Reagan Era?

I did note that despite the supply-side hype of the time, net national investment did not itself rise as supply-siders had hoped. In fact, it was a tad below the average in past recoveries and over the business-cycle, and lower than in the 1990s . . . though how much of that had to do with replacement capital-investment in outmoded energy-systems is something I can't say. See the charts in Benjamin Friedman, a good economist, on this: pp. 17-22, figures 1-4. (Note that replacing old machines with new ones --- say, old coal-driven generators with newer ones, fitted with advanced technology more benign to the environment --- amounts to GROSS investment; and hence isn't included in the chart. Whether that makes sense is another matter. New machines of a wide variety are likely to embody more advanced technology, and hence be more efficient and possibly raise a firm's productivity.)


(3) An economy with big excess capacity vs. a full-employment economy.

--- I. Nobody in the forum seems to grasp the difference between what fiscal policy ought to be when an economy is seriously afflicted by noticeable excess-capacity --- the condition of the US economy in the early 1980s and again in the early years of this decade ---- as opposed to one operating at full employment (the natural rate, the NAIRU). [Though note: whether the latter is even a sound guide for policymaking is itself questionable, as I hinted at in the questions raised about macroeconomic guides to policymaking. An important paper by Douglas Staiger, James Stock, and Mark Watson in 1997 found that with a confidence interval of 95%, a typical estimate can range over the past they studied from 5.1% to 7.7% (the year 1990).

--- II. Eisner's key point --- repeatedly made in the 1980s even as fellow liberals attacked him --- was that when an economy like the US is in serious job trouble marked by large excess capacity, massive federal deficit spending is needed. Far from that being an exotic view, though, it was standard Keynesianism of the old sort . . . vs. the New Keynesianism that, associated with Gregory Mankiw and most economists with liberal leanings draws on rational expectations and the need to look at the micro-basis of macroeconomics. Essentially, new Keynesians still regard the market economy as embodying some large market-failure(s) that can block effective short-term adaptability to various shocks --- endogenous and exogenous --- and hence in need of active macroeconomic policymaking that, though, should usually be rule-based.) For clarification of all this, see the buggy prof article, "Is Economics A Science? Can It Be?"

For the larger view of Eisner's outlook on how to treat an economy with large room for job-creation and GDP growth, see the survey of Eisner's policy recommendations of the 1980s in the light of what subsequently happened ever since by Benjamin Friedman, a well known liberal economist at Harvard:


(4) Mr. Bakho's Hard-To-Fathom Comments

--- I. Mr. Bakho seems to think that long-term economic growth and job creation in the US economy --- or any probably --- are dependent on macroeconomic policymaking, wholly a demand-side phenomenon. At least that's what his puzzling references to Alan Greenspan and Bill Clinton seem to imply, as though jobs and investment and GDP growth over a long period --- say 8 years --- are determined on the demand side. It was a deal, you see, worked out by Greenspan and the President. By contrast, most of us think potential output --- the long-term growth trend --- is structured wholly on the supply side: inputs of investment capital, growth of the labor force, the quality of the labor force, inputs of fuel and raw materials, and technological progress . . . plus effective legal, political, administrative, and economic institutions in the surrounding society and polity. About the only half-way meaningful point that Bathko seems to be driving at is that the Fed has the power to choke off a recovery if it tightens monetary policy too much --- deliberately or not.

--- II. Eisner, an old-fashioned Keynesian, is misinterpreted by Bakho --- to the point where you're left wondering whether the Wizard of Duhz isn't pulling out observations from the depths of ignorance.

As Friedman's article notes, Eisner believed that the need for fiscal deficits was built into a capitalist economy like ours, given a tendency toward insufficient aggregate demand on the private size. He would have been surprised, Friedman observes, to have lived to experience the fast growth of the late 1990s with first declining central government deficits, then a surplus. (Eisner, I add, was also active in showing in the 1980s and early 1990s that national debt as it mounted was exaggerated in nominal terms. If inflation were rising 3% a year, then total national debt in real terms was declining 3.0% too. He also noted that you had to consider what was happening with fiscal trends in the states: most were in surplus in the 1980s, and hence that surplus had to be deducted from federal government deficits. He also all along argued --- a good liberal point that the Wizard of Duz might even agree with if he knew more --- that government spending wasn't just consumption (as it was counted until the mid-1990s by the Bureau of Economic Analysis), but included highly desirable investment. We also know, thanks to the work of D.A. Aschauer in the late 1980s and early 1990s that government investment can be as effective and cost-efficient in generating long-term GDP growth --- and possibly raising its trend-rate --- as private investment, and at times even more efficient here. How much, though --- as with so much macroeconomic policy guidance --- is uncertain. The best overall comparative study of the subject across OECD countries --- carried out by a Dutch team in 1996 --- seemed to find at most a modest contribution to economic growth: See Jan-Egbert Sturm et al,

