Sometimes everything comes together in unintended ways. That has happened to me this week. I…
The “World’s Wrongest Man”, one Michael Jay Boskin, an economics professor at Stanford and former chairperson of the Council of Economic Advisors under George W. Bush is back with another stunning piece of sophistry. He has been an outspoken Op Ed commentator (particularly in the Wall Street Journal) for many years now, and, is typically completely wrong in the predictions he makes. His latest intervention into the policy debate is via the Project Syndicate banner – which claims it publishes “the Smartest Op-Ed Articles from the World’s Thought Leaders”. Having Boskin writing for them surely negates that claim. His latest offering (October 23, 2016) – Prepare for the next recession – while you can – continues his long career for making ridiculous statements about economic matters. One thinks it is really time he did something else.
By way of background, this New York Magazine article (March 5, 2013) – World’s Wrongest Man Ventures Latest Prediction – advises us that when Boskin predicts the worst, we should prepare for “a bull market”.
Such is the consistency of his poor record of analysis – just read his prediction and expect the opposite.
Some examples of his impeccable record of being really, really wrong are:
1. “It’s hard not to see the continued sell-off on Wall Street and the growing fear on Main Street as a product, at least in part, of the realization that our new president’s policies are designed to radically re-engineer the market-based U.S. economy, not just mitigate the recession and financial crisis.” (Wall Street Journal (March 6, 2009) – Obama’s Radicalism Is Killing the Dow.
Reality: At the time Boskin wrote this Op Ed, the Dow Jones Index had been falling steadily since it peaked in October 9, 2007 (at closing price of 14164.5303).
By March 6, 2009 (the day before his Op Ed was published), the Dow had fallen by 53 per cent – following the GFC turmoil.
On March 10, 2009, after Boskin’s prediction that ‘Main Street’ was giving up on the government, the Dow began to rise (4.5 per cent in 3 days). And rise it did.
By October 20, 2009, it has risen by 52 per cent on its March value. Around 4 years after Boskin’s WSJ prediction, the Dow had regained its pre-GFC peak (March 4, 2013) – having doubled in value – and at the near end of Obama’s ‘radical’ period in office (October 21, 2016), it is 173 per cent above the value it was when Boskin wrote.
‘Main Street’ certainly didn’t seem averse to the “radical engineering” that was going on in the US.
But as they say in tele-marketing world of snake-oil selling, ‘that ain’t all folks’ …
2. Earlier (in 1993), following the New York Magazine article cited above we learn that Boskin:
… accused Clinton’s administration of “fundamental distrust of free enterprise.” He made a series of predictions: “The new spending programs will grow more than projected, revenue growth will be disappointing, the economy will slow, and the program will reduce the deficit much less than expected.”
Boskin repeated his prophecies of doom in a summerlong media blitz. Boskin labeled Clinton’s plan “clearly contractionary,” insisted the projected revenue would only raise 30 percent as much as forecast by dampening the incentive of the rich, insisted it would “take an economy that might have grown at 3 or 4 percent and cause it to grow more slowly,” and insisted anybody who believed in it would “Flunk Economics 101.”
Wrong again needless to say. All predictions (growth, public revenue, deficit dynamics) were wrong and not by any small order of magnitude.
3. Fast track to the Presidency of George W. Bush who appointed Boskin as an economic advisor. Under some degree of political control, Boskin was some subdued in his “public punditry”.
But he was back to his ‘best’ on January 30, 2003 in this conversation – Debt and Taxes: The Bush Administration’s Tax Plan.
The discussion was about Bush’s “proposed new tax cuts: and whether they would be good for growth. Bush had “asked for new tax cuts amounting to some $674 billion over the next ten years”.
Boskin opined that:
First let me say that I don’t think it’s going to cost anywhere near $674 billion … the way it’s likely to work out in the political economy is to maybe cost half of that.
