Fiscal Conservatism And Necessity

We're in a depression. To many, that's stating the obvious. But it seems not quite everyone realizes just yet.

GDP depressed below normal levels from 2008 through this writing

Our commerce has been significantly below capacity for several years. By the end of 2008 the quarterly output gap exceeded even the previous record (from 1982) for output gaps since 1949. We've seen the main characteristic factors of depression beyond just the raw output gap: increased unemployment, tight credit for consumers and small business, and bank failures (though many of the potential failures were averted). And as anyone familiar with Irving Fisher's work should know, we'd surely have had significant deflation from the paying down of private debts were it not for a series of Fed actions to mitigate deflationary forces.

Deficit hawks ignore the reasons for our deficits in recent years. Depressions increase short-term costs. People out of work utilize the safety net when they wouldn't otherwise. We have a severe short-term increase in costs. At the same time, depressions also reduce revenue. We bring in less tax money because fewer people are getting paid, and often smaller real wages.

There's one clear answer to get rid of deficits: get people back to work. Rev up the economy back to potential. Close the output gap. Until we do that, we'll continue to have increased costs and reduced revenues.

In our attempts to close that output gap, today's fiscal conservatives hamstring us with massive state budget cuts to avoid the temporary tax increases and/or bond issuance needed for dealing with the downturn. Their unwillingness to raise revenue means lots of layoffs, slowing down our economy while hurting the quality of services that we the people want. Many of us would willingly pay more in taxes to keep quality of service through an economic downturn. Many of us would be more than willing to pay more in taxes to keep investing in the sort of growth-spurring government measures that can get us back to expansion. But fiscal conservatives will brook no such sensibility. So instead we get slower growth and less prosperity. Like our slow recovery? Thank a fiscal conservative. Like our rising tuition costs for students? Thank a fiscal conservative. Like our broken roads increasing business costs? Thank a fiscal conservative. Like fewer research patents being licensed to domestic businesses than we'd otherwise have over the coming years? Thank a conservative.

This impact is nothing new. We had deficit hawks and credit growth hawks to thank for the recession of 1937-38 when attempts to balance the budget and tighten monetary policy put a crimp in recovery from the Great Depression. We had sharp cuts in the name of balanced budget zeal to thank for the recessions and increased unemployment under Eisenhower. Time and again, we keep having to re-learn the lesson that sharp cuts hurt even when they're earnestly meant to help.

We're long overdue to stop letting fiscal conservatives shape the narrative. We need to stop worrying about balancing the budget when we're in the midst of a downturn. When the economy's roaring at full steam, then we can afford to mess about with budget balancing. Until then, we can't afford their cuts.

One needs to already be in good shape to recover from a deep, large, sharp cut. Until we've eliminated the output gap, we need more recovery efforts ... not more cuts.

Government and Job Creation: Where Both Candidates Got It Wrong (Although One More So), Government Does Create Jobs

No binders involved in this jobs question, not even Mitt's "binders full of women" for filling state cabinet positions. In the Presidential debate last night neither of the Presidential candidates got it right on government and job creation. One, of course, was more wrong than the other ... but neither got it right.

Mr. Romney:

"Government does not create jobs. Government does not create jobs. (Chuckles.)"

 President Obama (in response to "What do you believe is the biggest misperception that the American people have about you as a man and a candidate?"):

"... a lot of this campaign, maybe over the last four years, has been devoted to this notion that I think government creates jobs, that that somehow is the answer. That's not what I believe. 

I believe that the free enterprise system is the greatest engine of prosperity the world's ever known. I believe in self-reliance and individual initiative and risk-takers being rewarded. But I also believe that everybody should have a fair shot and everybody should do their fair share and everybody should play by the same rules, because that's how our economy is grown. That's how we built the world's greatest middle class."

Given his relatively conservative budget policy and restraint -- arguably ambivalence -- on fiscal stimulus, it seems plausible that the President really doesn't get that government can create jobs. Sure, he could have just been playing to conservatives, but his actual record suggests he really meant it. He may see more of a role for government in helping free enterprise than his opponent. But that just makes him less wrong. He apparently doesn't particularly believe in fiscal stimulus as a major tool to raise actual GDP towards potential GDP, which shouldn't be surprising to all of the Keynesian economists who called for a much larger, better stimulus and who read the accounts of how we came to get what stimulus we got, mostly without the President seriously pushing for any more. Sure, it might not have been politically feasible to get more, but that was partially because the President wasn't using the bully pulpit to push hard for more. Why? Apparently because he believes the widespread conservative myth that "government does not create jobs".