--- III. Economic Growth in the 1980s. The best way to compare economic growth in that decade is with the 1990s --- not earlier decades. The reason? The 1975 watershed, when --- because of the oil price surge in 1973-74, the short- and long-term dislocations it caused, and the sudden disarray in policymaking circles when the Phillips curve, faced with a supply-side shock, no longer offered any clear guidance of reconciling low unemployment and a predictable and stable level of inflation --- economic growth in the industrial world slowed down markedly: roughly, by 50% or more in Japan and Germany and most of the EU (though not the poorer EU Mediterranean countries or poor Ireland in those days, which --- in line with standard convergence catch-up growth --- eventually managed to raise their GDP growth rates in the late 1980s and 1990s). In the US, the leader country that had been the slow-grower in the OECD since 1945 --- again, fully in line with convergence theory that predicts that follower countries with proper educational levels in their work force and decent economic and governmental institutions will grow faster than the lead country once they are launched onto a path of sustained growth ---- GDP growth actually slowed down much less, around a third. Note that labor productivity fell off even more and stayed that way until 1996, only for labor productivity to rise noticeably ever since and more or less recover its earlier pre-1975 trend.

So what do we find in the 1980s and 1990s, across an entire business cycle from 1983's recovery to the short, shallow recession of 1991-92, and again from the 1993 recovery to the short-shallow recession of 2001?

Well, real GDP growth from 1983 to 1992, nine years, totaled 31.7%. In the nine years between 1993 and 2001, it totaled 32.6%. See BEA figures. Obviously, it's better to have grown without rising national debt --- rather declining debt on the whole; but that isn't what is germane here. In the 1980-82 period, inflation was averaging nearly 10% a year,, and unemployment was close to averaging 10% too. Ponder those gloomy figures. 10% unemployment; 10 percent inflation. Viewed from any angle, it was a horrendous period for the US economy. The contributors to this forum seem to think 6.3% unemployment is deplorable right now, something I happen to agree with --- at a time, mind you, when inflation is essentially dead in the water, with the Fed claiming to have worried about deflation as a problem this last spring. But 10% unemployment --- the highest we had since the 1930s Great Depression --- and a similar magnitude of inflation were markedly worrying and a huge policy challenge.

--- IV. In the process of growing rapidly in the 1980s, national debt did rise three fold as Mr. Bakho notes, for once managing to get a figure right. That, however, isn't the relevant stat. The relevant stat is national debt as a % of GDP. A better picture then of the Reagan years, compared to the previous decades and since, charts this at this site .

---- V. In his inimitable manner of reasoning, Mr. Bakho thinks that anyone questioning whether crowding out occurs because of fiscal deficits deserves to be called "stupid" and peppered with "duh".

Very briefly in response: The strong version advanced by New Classicists, starting with Milton Friedman in the 1960s, holds that rising federal deficits --- financed of course by selling new issues of Treasury securities in loanable markets that compete with private demand for investment capital --- will crowd out the latter by raising interest rates. Hard-core New Classicists predict 100% crowding out: hence expansionary fiscal policy can have no impact on the rate of GDP growth. Most others and even New Keynesians predict at least some crowding out. Unfortunately, the evidence for this --- as I noted in my original comments --- is simply lacking in any convincing manner. If anything, the evidence suggest there is no clear correlation at all. For a chart plotting ten year interest rates against publicly held debt --- based on some good regression analysis --- click on this link.

