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Economic Recovery Conundrum

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Message Seymour Patterson

Anyone who has had ECON 101 knows that cutting spending during an economic downturn is a bad idea. With unemployment hovering in the neighborhood of eight percent, cutting public spending is a sure way to prevent the economy from coming back entirely from the economic precipice. Wrangling at the state and federal level over deficits points to either a surprising ignorance of this--which would be preferred, of course, to the alternative--a deliberate effort to manipulate and mislead voters for political reasons.  In all fairness, some people believe the path to growth is tax cuts for "job creators"--the wealthy who invest. However, does this mean people who are not "job creators" should not get tax cuts?

The recession

Generally, recessions are caused by decreases in demand for goods and services measured over two (or more) consecutive quarters. In a recession, businesses find they have excess capacity and thus no incentive to invest in new plant and equipment--no matter how favorable are costs or interest rates. In this environment total demand underperforms, as does employment. Total demand for goods and services includes the sum consumer, and government spending. In a downturn, therefore, private demand is insufficient, because of high unemployment and real and perceived losses in asset values like falling real estate values, evidenced by the rise in foreclosures, and a stalled new housing construction market. The rising joblessness and exhausted unemployment compensation reduce consumption; people whose asset values decline feel poorer and reduce consumption. That leaves our maligned government (the people we voted into office) essentially as the only player in the game. Government spending can support demand when business and consumer spending sags. Another effective way to boost consumer demand in a recession is to increase disposable income with cut taxes. That's why extending the Bush tax cuts was a good idea. Another strategy is to increase government spending for a multitude of projects--new construction like fast trains; and the maintenance and the updating of the existing infrastructure--roads and bridges. It's a little shortsighted for New Jersey to reject funds for a tunnel project to NYC. Florida, Ohio, and Wisconsin refused stimulus money for high-speed rail projects. The actions of some state governors in refusing Federal government stimulus money for infrastructure improvement will slow the recovery and prolong high unemployment. One silver lining is that private sector job growth is rebounding and this can overcome the cuts in government employment--and this appears to be precisely just what is taking place in the current recession. And recently this appears to have occurred. Going forward, the refusal of stimulus funds for ideological or political reasons could undermine efforts to grow the economy and reduce the jobless rate, and forestall the anemic economic recovery.  

Blame to go around

You could blame credit ratings agencies like Moody's for not doing their job, Fannie Mae and Freddie Mac, or banks for sub-prime loans, and Wall Street greed, Democrats and Republicans, or the poor for trying to live the American dream of house ownership by buying homes they couldn't afford, all of these things for the debacle that plunged the U.S. and the rest of the world into the worse global recession since the Great Depression. But, balancing budgets by cutting spending, and rejecting stimulus money won't put the economy back on the road to robust sustained economic recovery soon, and could lead to a double dip recession. This is not a miniscule concern: ignoring the argument for more spending has far-reaching consequences for economic growth and employment. It matters little who's to blame, unless there is some motivation for understanding what precipitated the recession with a view for preventing it from happening again. But this understanding might lead to the undesirable conclusion (at least in some quarters) that more government regulations and spending are needed. We can't have that because for some, it is not money--but government--the source of the problem.

Budget balancing

The national debt is about $15 trillion and growing. It grows when the deficit--when the government spends more than it takes in, or when interest rates rise on the existing debt, or both. With interest rates near zero, it seems like a good time for government to borrow and spend.  Why? Because money is cheap. Targeted increases in taxes can reduce the deficit. A tax on the top 1 or 2 percent of taxpayers would raise revenue for the government without harming consumer demand.  For instance, give a rich person a dollar he's unlikely to rush to the mall with it; but a poor person would spend it. A tax cut on poor (or middle income) taxpayers will increase demand, but a tax increase on the rich would not reduce demand, class war, hardly. But if it were, the rich would win--they always do. The net effect of this sort of targeting of tax policies is lower deficits, more GDP growth and jobs. However, there's a caveat: if the goal is a balanced budget (at all costs), then cutting spending in a recession when government tax revenue falls would lead to more unemployment and more loss of government revenue, and more deficits, necessitating still more cuts in government spending. This cycle could repeat itself perhaps ad infinitum . You get a balanced budget with a woefully anemic economy.

Economic recovery

Some people say recessions are the economy's way of correcting bad decisions and inefficiencies in businesses. Inefficient firms find a place in the business graveyard. Falling prices make U.S. goods more competitive in the global market--so our exports increase and export sector jobs rise. Lower consumer prices are equivalent to a tax cut, and Americans with jobs will buy more. Here the government needs to step aside and let market forces restore the economy to profitability, productivity, growth, and full employment. Here the government is the problem because policy makers lack complete foresight to step in at the right moment to right a wayward economy. Pumping money into the economy will not increase output and might be inflationary. With inflation a sliver above zero, issue of concern is not inflation, but economic growth and jobs. Some stimulus to growth comes from extending the Bush tax cuts, extending jobless benefits as the congress has agreed to do for 2012. Apart from the unknown effects of the EU bailing out of Greece, and the tensions with Iran leading to higher oil prices, the performance of the US economy is encouraging. The stock market topped 13,000, so peoples 401(k)s, and mutual funds, and pension plans perform better, which also leads to higher consumer confidence. Higher stock market generated wealth effect and higher consumer confidence might translate into higher demand for the country's goods and services.

Repealing health care, reigning in the EPA, cutting social security, Medicare and Medicaid, defunding Planned Parenthood, destroying unions, stripping funding of The Endowment for the Arts, and NPR, seem to have the possible effect of reshaping the American economy into the likeness of poor countries.  Think about it. Poor countries in Latin America, Africa, Asia, and the Middle East are not known for universal health care services, monitoring environmental quality, social security, family planning services, strong and effective unions, and funding for the arts. A case could be made that developing countries face major freedom of speech and of the press challenges. Radio and TV outlets in developing countries are often government owned and controlled news services. However, NPR is partially funded but not owned and controlled by the government. But EU countries, North American, Canada, the UK, Australia and other developed countries have in place services that benefit people--social security, health care, unemployment compensation, and so forth. Whose company do we wish to keep? Developed countries are rich because of labor laws and employment legislation.* Why? Because labor laws and employment legislation create certainty about worker welfare; workers are happier and therefore more productive. We don't want our economy held hostage to and workers made victims of mandatory balanced budget policies that can have deleterious effects of economic growth.


*Employment and labor laws: Comparing Ghana, South Africa and the United States, (with Greene, Walter), Journal of African Business, 2004

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
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