Despite what the candidates appear to believe, the fact of the matter is clear. Government most certainly can create jobs when actual GDP is significantly below potential GDP. Such as now.

As Dean Baker put it in summing up a different debate, "the Baker-Rowe-DeLong-Krugman Deficit Debate",

"First, we all seem to agree that in a situation where the economy is clearly operating well below its potential, governments can run deficits to boost employment and output. I believe we all agree that in principle the government can also use these deficits to increase future output through productive investment in either physical or human capital. This would make future generations better off on net as a result of deficits today, since the economy will be larger than it would be without the deficits."

When the economy is running at capacity, deficit spending generally won't stably boost us above potential. At that point, extra government spending risks crowding out private enterprise and in some cases certainly will do so. We're not at that point. Heck, we're nowhere near that point. The economy is gradually improving, but we've got a long way to go. While we're still plugging an output gap, deficit spending most certainly can and does create jobs whereas government cuts directly reduce overall employment.

Yet deficit spending during a downturn just illustrates one of many ways that government can create jobs. Progressive tax rates combined with social safety-net programs mitigate inequality and -- by getting money to those who have more want than means to fulfill it -- increase commerce, both effective and potential. Then there's research and development, for which various estimates show it's just a matter of exactly how many dollars are added to the economy for each dollar we've spent on NASA research that we've patented and licensed out to domestic firms. The only question is the exact multiplier; it's certain that NASA spending (not to mention DARPA and others) has created some number of private enterprise jobs beyond those that would have existed without the space program.

Private enterprise certainly excels at many things and government would be the wrong choice for a number of tasks, especially producing most kinds of manufactured products from MP3s to ice cream. So please don't misconstrue this as suggesting that more government is always better; there's a limit to what government reasonably can be expected to do or should do. President Obama is correct to believe that a major part of government's role consists of working towards creating a level playing field for private enterprise. But like Mr. Romney, he's wrong to fall for the conservative delusion on government and job creation. Government most certainly can create jobs. And right now, even more than usual, we very much need government to stop cutting back and do all that it can to create jobs.

But how do we get these politicians and the general public they serve to understand that?

The "Burden of Debt" versus the Burden of a Weak Economy

Dean Baker from "Brad Delong Beats Me To Responding to Nick Rowe":

"... The burden of the debt only exists if there is reason to believe that debt is somehow displacing investment in private capital, which is certainly not true at present. 

I would probably argue the case even more strongly. In a depressed economy like we have today, there is reason to believe that the deficit, by boosting demand, is actually increasing investment, thereby making future generations wealthier. There is also the issue of human capital, that by keeping workers employed and keeping families intact, it is improving the productive capacities of the labor force in the future. 

Perhaps most importantly,it is essential that people understand that the measure of the burden of the debt in future generations is not the size of the debt, but the extent to which we believe the debt has reduced output in the future compared to a counter-factual where we did not run the debt. If the debt did not reduce the economies' future productive capabilities (or even raised them) then there is no burden of the debt. In any case, how well we are treating our children is measured first and foremost by the health and the economy and the society we pass on to them, not the amount of government debt."

(Emphasis added by me)

This is part of why it makes sense to put deficit spending into fixing the output gap. While the economy is rolling, it's rolling slower than it ought to be. If we use deficit spending to push our economy up to its potential, we pass on a more healthy economy to our children.

(For other related comments, see Mark Thoma's "Bogus Arguments about the Burden of the Debt")

And the reverse also holds. In a depressed economy, austerity should shrink what we're handing to our children. Apparently the IMF is starting to learn that lesson about Europe, though as Krugman points out, the GOP seems not to have caught on to the lesson.

When It Went Wrong

When did things start down? Where was the bump in the road that triggered the Great Recession? In this election season, that question matters in the short term for trying to choose the folks most likely to not send us back down the same path. Partisans from both major parties would love to tell us things when wrong under the other party's watch, but only one side can say it accurately. So when did it start?

To begin answering that question, we can't just look at GDP or unemployment alone. While those may tell us when things really got bad, they don't tell us when the problem started. To get a better idea of when the problem started requires focusing further back than when it became obvious to everyone. The overall economy was hammered by a financial crisis, but that financial crisis didn't just spring up on its own. The financial crisis was triggered by a stumbling housing market. So when did housing tumble off the cliff?

