Fault Lines: How Hidden Fractures Still Threaten the World Economy (18 page)

Second, Franklin Roosevelt obtained a strong political mandate, and broad nationwide legislation overcame the collective-action problem each state faced: the fear of frightening away business if it legislated worker protection alone.
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Third, there were exceptions carved out in the legislation: for instance, in a nod to the powerful Southern Democrats who did not want to raise the cost of their black workers (or have the legislation derailed by politicians raising fears that benefits would go to blacks), agricultural workers were not covered. Finally, surprising as it may seem, strong business interests also supported the legislation.
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This last reason is interesting. Why would businesses want to increase their own costs? Having the state provide worker benefits had two tremendous advantages for some firms, especially large ones. First, firms that already paid their workers benefits like old-age pensions (because these made broader economic sense, as discussed earlier), could offload some of the costs on to the state. Moreover, all firms, especially pesky small competitors to big business, would be subject to the additional costs, whether or not they were able to increase profits by providing worker benefits. And for small firms employing unskilled workers, the imposition of worker benefits typically increased costs without any redeeming increase in profits. Thus the legislation reduced competition for powerful incumbents by eliminating one of the important advantages of entrants: their ability to pay low wages and benefits. Like much of the legislation during the New Deal era, the good parts came with bad, anticompetitive elements.

What are the lessons from all of this? Huge adverse economic shocks have powerful effects on concentrating the national mind because everyone is similarly affected. They thus offer opportunity for change. Even so, and despite large legislative majorities, compromise is inevitable because people also look beyond the calamity to their interests in the recovery. Finally, there is typically a trade-off between competition, innovation, flexibility, access, and efficiency on the one hand, and security on the other. Security implies a protection of privilege, a protection that has to be indiscriminate if it is to calm anxiety. But this invariably means that resources will be transferred to beneficiaries regardless of the efficiency with which they can use them. One person’s safety comes at the expense of another’s opportunity or efficiency, and good legislation has to tread carefully to achieve the right balance.

I have argued that there are a number of reasons why the United States has a weak safety net. But why is that a problem? After all, the United States has a flourishing democracy that responds to the concerns of the people and can enact policies in a downturn to help those who are in difficulty. Unfortunately, policy made in the midst of a downturn is often hurried, opportunistic, and poorly thought out. Although deep crises offer an opportunity for serious rethinking and transformation, if new policies have to be devised in response to every downturn, the result is inappropriate, unpredictable, and excessive policy making.

John Maynard Keynes, perhaps the most influential economist after Karl Marx, argued that recessions were caused by a deficit of demand, and that governments could play a role in a recovery by increasing spending, financed by running budget deficits. His views enjoyed immense influence in the decades after World War II, but his policy recommendations were effectively institutionalized earlier, during the Depression, through structures such as unemployment insurance. If demand faltered, the government would automatically transfer purchasing power to people, for example through unemployment benefits. Also, because firms would pay lower taxes as a result of lower profits, taxes were effectively reduced. Most mainstream economists believed the case for increasing government spending beyond these “automatic stabilizers,” except in truly severe recessions, was weak. Instead, much of the task of putting the economy back on the road to recovery was left to monetary policy.

In the United States, though, the absence of a strong safety net, coupled with slow job growth in recoveries, has made every one of the recent recessions “truly severe” from a political perspective. This has created tremendous pressure on governments to stimulate, both through fiscal means—tax cuts and spending increases—and through easy monetary policy. Some parts of the stimulus do go toward extending the safety net—for example, unemployment insurance benefits and subsidies for health insurance have been extended in the current recession for some laid-off workers. But stimulus packages invariably do a lot more. The key question therefore is this: If job recoveries continue to be slow, is there a problem with allowing stimulus to be discretionary instead of strengthening the safety net?

There is! First, workers themselves face tremendous anxiety when benefits are discretionary because they do not know if the recession will be deep and prolonged enough to provoke stimulus spending, and, even if it does, whether they will benefit. Second, both fiscal and monetary policies work with lags. The expenditure for roads that is voted on today will probably not be spent until many months from now. But voters want politicians to respond to their current needs. A politician’s counsel of patience is taken as a reflection of impotence and is therefore not conducive to her reelection. If the current unemployment rate as well as current job growth drive policy actions, then it is possible that policy will remain far too stimulative for far too long. The roads that are budgeted for today will be built a year from now, when recovery is already well under way, potentially causing the economy to overheat and forcing costly policy reversals then.

Third, and perhaps most important, discretion leads to abuse. More problematic, when politicians exercise discretion at a time of great necessity, it leads to inventive abuse. Specifically, politicians bring out all their pet projects during a downturn, and then some more, all under the guise of stimulus to support recovery. Significant elements of spending are simply payback to powerful interest groups, or a fulfillment of election promises with little need to justify their short-term benefit. Over one-third of the stimulus package passed by the Obama administration in its early months consisted of one-time tax rebates, which are known to, and did, have little effect on spending: they were more a form of redistribution to fulfill election promises.
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As an example of more egregiously directed spending, $6.5 billion was approved for cancer research to appease a particular senator.
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Cancer research is unlikely to create many jobs in the short term: indeed, it would be more appropriate if the money were spent slowly rather than wasted on harebrained proposals fished out from the bottom of researchers’ drawers in response to an announcement of new grant funding. Yet it features as part of the stimulus simply because the need to pass a stimulus package gives every politician the right to a share of the pork.