The alternative version developed in the mid-1980s --- when long-term real interest rates turned out not to rise as predicted by crowding-out --- was that the higher short-term interest rates that the Fed purposely set by its ability to control bank reserves (high-powered money) then led to a huge inflow of foreign capital into the US loanable funds market. That was then interpreted to mean that the higher rates were caused by competing sales of Treasury securities in private markets. The result? No crowding out of net investment occurred --- not much anyway --- because foreign capital compensated for the higher levels of demand in US loanable funds market, or so the new variant's interpretation went; but --- it was now claimed --- crowding out occurred all the same, only elsewhere: in the balance of payments. Specifically, US exports were allegedly crowded out, and our trade balance in goods and services worsened. (That's because, of course, the rising flood of capital inflows from abroad raised the price of the dollar to sky-high levels and made US exports increasingly costly while progressive lowering the price of our imports.

The conclusion? The size of a current account deficit in the balance of payment --- trade in goods and services --- could be blamed on the Reagan deficits . . . and more generally, it was claimed as a new theoretical variant of crowding out, closely correlated with the size of any fiscal deficits.

For clarification of the reasoning here, see the buggy prof article for August 22nd, 2003: "What Causes US Trade Deficits, and Should We Worry?" But to illustrate in shorthand here, let me reproduce the equation derived from national income accounts that's found in a book written by someone regarded, apparently, as the economics equivalent of Gospel Truth: Paul Krugman . . . specifically, from his co-authored book with Maurice Obstfeld, International Economics: Theory and Practice (3rd ed), p. 315:

CA = S (personal savings) – I – (G – T)

CA means Current Account; S is personal household savings, I is net investment, G is government spending, and T is taxes

G-T is the size of a federal surplus with G exceeds T, and vice versa the size of a deficit when G spending outpaces T.

Mr. Bakho seems to think this new crowding out variant is Gospel stuff. In fact, it isn't. What turns out to be the case is that there is no correlation whatever between current account deficits --- and hence capital account surpluses --- and either the size of US governmental deficits or its trend (toward surplus at the end of the 1990s, at a time of record current account deficits). Again, if Mr. Bakho can control his urges to stutter "duh" and look at the Benjamin Friedman article, he will find some statistical evidence of this (much as it might disturb the cocksure nature of his convictions).

---- VI. Why, exactly, crowding out doesn't occur in either of the ways that New Classical Economics predicts isn't clear.

Probably the best candidate-theory is Barro's updated Ricardian view that fiscal deficits have no discernible impact on the macro economy. That's because when tax cuts aren't accompanied by declining government spending, the public knows that rising deficits in the present --- financed by borrowing from the public --- will have to be compensated for in the future by new tax rises. The result? The tax cut money is immediately saved for future tax rises, and a triple-header consequence follows: there's no fiscal stimulus to GDP from higher consumption; interest rates don't rise (because new savings offset the sales of new Treasury securities); and hence if interest rates don't rise, there's no correlation between capital inflows from abroad and the fiscal deficit, and hence between the latter and any current account deficit in the balance of payments.

The trouble is, as I noted in my comments about the problems with macroeconomic theories and policy guides, the Barro thesis has never found unequivocal statistical support in most cases, whether here or abroad. Lots of studies show it applies; lots don't. Since I believe DeLong discussed this work --- at least a study by Mankiw and someone else --- and did this recently (ever since I started looking at the site not long ago), there's no need for me to rehearse the (inevitable) uncertainty of the thesis, and the studies that seek to confirm or disconfirm it.

---- VII Mr. Bakho also seems to be some sort of economic nationalist, worried that there are vast corporate profits flowing out of the US when foreigners invest here --- presumably, he means FDI, multinational investment. Two or three brief replies.

One: if all countries restricted or prohibited multinational investment --- or for that matter portfolio investment ---- the US would be a big net loser: the inflow of profits, and payments on US licenses and royalties, each year is a big net plus in the US trade-in-services part of the Current Account

Two: the outflows of profits to the parent firms of multinational enterprises here are their rewards for creating profitable businesses that employ millions of Americans, add to our GDP and per capita income, and pay taxes to local and federal governments . . . the same as US firms do when they operate abroad.

Three: the outflows of the profits don't presumably go under the mattresses of French, British, Dutch, German, and Japanese multinational CEO's and equity-holders. They in turn spend or invest them: spend some of US exported goods and services, invest some back here, and do the same in other countries to which we then export in turn.