Housing fell off a cliff in 2006; in 2007/8, it was just still falling from 2006.

Building permits peaked on September 2005 and then proceeded to fluctuate through January 2006. Housing starts peaked in January 2006. Then after January 6th, both building permits and housing starts tumbled off that cliff, followed soon after by residential construction. Between the January 2006 peak and the start of the 110th Congress in January 2007, housing starts dropped by 38% and residential construction dropped by 15%. The housing industry was collapsing throughout 2006 and bringing layoffs starting with housing and spreading into related domestic industries such as window and cabinet making. Following on housing's decline, manufacturers new orders hit choppy waters in 2006, . By the end of 2006, the effects weren't yet enough to seriously shake unemployment or turn GDP negative, but the decline did start to show in other measures and a slackening of quarterly GDP growth. The annual growth in consumption per capita for 2006 started back down from what we'd seen in 2005.

Demand/person slowed down in 2006 ... before getting to an actual drop.

Put it all together it's really only a technicality that the recession didn't hit until late 2007. In fact, the economy was already in rough shape in 2006, with really lousy growth evident over the 2nd and 4th quarters of 2006, to the point of quarterly GDP growth just barely staying out of negatives.

2006 wasn't technically recession; but it was darn close.

Clearly, the first wave of what became the Great Recession was well under way during the watch of the 109th Congress (2005-2006) under President Bush II, even though we hadn't reached technical recession yet. What happened during the 110th Congress was just that it became clear that the problem -- which was already under way -- was spreading from housing into finance and from there to everything else. The curtain covering over the problems was pulled away in 2007-2008, but the trouble was there before the curtain pulled away. Republicans held majorities in both Houses of the 109th Congress, as they had for almost all of the time since 1995 (except for a slim Senate flip in part of the 107th Congress). By 2006, Republican policies had held sway in both the executive and legislative for years and they were still in control. While there's room for debate as to how much involvement government had in the creating or allowing the mess, the weight of evidence says that if one were going to blame governance, the party to blame for that mess is Republican.

The Economic Engine: Is It Fixed?

If our car had a busted transmission, we base whether to call it fixed by how it responds when it's in drive and we press on the gas. Does it go forward when we apply gas? Does it go faster when we apply more gas? If so, then it's fixed ... even when it happens to be going slower on the on-ramp than it was when the transmission first broke on the highway.

We don't base whether to call it fixed on its speed at the moment or how full its gas tank is. That'd be ridiculous.

Right now the Republican House is pulling back on our foot ... keeping us from putting the pedal to the metal. The Fed Chairman filled the tank with monetary measures. The President didn't even try to floor it, but he's tried to apply a bit more gas than the current House is letting him apply with fiscal measures. The 111th Congress was applying more gas than the 112th Congress is applying.

We could be going faster if we applied more gas. That we're not putting the pedal to the metal doesn't mean the car isn't fixed.

Given the output gap between actual and potential GDP, we're driving below the speed limit. The potential GDP is the speed limit. Any faster than that and we're liable to be pulled over and get a ticket. But we could be going faster. There's a good bit of room to step on the gas and get ourselves up to speed. That would require the House to stop holding us back from applying the gas it'd take to get up to speed.

Clinton's Convention Speech in Images

On the argument for President Obama's reelection:

Are we doing better than that today?

Job scoring:

Republican economic policies:

Trickle-down:

The Second Paradox of Thrift

We generally consider savings good for individuals as a matter of common sense. One would naturally think it would be good for the nation as well. As it was put to me at one point, "But if a household gets ahead by saving, not spending, why don't a million households?" The question requires different answers depending on whether you're concerned with those million households as an aggregate of individual spenders or as a unified spender through a national government.

The traditional answer considering the aggregate of individual spending hails as the paradox of thrift. The typical increase in savings by the average consumer comes via reducing spending rather than from an increased income. Given level income, as one consumer spends less in order to save more, that consumer increases his personal net worth. However, the decrease in spending lowers that individual's contribution to demand. If decreased spending by half the potential spenders is offset by increased spending from the other half, then there's a break even for the overall economy. But if every spender in an economy spends 1% less in an effort to save more, then overall demand for goods and services would be diminished by roughly 1%. When supply and demand happen to be matched, that reduced demand doesn't require as many employees as before to fill the orders. The resulting layoffs mean fewer people can save thus ironically causing reduced aggregate savings from a too aggressive (or panicked) shift towards individual savings.