Finally, even as I write, the real estate industry has ensured the renewal of a “temporary” tax break to first-time home buyers on the grounds that withdrawing it will seriously damage home prices. Such tax breaks amount to a subsidy to a few—first-time buyers, brokers, and construction firms—and typically have limited effects on growth because they simply substitute current sales for future sales. Their merit, if any, is that they are temporary, and thus bring forward purchases at a time when activity is lean. Renewal defeats their very purpose. But subsidies are an addictive drug. It is precisely because the benefits are enjoyed by the few (who lobby strongly for them) and the costs paid by the many (who don’t care enough to lobby) that they endure.

Opportunism is bipartisan. When the 2001 recession hit, the U.S. Treasury did not stand idly by. In order to stimulate growth as well as fulfill campaign promises, the Bush administration cut taxes on earned income and on capital gains and dividends. This response, which differed from standard Keynesian prescriptions espoused by the Obama administration to boost government spending, reflected the more conservative, supply-side roots of the Bush administration: it was an attempt to improve the incentives for businesses to raise investment and production. But when coupled with rising expenditures on national security after the September 11 terrorist attacks on the World Trade Center, its effect on government finances was decidedly not conservative. More important, given that industry had been on an investment binge, the stimulus was unlikely to be effective in supporting investment and job growth in the short term, no matter what its long-term benefits.

The broader point is that discretionary fiscal stimulus tends to be based on ideology and on past obligations or interests rather than attuned to the needs of the moment. Clearly, if there is a strong case to be made that it will “work” in creating long-term jobs or averting a self-destructive downward spiral in the economy, few would dispute the need to spend. Typically, such action entails limited, targeted spending or tax measures. In practice, though, administrations use the shadow of the recession to do what they have always wanted to do. Rahm Emmanuel, President Obama’s chief of staff, captured this mindset perfectly when he said, just before the Obama administration took office, “You never want a serious crisis to go to waste.”
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The policies that tend to be legislated at such times are unlikely to be centrist. When the government of the day seizes the opportunity to ram through its longer-term policies, it naturally focuses on making down payments on policies that could likely be pruned by more prolonged, reasoned debate. The window afforded by the emergency therefore has led to more partisan legislation in the past and will likely do so in the future, especially because the increased polarization of Congress ensures that any legislative agenda that is not firmly centrist will have difficulty passing once the window of opportunity closes. Because partisan legislation tends to be reversed by future administrations from the other side, the lack of an effective safety net can lead not just to waste but also to more policy fluctuations and uncertainty.

There are three additional downsides to the absence of a strong U.S. safety net when recoveries are turning out to be jobless. First, even with the possibility of discretionary stimulus, workers themselves do not know if they will be supported and when: this uncertainty creates exactly the personal anxiety and political pressure that the safety net is meant to avert. Second, the United States’ lack of a firm safety net and its willingness to stimulate until the jobs come home is well understood by the rest of the world. When a global downturn adds to the effects of the persistent structural demand shortfall created by export-led strategies, as it did in 2001, not only do many countries find it hard to stimulate their economies effectively, but they also know that in a global game of policy chicken, the United States will flinch first. Many countries hitch themselves to the U.S. engine and do commensurately less on their own. The weight the United States has to pull increases, and the likelihood that it will do it itself serious injury multiplies. Finally, and most important, the persistent and politically motivated monetary stimulus that accompanies discretionary fiscal stimulus is, if anything, even more dangerous for the long-term health of the U.S. economy, and indeed the world, for it affects the behavior of the financial sector. I turn to that fault line now.

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O CENTRAL BANKER HAS HAD
to adapt his views more under the public eye than Ben Bernanke, the chairman of the Federal Reserve Board. In February 2004, in a speech to the Eastern Economic Association, Bernanke, then a governor of the Federal Reserve Board, spoke of the “Great Moderation,” the observation that the fluctuations of output and inflation in industrial countries had come down steadily since the mid-1980s. Because the Holy Grail of economic management is strong, steady growth, without booms, busts, or high inflation, this trend suggested that something was working.

Bernanke considered three possible explanations: first, that we might have just been lucky, with the world economy experiencing fewer accidents such as war and oil-price increases over this period. Second, that economies had changed, for example as corporations developed systems to acquire sales information more quickly and to translate it more continuously into production and inventory decisions. Such improvements could explain how economies had been able to avoid the more dramatic inventory buildups and production cutbacks that had characterized previous recessions. Third, as a result of advances in our economic understanding, central bankers, many of them former academic economists, understood better how monetary policy affected economic output.

Because he is a careful economist, in addition to being a very good one, Bernanke suggested that there was merit in all three explanations. However, he stressed the view that monetary policy had become much better. Unlike the policy makers in the 1960s and 1970s, who operated with rudimentary and often incorrect beliefs about economic relationships, today’s central bankers, he felt, understood far better how the economy works. Bernanke is, if anything, more cautious and nuanced than the typical policy maker, but the overall tone of his speech was triumphant: the policy levers for managing a modern economy were well understood, which was why we already had milder recessions. The implication, perhaps unintended, was that with steady progress, we could do away with recessions altogether.

By September 2008, however, Bernanke, now chairman of the Federal Reserve Board, having realized the limits of monetary policy, was pleading for help from Congress, arguing that “despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy.”
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In short, monetary policy was not working, and only a bailout of the financial system by Congress could stabilize the economy and avert a depression. Where had the Fed gone wrong?