Demand-Side Economics

Robert Reich, who I'm glad to have in the room advising President-Elect Obama during the transition, has written a piece about what he calls the "Mini-Depression" and how we can best undo it. The first thing is to understand the nature of the problem.

First, understand that the main problem right now is not the supply of credit. Yes, Wall Street is paralyzed at the moment because the bursting of the housing and other asset bubbles means that lenders are fearful that creditors won't repay loans. But even if credit were flowing, those loans wouldn't save jobs. Businesses want to borrow now only to remain solvent and keep their creditors at bay. If they fail to do so, and creditors push them into reorganization under bankruptcy, they'll cut their payrolls, to be sure. But they're already cutting their payrolls. It's far from clear they'd cut more jobs under bankruptcy reorganization than they're already cutting under pressure to avoid bankruptcy and remain solvent.

This means bailing out Wall Street or the auto industry or the insurance industry or the housing industry may at most help satisfy creditors for a time and put off the day of reckoning, but industry bailouts won't reverse the downward cycle of job losses.

The real problem is on the demand side of the economy.

Consumers won't or can't borrow because they're at the end of their ropes. Their incomes are dropping (one of the most sobering statistics in Friday's jobs report was the continued erosion of real median earnings), they're deeply in debt, and they're afraid of losing their jobs.

Introductory economic courses explain that aggregate demand is made up of four things, expressed as C+I+G+exports. C is consumers. Consumers are cutting back on everything other than necessities. Because their spending accounts for 70 percent of the nation's economic activity and is the flywheel for the rest of the economy, the precipitous drop in consumer spending is causing the rest of the economy to shut down.

I is investment. Absent consumer spending, businesses are not going to invest.

Exports won't help much because the of the rest of the world is sliding into deep recession, too. (And as foreigners -- as well as Americans -- put their savings in dollars for safe keeping, the value of the dollar will likely continue to rise relative to other currencies. That, in turn, makes everything we might sell to the rest of the world more expensive.)

That leaves G, which, of course, is government. Government is the spender of last resort. Government spending lifted America out of the Great Depression. It may be the only instrument we have for lifting America out of the Mini Depression. Even Fed Chair Ben Bernanke is now calling for a sizable government stimulus. He knows that monetary policy won't work if there's inadequate demand.

This doesn't mean we don't bail out the auto companies, but that we focus our efforts on the demand side of the equation for once. If we can use government to create jobs and raise income, consumer spending will rise, and then investment will rise, etc. Now, saving the auto industry might be part of that - after all, the carmakers and their parallel industries employ 3 million people. But to meet the scope of the problem we're going to have to do much more - probably spending up to 4% of GDP. And paradoxically, we're going to have to spend on things that work at cross purposes with selling more inefficient automobiles; things like transportation infrastructure.

The answer to the second question is mostly "infrastructure" -- repairing roads and bridges, levees and ports; investing in light rail, electrical grids, new sources of energy, more energy conservation. Even conservative economists like Harvard's Martin Feldstein are calling for government to stimulate the economy through infrastructure spending. Infrastructure projects like these pack a double-whammy: they create lots of jobs, and they make the economy work better in the future. (Important qualification: To do this correctly and avoid pork, the federal government will need to have a capital budget that lists infrastructure projects in order of priority of public need.)

Government should also spend on health care and child care. These expenditures are also double whammies: they, too, create lots of jobs, and they fulfill vital public needs.

Which is why an auto industry bailout must be tied to fuel economy, because otherwise, you're funding new, fast, efficient means of transport that would reduce greenhouse gas emissions AND the old model of 20 mpg and under gas guzzlers. Chris Dodd said yesterday that the votes aren't there for an auto industry bailout in the lame duck session of Congress. If the guarantees on efficiency are made, I think the votes could be there in January.

But the big emphasis here is on the new energy economy. There can't be a better way to reindustrialize America with jobs that can't be shipped away. I know that some believe industrial output has been rising due to productivity, but if you go into the numbers that only holds among a couple sectors - basically, if it wasn't for the computer we would hardly have any industrial output at all. And so building out a new energy grid that can transmit wind and solar power to anywhere in the United States, building high speed rail that runs on clean electricity, building new renewable facilities, all of these will create jobs that spur demand, and raise wages by giving job-seekers an option outside of the dead-end service sector. The fact that the EPA rightly blocked the new production of coal-fired power plants makes this a practical necessity.

And yes, health care is a part of this. There was hastily dismissed talk of adding health care to the stimulus package yesterday. As Reich says, it's a double whammy - you create jobs, and fulfill public needs.

Reich finishes by pre-empting the neo-Hooverist argument:

Expect two sorts of arguments against this. The first will come from fiscal hawks who claim that the government is already spending way too much. Even without a new stimulus package, next year's budget deficit could run over a trillion dollars, given the amounts to be spent bailing out Wall Street and perhaps the auto industry, and providing extended unemployment insurance and other measures to help those in direct need. The hawks will argue that the nation can't afford giant deficits, especially when baby boomers are only a few years away from retiring and claiming Social Security and Medicare.

They're wrong. Government spending that puts people back to work and invests in the future productivity of the nation is exactly what the economy needs right now. Deficit numbers themselves have no significance. The pertinent issue is how much underutilized capacity exists in the economy. When there's lots of idle capacity, deficit spending is entirely appropriate, as John Maynard Keynes taught us. Moving the economy to fuller capacity will of itself shrink future deficits.

The second argument will come from conservative supply-siders who will call for income-tax cuts rather than spending increases. They'll claim that individuals with more money in their pockets will get the economy moving again more readily than can government. They're wrong, for three reasons. First, income-tax cuts go mainly to upper-income people who tend to save rather than spend. Most Americans pay more in payroll taxes than in income taxes. Second, even if a rebate could be fashioned, people tend to use those extra dollars to pay off their debts rather than buy new goods and services, as we witnessed a few months ago when the government sent out rebate checks. Third, even when individuals purchase goods and services, those purchases tend not to generate as many American jobs as government spending on the same total scale because much of what consumers buy comes from abroad.

We have had 28 years of supply-side economics, and it has gotten us precisely to this crisis. Shifting this to job creation and wage increases, demand-side economics, would be maybe a quiet revolution for the cable news gasbags who focus on personality, but a revolution nonetheless. And to quote Dick Cheney, not a noted economic scholar but in this case appropriate, "This is our due."