On the other hand, if we're talking about those million households in the unified sense of a national government, we need to look at a different aspect of the question. At that point, we can shift our focus to that first part about "gets ahead". Almost no household truly ever gets ahead by saving rather than spending in real life. Saving is how households that are already ahead maintain that being ahead. Households get ahead in the first place by spending on tools to increase income (such as job training, education for higher-wage jobs, tools for trades, goods to improve and sell, etc.). Saving foolishly can be far worse than spending wisely.

In that sense that recognizes that certain debts can increase future income by more than the debt, what's good for households can be good for nations. For a nation that's already doing great, saving could do a wonderful job of steadying the already rolling wealth. For a nation that's not doing well, investments in improving the national potential will tend to do much better. In that sense, it's just like an individual. Your high-income CEO would be wise to put enough money into safe investments that he no longer has to have his job to pay the bills and just does it for personal satisfaction. Your broke high-school graduate would be better advised to get an engineering degree on loans than to try to save up from working at a gas station or other low-wage job. A nation in steady growth (or a boom) mirrors the situation of the well-paid CEO or engineer. A nation in low growth (or recession) mirrors the situation of the low-paid laborer who can't quite afford the basic cost of living and will never be able to save up enough to make a difference without taking on debt to achieve a higher income.

Simply put: If you have a high income (strong growth), it is wise to save. If you have a low income (weak or negative growth), it is more wise to spend on increasing your income. The second paradox of thrift: for an individual or nation, you have to already be doing well before thrift makes as much sense as spending wisely.

Bastiat's Fallacy In The Parable Of The Broken Window

Frédéric Bastiat

The Broken Window may be the most popular story among today's Libertarians and disciples of Mises. Discuss government spending, and they will almost assuredly bring up Bastiat's parable of the Broken Window as if its mere mention should ward off all thought of govt spending. Unfortunately for Broken Window devotees, Bastiat's bases his conclusion on a false assumption.

For anyone not already familiar with the story, Bastiat presented us with a citizen whose son had broken his window. Bystanders consoled the citizen with the thought that at least some good would come of the broken window in that it would mean business for the glaziers. Bastiat, however, argued that had the citizen not needed to pay six francs to the glaziers to fix the window, then those six franks would have been spent on new shoes or a new book. As such, according to Bastiat's telling, the additional work for the glazier came only at the cost of work for the cobbler, the bookbinder, or some other profession. Bastiat offered up his story as an argument against the trade restrictions of protectionism, although today it is more commonly used as an argument against figures showing an increase in economic activity in the wake of a disaster. It's also rolled out against any govt project on the basis of the opportunity cost of what might have happened otherwise.

Bastiat's fallacy: The six francs would not necessarily have been spent. The shoes might not have been bought. Nor the book. His six francs might well have sat buried in his mattress, his house fell down, and someone built over it. Bastiat and all those who call out "the parable of the Broken Window" depend upon an assumption that does not hold, namely that the citizen must certainly have spent that six francs. Clearly that is not the case. The citizen may or may not have spent the six francs. If they were not spent at that time, the six francs may have been lost or forever stored in a static asset (such as cash or gold physically kept in a safety deposit box). Even if it were spent, there is no guarantee that it would be spent in the region of the window and employ a local cobbler or bookbinder.

The safe or safety deposit box are among many options for static assets representing inactive money for our economy. For a domestic economy, any store of assets outside of that economy (e.g., in a foreign nation) will generally spur no activity whatsoever in the domestic economy while those funds remain outside. If the citizen must withdraw funds from a foreign investment to fix the window and those funds would have otherwise stayed in the foreign investment indefinitely, then activity has been added to the domestic economy. Likewise, funds that the citizen would otherwise have invested in foreign assets can not be said to cause the domestic bookbinder to lose a sale because of those funds going into fixing a window. An event that diverts funds back into the domestic economy has increased the domestic economy from funds that would not otherwise have been put to use in the domestic economy.

In Bastiat's example, this obviously means the son breaking the window did not necessarily hurt the cobbler or bookbinder. That would only be the case if the citizen was sufficiently impoverished by the replacement of the window as to be unable to afford the shoes or the book. That may have been the case for Bastiat's citizen, but will not necessarily be the case whenever a citizen's window is broken by his son. Some citizens will have spare gold in the vault or spare funds in foreign investments that they will bring into the economy in order to replace the window and still get the new shoes or book.