On June 7, 2012, the US Congressional Budget Office (CBO) released its Changes in CBO’s Baseline Projections Since January 2001 – which “summarizes the differences between CBO’s baseline projections in January 2001 and the actual results for each of the years over the 2002-2011 period.”
The data for tax revenue shows how wrong Boskin was. In 2003, total revenue was $US561 billion less than predicted, in 2004 573 billion, in 2005 416 billion, 2006 282 billion, 2007 248 billion, and so on. The discrepancy worsened with the onset of the GFC as would be expected.
The New York Magazine concludes that “in addition to being in thrall to a rigid and disproven ideology, Boskin suffers from unbelievably bad timing. Any investors who have actually put real money on the line after listening to him deserve the punishment they’ve received.”
So it is with track record in mind that I read Boskin’s latest offering in Project Syndicate (October 23, 2016) – Prepare for the next recession – while you can – the title indicating that he wants central banks to hike rates (“normalising monetary policy”) and governments to cut deficits before it is too late.
Given his appalling track record we are immediately tempted to ‘think opposite’ – keep interest rates around zero and increase the deficit – which isn’t far from the ideal solution to the declining growth rates around the world at present.
Boskin might have use after all – he brings clarity – just think opposite – easy.
His latest offering is in the context of declining economic growth forecasts for the global economy, the ongoing issues in the Eurozone (particularly the looming banking crisis), the scaremongering over Chinese debt, and to bring the topic back to his favourite area – “historically high private and public debt”.
He also believes that “the reluctance of heavily indebted Greece and Portugal to comply with IMF programmes” is a major global problem at present.
His basic proposition is that in dealing with the last crisis:
Unprecedented long-term monetary stimulus and massive spikes in public-debt burdens have left governments poorly equipped to manage the next economic downturn when – not if – it arrives. The next recession probably will not be as bad as the last one, but advanced economies will be far better prepared for it if they undergo gradual monetary-policy normalisation and fiscal consolidation in the meantime.
So it is the familiar refrain. The claim is that the capacity of a currency-issuing government to net spend, that is, run fiscal deficits, is dependent on its current fiscal situation (the size and sign of the fiscal balance), and its fiscal history (embodied in its public debt).
That claim is clearly false and with it all the rest of the suppositions that are inferred from it.
The reality is that a currency-issuing government can purchase whatever is for sale in that currency whenever it so chooses, which is not the same thing as saying that it should.
The current public debt ratio and the current and previous fiscal balances (in absolute terms or relative terms) do not constrain or enhance the capacity of such a government to spend its own currency.
Such a government is never in danger of defaulting on any outstanding liabilities which remain in the non-government sector until maturity and presentation for repayment.
Such a government, through its central bank, can buy any debt that the government issues (either directly from the Treasury or indirectly in the secondary markets from the non-government sector), and, if it chooses, can keystroke that debt into oblivion.
Such a government never has to issue debt in the first place.
Such a government does not need to raise taxes in the future to ‘pay back the deficit’. The deficit yesterday – an outcome of two flows (spending and taxation) is gone and does not need to be paid back.
There is one qualification that might be made. If a government has been running large deficits to support growth in the past then it might have to introduce discretionary measures to reduce net spending as the economy approaches full employment to avoid invoking an inflationary spiral.
But that point is far removed from the sort of nonsense that claims that past government deficits drain the amount of ‘money’ the government has to spend in the future.
Of course, the other point to make is that with global growth slowing as private consumption remains relatively subdued and private capital formation (investment) is well below pre-GFC levels in many countries, the ongoing fiscal deficits are supporting growth.
If central banks were to start hiking rates there would be a rise in private bankruptcy rates (given the private-sector debt remains at unsustainably high levels) and this would have some deflationary impact. However, the sensitivity of economic growth to monetary policy changes is probably quite weak.
But if governments followed Boskin’s advice and started to implement “fiscal consolidation”, which is just code for implementing fiscal austerity (cutting net public spending) then nations would quickly find themselves back in recession.