The only possible objection to be raised to any of this --- except outright jingoism --- is our paying profits on US investments of the Saudis for oil sales, and on political grounds: like all the other 21 Arab countries, Saudi Arabia is a despotism run by a small clique of corrupt self-serving gangster types, 4000 royals . . . only with these added twists:

1) They have squandered even more money through profligate consumption (about 2.5 trillion dollars worth of oil revenue calculated in 2001 dollars), even as per capita income in that country of 20 million or so has fallen by two-thirds since 1980 . . . with unemployment among men alone around 30%;

2) They have exported a racist, US-hating, anti-western form of Wahhabi Islam with their oil money that fans fundamentalist zeal and hatred around the Muslim world and elsewhere;

and 3) They have used at least a fair amount of their oil revenue to support Al Qaeda and other mass-murdering Islamist terrorist movements, which have among other things caused thousands of American deaths. The latest effort of the Bush White House to conceal the Saudi role here that was apparently documented in the recent Congressional study of 9/11's mass-murder shows just how treacherous these so-called Saudi friends happen to be. Not long after that mass-murder, the Saudi gangster regime sponsored a secret public opinion poll --- subsequently leaked to the US press (no doubt lots of bucks were passed here) --- that showed the following startling figure: 95% of Saudi men between roughly 19 or 20 and their late 30's admired bin Laden and his terrorism on behalf of fanatical Islam. Those who want further buggy prof studies of this can find them here:






The latter article, I add, is a political-economy analysis of Israel's thumping success in fostering a modern economy and democracy, compared to the economic backwardness and despotism rife throughout the Arab Middle East. Surprisingly, as the article shows, Palestinians turn out in survey data to admire Israeli democracy more than any other democratic country.


(5) One final point; Paul Krugman

Krugman did some good work once on trade theory amid conditions of monopolistic competition (oligopoly) and the growing role of governments in modern economies that didn't figure in 19th century and most 20th century work until then. Not that Krugman was alone in developing New Trade theory, never mind the Strategic-Trade Prisoners' Dilemma variant of it (which he later renounced anyway).

That said, why he has such guru status in the minds of those here remains a puzzle of sorts. Specifically, it's puzzling to understand why just citing his name or his views in incantatory manner, like a pulpit-pounding evangelist invoking the name of the Deity, is supposed to stop an intellectual discussion like this.

Krugman may be right about certain things in his New York Times columns, and he may be wrong; but summoning up his name in adulatory terms does nothing to establish anything (other than naiveté or true-believing adulation, I suppose). Earlier in the last decade, to clarify this, Krugman wrote a book called The Age of Diminished Expectations, which went through, I believe, three editions. In it, he predicted that the US economy had fallen on permanent hard times: productivity growth would very likely remain low, per capita income growth would do the same, the US foreign debt would likely cripple the US economy's future, the high levels of national debt he discerned would do the same, and quite likely, sooner or later foreign investors would be spooked out by the size of our foreign debt, at which point a stampede out of the dollar would occur and its value plunge in currency markets, with dire consequences for the rest of us. More specifically, Krugman ended up, if I remember properly --- it's been about a decade since I looked at the book and I've no copy of my own --- with three scenarios, and the gloomier two seemed more likely to materialize than even the slightly dismal one . . . the best we could expect. The outcome? We should all adjust our expectations of economic prosperity and good job-creation downward.

The book, as it happened, turned out to be a bust as a sooth-saying work. The exact opposite on all these scores occurred in the years after the book went through its last edition.

Whether this fact dims the glories surrounding his name in these forums is something else. Adulating true-believers seem impervious to discordant realities, however bluntly they collide with their convictions. Does that mean Krugman is always wrong? No, obviously not. But it would help, I believe, if the persons conjuring up his name and columns could reason for themselves, backing up their points with solid evidence, showing some rigor in their analysis, and being less cocksure about their views.


I trust this answers effectively all the people who were kind enough to comment on my earlier commentary.

Replies: 3 comments

Paul Krugman is a brilliant economist and easily the finest and perhaps the most courageous social science columnist America has. Your mean spirited criticism is typical for a troll. Perhaps Faux News will have you if not the National Review.

Posted by jd Fair and Balanced @ 08/26/2003 01:23 PM PST

Why not try the National Review after bashing PK? Hoot.

Posted by anne @ 08/25/2003 12:19 PM PST

Spent time carefully reading your posts. Yuch. Never again. What you are decidedly not is an economist, and the snide remarks are a hoot. I suggest you pay attention to Paul Krugman and Brad DeLong and learn some macro. Hoot, hoot, hoot.

Intellectual discussion. Hoot, hoot.

Posted by anne @ 08/25/2003 12:17 PM PST