Beyond Bastiat's example, at least some of the funds used to rebuild after a disaster will normally have been sitting in static assets. For the region being rebuilt, it doesn't matter what those static assets were so long as they were not otherwise going to be spent in that region. That's how regions get an economic boost from disaster recovery, such as fixing windows. Of course, recognizing this effect does not mean celebrating the disaster. No reasonable person is happy to see damage just because of the effects of the rebuilding. Among other reasons for non-celebration, the additional activity for repairs will not always be sufficient to more than make up for jobs lost or suspended because of damages. Still, deploring the damage doesn't mean we can't recognize the economic effects of the rebuilding itself.

For govt projects in general, the fallacy shows us that govt spending will generally defy its Broken Window critics and add to the economy so long as the spending draws a sufficient portion from outside the active, domestic economy. Unless too much of the funding comes from taxing those on a tight budget, building a new or expanded road and hiring a construction worker should not be expected to impoverish the taxpayer even before we consider the long term benefit of the road to the taxpayer. Only taxes on those who have the least will necessarily withdraw money from the economy. Upper-bracket taxes can simply mean somewhat less being stored in static assets such as foreign investments that would not benefit the domestic economy anyway. And issuing T-Bills at today's extraordinarily low rates to pay for expanding and improving infrastructure will not tend to divert funds from business investment either. My choice of how much to invest in risky start-ups with high potential return will be determined by my risk tolerance rather than how many bonds the Treasury issues. It's a safe bet that's the case for most other investors too. That risk tolerance isn't likely to increase until we have a credible boost for the economy -- not just some half-hearted nod to the idea. Let's fix some windows. And make those "windows" big infrastructure improvements and lot's of 'em.

No, World War 2 Didn't End The Depression

There's a common myth out there that goes, "the Great Depression was finally ended by World War 2". It has some slight variations, such as "the Great Depression lasted 15 years" or even "the market didn't recover until govt spending stopped".

All of these are complete misunderstandings of history if not outright lies.

While there may not be as accepted a definition for depression as for recession, there's a good bit of consensus along the lines of these two criteria for an economic depression:

1. real GDP decline beyond 10%
2. period of decline lasting more than three years

Year	2005 Real GDP
1929	977,000
1930	892,800
1931	834,900
1932	725,800
1933	716,400
1934	794,400

Real GDP declined every year from 1929 through 1933. By 1934, the economy had been pushed back into growth again. There you have it: the end of the Great Depression. It was 1929-1933, far short of 15 years. One can not be in a depression and have real GDP growth because a depression is defined by GDP decline. One can note other factors peculiar to depression, such as deflation. But a depression only exists while there is a declining economy as measured by real GDP. One can debate what ended the Great Depression, whether it was a combination of monetary and fiscal policy, deficit spending alone, monetary policy alone, or some other set of factors. But there is no reasonable debate that the Great Depression ended years before World War 2 when the economy returned to growth.

Some effects of the Great Depression -- though mostly diminished -- did linger somewhat until World War 2. That much is true. Although unemployment had been drastically reduced before the war, it was still high until the war. Yet while it took quite a while to achieve full recovery, it did not take all that long to achieve renewed growth. Unemployment peaked in 1933. By 1936, the New Deal had kicked the economy into rolling again and -- though unemployment was still high -- the main economic indicators were back in gear. In early 1937, industrial production reached a level above that of 1929. But then pressure picked up to balance the budget, and FDR and Congress cut back spending. Although unemployment had been dramatically reduced from its peak, it was still too high for the economy to be self-sustaining. With the fiscal and monetary tightening of 1937, production dropped and unemployment went back up. Seeing the mistake, they stoked spending back up in 1938 and the recovery resumed.

Unemployment remained problematic throughout the 1930s and into the start of the 1940s. But even that measure declined every year that the New Deal was fully in force. The recession of 1937-1938 showed the effect of govt cutbacks pushed by Republicans overzealous to balance the budget at the wrong time. The cuts interrupted the full weight of the New Deal to push the economy forward. The unemployment rate continued to drop right up until the start of the war. We were already growing towards full recovery before the war. Admittedly, the massive increase of spending for the war -- far beyond that of the New Deal -- did push unemployment to very low levels far more rapidly than we would have achieved without the focus of a war effort. But the war boom runs quite the opposite of a case against spending. The extreme, focused spending for the war effort rocketed our economy higher. It was a finale to the New Deal, like a burst of fireworks at the end of a good 4th of July show. It couldn't be further from the truth to say that "the market didn't recover until govt spending stopped". When govt cut spending while the economy was still weak, the economy suffered. Except for the disastrous cut-backs that brought us the recession of 1937-1938, government didn't stop spending until the markets had recovered.