Boskin seems to think that the US is “close to what most economists consider full employment” and that the US central bank is dragging the chain with respect to interest-rate hikes.
Fortunately, the US Federal Reserve Bank seems to be much more in tune with the reality of the situation and probably realises that there is still considerable slack in the US labour market.
Please read my blog – The US labour market is nowhere near full employment – for more discussion on this point.
I will write a separate blog on the ECB in the next few days given some people are claiming it is heading for insolvency. Boskin just notes that its QE policy should be questioned – and I agree with him on that but for different reasons.
The substantive part of his argument is that fiscal policy has failed and that governments should have implemented so-called:
… sufficient supply-side structural reforms to control public-pension growth, reform growth-inhibiting taxes, and liberalise labour markets. These fiscal-policy failures have put too much of the burden on central banks, even though growth would more likely accelerate with productivity-enhancing supply-side measures.
First, Boskin has long claimed that the US Social Security system has a “long-term insolvency problem”. See, for example, Straight Talk on SS Reform.
Yes, he is one of those!
The reality is that national social security systems can never become insolvent if the government has sovereignty in its own currency.
Further, the pursuit of fiscal surpluses as a means of accumulating ‘future public spending capacity’ undermines the capacity of the economy to provide the resources that may be necessary in the future to provide real goods and services of a particular composition desirable to an ageing population.
Some might get confused by the the accounting structure that a particular government overlays on the spending and taxing flows that support a social security scheme. For example, the US Social Security Administration has two separate funds which underpin its social security system. First, the Old-Age and Survivors Insurance Trust Fund is the accounting device that the US government uses in relation to the payment of future retirement benefits. Second, the Disability Insurance Trust Fund is the accounting device that the US government uses in relation to the payment of disability support pensions.
The US system is referred to as pay-as-you-go system because employed workers pay into the funds during their working lives and retirees etc draw payments from the fund when eligible.
So while there are spending and taxation flows occurring, this accounting overlay creates an illusion that the two (the workers’ contributions and the social security payments) are causally related. They are not.
The contributions are just taxes that the US government levies. They don’t actually fund anything. They drain disposable income and result in net financial assets held by the private citizens being destroyed forever. The fact that they are recorded against the Social Security Trust Fund for accounting purposes is irrelevant. The fund is just an accounting record of the payments. There is no store of dollars sitting somewhere as a result of the taxation flows.
The fact that the fund might hold financial assets which seem to be bought with the excess receipts over outgoings is another source of illusion (and confusion). The financial assets it holds are purchased with US government spending, which of-course, is not revenue-constrained.
Additionally, the social security payments are just another type of US government spending. The spending comes from political decisions to provide a certain level of social welfare in the US and involves the Government crediting bank accounts of recipients on a regular basis in US dollars.
It is crucial, if you want to understand the underlying monetary economics involved, not to get seduced by the illusions created by the accounting structures which sit on top of the essential monetary operations.
Please read my blog – Social security insolvency 101 – for more discussion on this point.
Second, labour market reforms aka cutting wages and conditions are not growth inducing. In fact, if that were the case then Greece should be booming.
Or a less extreme example. Wages growth in Australia is the lowest in the history of the current Wage Price Index going back to the 1990s. Real wages growth is lagging well behind productivity growth.
Employment growth has been particularly poor over the last few years in Australia and negative for the second consecutive month up to September.
Wages are a cost, but as Keynes so clearly showed in his debate with the Treasury in the 1930s, they are also a significant component of total income.
Boskin and his ilk only focus on the cost-side of wages, which reflects the flawed view that by cutting nominal wages, employment will grow as it will become more profitable for firms to take on the extra staff.
Wage cuts were tried in the early days of the Great Depression and the situation worsened.
The reason is that firms will not take on extra staff unless there are clear signs that the extra output that would be produced will be sold. That requires an expectation of higher sales via higher spending. Cutting wages reduces household income, which, in turn, reduces total spending.
That debate was done and dusted in the 1930s but, for the neo-liberal ideologues, history is an inconvenience as they keep pushing these moribund ideas into the public debate as if they have the authority of credible knowledge.
Boskin challenges the idea from “left-leaning politicians” that:
… growth, employment, and incomes will rise if policymakers embrace massive new deficit-financed spending to create demand for goods and services. They argue that with borrowing costs so low, deficit spending is virtually free, and we need not worry about high debt levels.
He makes the usual argument against fiscal activism that there are lags between the political decision to spend and the flow of funds into the economy. As a result, the stimulus occurs “when economic conditions are projected to be better”.
I find these arguments interesting given that they are typically followed with statements that fiscal multipliers (that is, the overall impact on real output of increased government net spending) are negative.
On the one hand, the timing lag argument is that the stimulus comes at a time when the non-government sector spending has recovered and, thus, the former is not only unnecessary, but destabilising (in the sense that it pushes the economy headlong into the inflation barrier).
On the other hand, the negative fiscal multiplier argument is that fiscal stimulus actually undermines growth (even if in the immediate period following the policy change there is some positive effect).
Obviously, the two claims are incompatible.
The timing lag argument has justification but is easily overcome. First, government should adopt planning horizons for public infrastructure and public service expansion and maintenance that permit relatively fast changes to be made in fiscal allocations if necessary.
This addresses Boskin’s criticism that the US “2009 stimulus bill” was hampered because “the shovels weren’t ready.”
Second, this is a reason why I advocate the introduction of a Job Guarantee, which would become a very effective automatic stabiliser and overcome any time lag problems.
In other words, the government offers an unconditional job as a socially inclusive minimum wage to anybody who cannot find work elsewhere. The job offer is always available. A person can access the job at any time and immediately start receiving the wage.
In this sense, full employment is always maintained and the fiscal shift is immediate.
Boskin also says that:
Japan has attempted government spending stimulus for decades, with little to show for it in terms of overall economic growth.
Yet, as I show in the blogs under the Japan category, despite a massive property collapse in the early 1990s (a far greater proportions than occurred during the GFC), Japan avoided an official recession.
Even during the 1990s, and then, later, during the GFC, Japanese unemployment remained relatively low compared to what happened in other nations in similar circumstances.
It is simply not true to assert that Japan has been a basket case for decades as a result of its fiscal policy positions.
In fact, without the willingness of Japanese governments to defy credit rating agencies, the IMF, and the bevy of pundits predicting its insolvency, the Japanese economy would have collapsed in the early 1990s.
Boskin does fall into the argument (how predictable!) that fiscal policy is, in fact, counterproductive. He writes:
But studies show that the multiplier effect of government spending – when it may increase GDP by more than the expenditure – shrinks rapidly after a few quarters, and then turns negative. In fact, the multiplier effect can even be negative during economic expansions when central banks maintain zero-interest rates and households expect taxes to rise when interest rates do.
He cites a University of Chicago study from 2010 – Some Fiscal Calculus.
This particular piece of work attempts to estimate the impacts of the “American Recovery and Reinvestment Act (ARRA) of 2009”.
It uses a “a baseline neo-classical growth model with endogenous labor supply and fiscal policy, allowing for government spending transfers, government debt and distortionary taxes on labor and capital income”.
Another excursion into the neo-classical fantasy world where:
1. A representative consuming agent has “rational expectations” – that is, on average knows exactly what will happen in the future. So if that was true there would be no need for economists! We would all have perfect foresight until infinity. That is the sort of rot they write in their papers. When the assumption is relaxed – the results often collapse.
2. Governments increase taxes “to repay the increased debt” resulting from the earlier decision to introduce a stimulus.
3. A host of important real world production realities are assumed away (using a Cobb-Douglas production function approach) because they get in the way of a tractable mathematical solution. This is a standard problem in mainstream economics – the maths wags the dog!