The Wealthy Don't Create Jobs; Good Jobs Create The Wealthy

What came first, the wealthy or the building blocks of wealth? This is no idle "chicken or the egg" question. Major political players base real policies with serious impact on their own answer to the question. What if most of them are getting it wrong? What if getting it wrong could wreck the system and ransack wealth?

To get the answer, the GOP base are obviously looking at wealthy investors. Our tax-cutting crowd clearly thinks they're the starting point. They say that getting more money to them will mean more jobs. The idea runs that investors bet their capital on starting or expanding a company that can then hire folks, thus jobs. This seems to pass for unquestionable truth among the "starve the beast" set. They figure that the more money the wealthy have the more they'll put into creating jobs. Even leaving aside the question of whether they'd likely choose to invest their money elsewhere, the anti-tax set need to reconsider two questions: 1) Is that usually how jobs are made? and 2) Where'd the capital come from in the first place? These two questions are necessarily linked. You can't explain where the capital came from without considering ways to make jobs without capital.

So where'd the first capital come from? Unless you think it was somehow handed over to man by divine intervention -- capital raining down from heaven or appearing from nothing -- it had to come from work. We can set aside the factor of inherited wealth, since somebody had to collect it in order to pass it down to lucky heirs. That first capital accumulating work -- whatever it was -- was collecting and/or making something that could be sold or traded. In short, it was a job. It may not have been a modern job, but close enough for our question. Somebody did some work. It may have been all on his own. Or the work may have been getting others to do things for him. But whatever it was, somebody did some work that produced a surplus. Perhaps that surplus was then -- directly or through heirs -- reinvested by getting other folks to do more work to produce more surplus. At root, the workers involved still created the surplus. The worker-created surplus was then used to spur more work to create more surplus. The job came first. The assets produced were just a product of the job that lets that job contribute to even more jobs. Get together a lot of surplus produced from a lot of jobs, and you've got wealth. Even if you then use that wealth to spur more work that creates more wealth, the wealth still didn't create itself but rather came as the sum effect of the work ... the jobs.

"Labour was the first price, the original purchase - money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased." -- Adam Smith 

Ultimately, the idea that wealth comes from somebody investing in business is a myth. If I build a factory and hire 50 people to make widgets, I'm not going to get any return on my investment unless there are people who can be interested in widgets and have enough money to spend on my widgets. If my widgets aren't essentials, those people will only have enough money to spend if they're making a surplus beyond the cost of living. Even if the widgets are essential, folks who don't have an income aren't going to be buying many widgets. If I don't have enough potential customers to break even, I'm not going to be employing those 50 widget makers for long. But if I have enough customers to make a profit, I'll keep employing them. And if I have too many customers for them to keep up, I'll hire more. Then who really created the wealth I reap from my factory? Sure, I made the factory investment that allowed me to sell widgets. But without the customers, that investment would have just been a foolish building that couldn't support long term jobs. It's the customers who really make the difference.

Jobs further wealth in two ways. Obviously there's the surplus collected by the initial business owner. But there's also the circulation of resources wherein the worker's share of surplus is spent at other businesses. The worker's paycheck allows him to be a customer contributing to other jobs that yield other surpluses for other business owners. The paychecks from those other jobs may in turn be spent at yet further businesses or even end up winding back to the initial business. Jobs have no choice but to create wealth, even when they fail to do so directly for a specific employer. Unless they're inefficient jobs, they'll create a surplus. And even if they're inefficient jobs they'll mean money for workers to spend at efficient businesses yielding surplus. The job just can't hold itself back from contributing to the creation of wealth. Wealth, on the other hand, can sit idle. It can be stored in some valuable thing that'll sit collecting dust. Sure, wealth may be further invested in jobs and help yield more wealth. But it can also hang on the sidelines for years or even centuries and do nothing productive.

Clearly it's the job that creates the wealth. We can use that answer to figure out what to do to get our economy rolling again. We want wealth and jobs. We need to push the one that creates the other. If we change our tax structure to get more money to the wealthy, we're just tinkering with accelerating redistribution of income to the rich who may just sit on it. That risks having it grind to a halt if too much money is removed from the system to just sit idly in the stockpiles of the wealthy. I'm all for building wealth, but not at the cost of having all the money locked down to the point where it no longer flows from business to business through employees and customers. Since wealth ultimately comes from jobs, those of us who want both more jobs and more wealth need to focus on jobs in order to get both. With more wealth, there doesn't necessarily have to be more jobs. With more jobs, there will be more wealth.

Now we've got a situation where there isn't enough demand for products and services to spur widespread hiring. Too many people don't have enough money to spend. And unemployment causes much of that current lack. Private industry can't fix the situation because it won't make any sense for them to hire until there's demand for products and services. There's only one credible way out: govt must step in to fill the void. Govt must stop hiding their heads in the sand and pretending that we can count on the wealthy to hire out of the goodness of their hearts -- without enough demand causing it to make sense as an investment -- if we just help a bit more money stick in their accounts. Govt must stop laying off workers and start hiring so there will be more paychecks to spend on goods and services. And to do that, govt is going to have to start leveling with us and facing that we'll have to rack up a future bill in order to make things work here and now ... and for the future.

What Can We Really Learn From Estonia?

S&P Downgrade of U.S. and Upgrade of Estonia Inspires Misguided Admiration

In the wake of a few recent S&P decisions, fans of budget cuts are practically waving the Estonian flag. They point to Estonia's recent austerity measures and it's Q1 2011 growth as some sort of vindication. "Look, look ... we've got a positive example!" Ah, but if only it were that simple. There's more to Estonia's austerity and growth than meets the eye of the starve the beast crowd who would have us emulate their example. Estonia chose "internal devaluation," including wage cuts. So keep in mind what following the Estonian script would mean: big wage-cuts and a lower standard of living. Who really wants to sign up for that?

But more importantly, one should take a closer look at the impact on the Estonian economy before declaring them a model that everyone should copy. I'd swallow some short-term pain if it made the overall situation better for my country in the long run. But in the case of Estonia, the trouble didn't entirely end with the turn-around from the -13.9% plummeting GDP in 2009 to the 1.8% growth in 2010 and varying more-or-less positive growth forecasts for their future. While Estonia has returned to GDP growth, they're doing so on the backs of their neighbors. The one bright-spot in their economy is exports, which were up 43% from a year earlier in June. (Although June's figures showed a drop from the previous month.) Their unemployment remains high. Their retail sales and non-govt construction are both still down significantly. The domestic market isn't looking so good there. But in Sweden, Russia, and Finland demand is rising. All three of Estonia's biggest foreign markets saw significantly higher GDP growth in 2010 than Estonia. The strong growth continues in Sweden in particular ... plenty to explain why Estonian producers have still had a market in the face of lower internal demand. Having growing trading partners is great. But in the long run it's a poor substitute for steady internal demand. Estonia's internal devaluation has made them even more dependent on their neighbors. Should the growth in Sweden, Finland, and Russia cease or even slow down significantly, Estonia could find itself in deep trouble with no fuel for its economy. That sort of dependence on -- and vulnerability to -- foreign trade partners has lots of drawbacks. Sacrificing domestic demand to gain foreign demand means a weakened domestic economy.

So what can we really learn from Estonia? Mainly that it's good to have trading partners who have money to spend on what you're making. That's not a lever we (or anyone else) can control. It's up to our trading partners to keep their economies moving. Aside from maybe lending the occasional wrench, we can only look to get our own engine revving again. But we can also learn that worrying too much about increasing our exports can cause a nation to become export dependent -- at the mercy of the whims of foreign markets. While that may be nice when those markets are thriving, do we really want to count on them completely and make ourselves export dependent? Wouldn't you rather we fixed our domestic shortage of demand instead of sacrificing what's left of it in the vague hope for an uncertain boost to exports?

Gross Govt Impact

The idea that we should make huge govt budget cuts is premised on the notion that our economy would be better off that way, wouldn't be hurt by it, or at least would soldier on about the same. Sometimes the best insight into that notion comes from people who weren' even discussing budget cuts directly. Daniel Gross's recent article about whether to buy bonds or not didn't touch on the idea of budget cuts at all. It's one and only focus was on whether US govt bonds are still a safe-haven investment compared to stocks. To explain that, he covers the impact on stocks if the US runs up against the debt ceiling and stops spending to not default on bonds.

"The U.S. government occupies a pretty large footprint in the economy. It employs 2.85 million people directly. Next, think of all the businesses, many of them publicly held, that rely on the government  for a big chunk of their business. For-profit education companies, defense contractors, the entire health care industry, Wal-Mart and other retailers that cater to people who depend on federal benefits to help pay their grocery bills. Every large consulting firm, every large tech firm (from Microsoft to IBM) has a large unit that provides services and products to the federal government.