4. The fiscal stimulus only increases output for a time because “the representative agent” consumes “less leisure, i.e., supply more labor” as a result of the “reduction in wealth”.
So the “agent” – a proxy for households and firms – is less wealthy because of “the anticipation of the increase in … taxes”.
As a result, they choose to work harder (and jobs suddenly materialise to meet their desire) to save up more to pay for the higher taxes in the future.
5. Government spending then soon generates a negative output effect – that is, total output falls per dollar of extra government spending because of the deficit “financing” effects – “higher taxes eventually”.
The rising “labor tax rates” reduce the willingness of the “agent” to supply labour and the withdrawal of labour by the “agent” reduces total output.
Unsurprisingly, given the parameters that the author imposes (makes up) for the key relationships in his ‘simple’ model and the logic of the ‘model’, he finds that “$3.40 of output is lost eventually for every dollar of increased government spending, when discounting them to the current period”.
That is a massive negative effect. The author claims to have found “drastic long term consequences of fiscal stimuli”, which “ought to receive more and sufficient attention in the debates.” Well, he will be pleased that the likes of the ‘World’s Wrongest Man’ chooses to give them oxygen!
It is amazing that in this era of advanced knowledge about most things, economists of this persuasion still retain their jobs (and credibility).
They still think that they can produce papers with a heap of equations and talk about household behaviour in terms such as “positive, decreasing, concave, and thrice differentiable”, a property that is required mathematically to ensure that the assumed behaviour is “consistent with long run growth” requirements (imposed by assumption).
These papers are devoid of reality. The substantive results break down soon after any semblance of reality is introduced. They parameterise their equations (that is, put numbers on the relationships) by making up numbers that deliver the assumed result. These numbers have no necessary foundation in reality and rarely do.
For example, their production model assumes stable (constant) shares in national income for labour and capital. The real world has not delivered anything remotely like that.
I could spend hours documenting these types of flaws.
Even the IMF has admitted that fiscal multipliers are likely to be of the order of around 1.6. Please read my blog – The culpability lies elsewhere … always! – for more discussion on this point.
Boskin’s citation of that particular University of Chicago article is testament to his lack of judgement. It is an appalling piece of work.
It continues the myth of the rational ‘representative’ consumer/firm (that is, everyone is the same and represented by this one behavioural unit) and thus manages their lifetime spending in each period with perfect foresight of what is ahead.
Further, it explains the economic cycle in terms of households oversupplying labour in good times and then withdrawing that labour later on because they don’t want to be taxed as much.
Unemployment then becomes a chosen state (leisure) where individuals maximise their happiness given the parameters they face (wages, tax rates etc).
A variant of this theme is the Ricardian Equivalence myth where the non-government sector exactly withdraws the same volume of spending as the government injects because it wants to save up for the higher taxes that the government will levy to pay back the deficit.
Boskin concludes that:
As history and theory indicate, this fiscal consolidation should happen through reduced future spending growth, especially on transfer payments. Economic policymakers should heed this lesson so that they can gradually re-arm themselves; otherwise, they could be left with no firepower when they most need it.
First, history tells us nothing of the sort.
Second, as noted above, currency-issuing governments don’t have “firepower” that can be exhausted. The whole analogy between the ammunition stocks an army might have at some point in time (and how many shots they have fired) and government spending capacity is flawed at the most elemental level.
Please read my blog – When journalists allow dangerous economic myths to pervade – for more discussion on this point.
Third, if governments cut spending now, there will almost certainly be a recession – in any economy you might like to nominate.
Governments, in fact, need to increase deficits to support necessary private sector deleveraging (reducing the debt they hold). That process will take many more years.
The ‘World’s Wrongest Man’ unfortunately still garners important media attention, which is just a reflection of the bias in the media towards his free market, anti-government position.
What Project Syndicate is doing giving the likes of Boskin any space is another matter!
That is enough for today!
(c) Copyright 2016 William Mitchell. All Rights Reserved.