Should the U.S. bump up against the debt limit without resolution, it's possible the Pentagon would delay indefinitely the signing of new contracts for fighter jets. Or agencies would cancel or slowdown payment on IT projects. Or Congressmen and their staffers would see their wages reduced. Or fewer people would get food stamps. The cumulative impact would be less demand, less economic activity, more uncertainty."

In pointing this out, Mr. Gross was ostensibly more concerned with explaining why bonds seem a relatively safe investment at this point. He says, "government reliance on debt to fund of operations and investments is so great that they'd rather alienate workers and citizens and taxpayers than anger the bond market." So all the explanation of what they'd have to do to avoid angering the bond market just explains why stocks are the more risky bet despite debt ceiling fears.

Yet there's a far more important take away than Mr. Gross's surface question of whether it makes more sense to invest in bonds versus stocks. Those payments we'd have to avoid making? They're a lot like the cuts the GOP wants to make. If the Republicans got their way -- the whole thing for which they're playing chicken with the debt ceiling -- we'd see most of those cuts. No wonder they don't care about the debt ceiling, if what they figure we'd avoid paying to avoid default are the things they don't want to fund anyway. And "Of course, all these moves would be contractionary — they'd help slow economic growth."

Contraction, by the way, is more or less a general term for things like recessions and depressions. Mr. Gross didn't speculate on whether those non-payments (or cuts, if de-funded in a relatively orderly manner) would cause a mere recession or a full-fledged depression. But that's really the remaining question for anyone who might be paying attention to where the Republicans goals would shove us. If the Republicans get their massive budget cuts, the question isn't whether it'll hammer the economy, the question is only how hard ... and whether we've ever seen it hammered that hard before.

Debunking Subramanian: No, China Isn't Bigger

Tom Gjelten of NPR in a piece asking "Is China's Economy Already No. 1?" tells us that "By traditional measures of gross domestic product — the value, in U.S. dollars, of total goods and services produced — the size of the U.S. economy is $14.6 trillion. China's GDP is only $5.7 trillion. But if China's economy is assessed according to its "purchasing power," it may be a different story." He further relates how Arvind Subramanian tells us that by purchasing power, their economy is already larger.

But this isn't just in conflict with tradition. Purchasing power parity (PPP) is mainly useful for assessing living standards because it adjusts for the costs of selected goods within a currency's market area. PPP gives a better sense of how many bowls of rice the average Chinese citizen can buy with their Renminbi vs how many bowls the average American can buy with our Dollar. The strength of PPP comes as a per capita measure on internal purchases. For 2010 the IMF rated per capita PPP of China at 7,518 International Dollars whereas the per capita PPP of the US is 47,123 International Dollars. So we can see that the average American can buy a lot more bowls of rice (or most anything else) in America than the average Chinese citizen can buy in China. By contrast, when they're both touring Germany, if you want some idea what the Chinese citizen can buy there vs what the American can buy there, PPP won't help you as much as GDP because their PPP figures aren't tuned for Germany's market. For international buying, you need to use the actual exchange rates, which means you want the GDP because it is listed using those very same exchange rates that would take effect for international purchases. Anyone (like Subramanian) who'd use PPP as an assessment of "the bigger economy" internationally should generally be considered dubious at best. There are good reasons why it is traditional to use GDP to compare the size of national economies. When you're looking at the ability to purchase outside of your own market, it just doesn't make sense to use a figure tuned to purchasing strictly within your own market.

If that weren't enough, by all accounts other than Subramanian, his assessment of Chinese PPP is bizarrely high. While the IMF, World Bank, and CIA World Factbook all come up with slightly different calculation results from each other, they're only slightly different from each other and way, way below what Subramanian claims. They all list China below the US in PPP by a fairly wide margin.

Then, for icing on the cake, there are the very big problems in China, such as the housing bubble mentioned in Gjelten's article. Their growth is currently on a trajectory to overtake us. But past results do not guarantee future performance. China is likely to generally grow over the coming decades, but they may face some serious stumbles and possible huge crashes as well. And while we're not doing it now, if we were to start revamping our infrastructure and investing more in our own growth, we could actually use our head start to keep our advantage. Not that we necessarily will. But it is a bit premature to say that China's economy will necessarily eclipse our economy at any point in the future. It may. It seems plausible that it will. It isn't guaranteed.