For much of the past five years readers of the political and economic news were left in little doubt that budget deficits and rising debt were the most important issue facing America. Serious people constantly issued dire warnings that the United States risked turning into another Greece any day now. President Obama appointed a special, bipartisan commission to propose solutions to the alleged fiscal crisis, and spent much of his first term trying to negotiate a Grand Bargain on the budget with Republicans. That bargain never happened, because Republicans refused to consider any deal that raised taxes. Nonetheless, debt and deficits have faded from the news. And there’s a good reason for that disappearing act: The whole thing turns out to have been a false alarm. — Paul Krugman, “The Fiscal Fizzle: An Imaginary Budget and Debt Crisis,” The New York Times, July 20, 2014, here.
[W]hen economic myths persist, the explanation usually lies in politics — and, in particular, in class interests. There is not a shred of evidence that cutting tax rates on the wealthy boosts the economy, but there’s no mystery about why leading Republicans like Representative Paul Ryan keep claiming that lower taxes on the rich are the secret to growth. Claims that we face an imminent fiscal crisis, that America will turn into Greece any day now, similarly serve a useful purpose for those seeking to dismantle social programs. — Paul Krugman, “Hawks Crying Wolf,” The New York Times, August 22, 2014, here.
As often happens, on a day I sit down to write a post, Paul Krugman publishes an Op-ed that helps me focus. Let’s get Krugman’s points from July 20 and today (August 22) freshly in mind: In today’s Op-ed, on the topic of monetary policy, Krugman opened by pointing out that the political right bases its case for lower taxes on top incomes and corporations on Paul Ryan’s false “trickle-down” argument while arguing that, because we face a fiscal crisis, we must “dismantle social programs.” A month ago, Krugman challenged the warnings from the right that there is a fiscal crisis, citing the “distinctly non-alarming” July 2014 report from the Congressional Budget Office (CBO). I.e. — there is no fiscal crisis, hence no need to dismantle social programs.
Krugman is correct about the Republican Party in Congress consistently seeking budget cuts and also seeking to cut top tax rates and taxes on giant corporations. The problem is, there actually is a demonstrable fiscal crisis, one that CBO inexplicably saw fit to cover up in its July Report. (See my post “Breaking News: CBO Infected With Trickle-Down Disease,” July 27, here.)
A brief summary of the data revealing this cover-up was included in a letter to the editor of the Albany Times Union, here. In that letter, with no reference to any implications or motivations (letters to the editor have to be short), I merely observed that CBO’s published baseline ten-year “outlook” (a projection that assumes current “laws” remain unchanged) had debt interest increasing 278% by 2024, while discretionary spending would go up by only 16%, the defense portion of that by 19%, and non-discretionary spending by 77%. By 2021, the cost of the debt would exceed the entire defense budget.
In its July “Outlook,” however, CBO presented graphs (no data) representing that debt interest will remain well below, and grow roughly parallel to, major medical programs and Social Security, not only out to 2024, but for another 25 years as well. This directly contradicted it February projections, which CBO said it was re-endorsing. My only inference from these facts, apart from CBO’s gross misrepresentation, was this: “Obviously, mushrooming debt and interest are squeezing out financing for government programs.” The cited facts, well vetted by the TU, stand in direct contradiction to Paul Krugman’s assertion in July, based on CBO’s July report, that the “alleged fiscal crisis … turns out to have been a false alarm.”
The Discomfort Zone on the Left
Although such a letter to the editor would get support from the “Left” if, for example, it was accompanied by a request for higher taxes on the wealthy and corporations, merely asserting there is a fiscal crisis makes it look like I am siding with the “Right.” That is because Paul Krugman, instead of arguing that higher taxes on the rich are required, has opted instead to contend that there really is no looming fiscal crisis and because, since Krugman’s views dominate progressive thinking, people tend to believe him.
Thus, my letter was not welcomed by the Left. One former colleague in mediation services, who never fails to provide supportive reactions, sent an e-mail saying: “It’s a dense subject that, I have to admit, I have not fully appreciated.” He suggested I should have emphasized up front that government programs are being squeezed out.
Another former colleague sent me this e-mail message:
Michael, I am stunned. You are a traitor to the left. Haven’t you been reading Paul Krugman, telling us how the deficit hawks are nuts, it’s not a problem?
There it was: the argument that, given Krugman’s proclamation that there is no fiscal crisis, I must be aiding and abetting the Right. Many progressives who read my article may have had that reaction. When I explained that I thought Krugman was wrong about that, he responded:
Oh. Sorry, I guess I didn’t get that Krugman is just not left enough for you!!
This former colleague, by the way, is a “conservative” who said he agrees with my assessment of the budget problem. Hence, he was merely chiding me for taking issue with Krugman. He happens to agree with Krugman’s perspective that inequality is merely a non-economic, political issue: Indeed, it is this perspective, attractive to the Right, that has taken Krugman out of the game. Without appreciating how inequality affects growth and decline, neither Paul Krugman nor my “conservative” friend can get beyond moral considerations pertaining either to inequality or to taxation. If inequality is presumed to have no economic consequences, the debate is an inconclusive one over moral and philosophical issues, and this is emotional turf on which the Right has held its own.
This leaves my perspective — that inequality is a dangerous economic condition — in a no-man’s land I’ll call: “The Discomfort Zone to the Left.” By that, I mean, to the “left” (for those inclined to see economics in terms of a left/right continuum) of Paul Krugman, and of the neoclassical economists whose world-views still have not allowed them to understand the mechanics of growth and decline. So far, it’s been fairly lonely in the Discomfort Zone. Robert Reich and Joseph Stiglitz are here, along with a handful of heterodox economists. If Paul Krugman would expand his perceptions, he could narrow the Discomfort Zone, but so far he has pointedly rejected Stiglitz’s analysis.
Unfortunately, in conceding the economics of inequality to the “Right,” Krugman has given up an enormous amount of territory, indeed most of it. As I have increasingly emphasized over the past three years, because his views are taken as gospel by most of the “Left,” he endangers us all. So I’ll review my perspectives on growth and inequality again, with emphasis on political considerations, to explain the grave danger Krugman’s perspectives have put us in.
The Inequality Problem
As shown in my last post (“Inequality Suppresses Growth: A Serious Problem?”, here), income inequality began to grow quickly in the U.S. during the Reagan presidency, when deregulation and lax enforcement of anti-monopoly laws allowed corporations to consolidate and greatly increase their profits, and the wealthiest Americans correspondingly to greatly increase their incomes. Simultaneously, a trend of reduced taxation of their income and wealth enabled them to keep increasingly more of these profits, and wealth concentration grew commensurately.
Here in the Discomfort Zone, I have found no one other than myself willing press this point strongly, although as the decline continues economists like Reich and Stiglitz appear to be increasing the call for progressive taxation. I can only assume that others demure for political or professional reasons. But these tax reductions lie at the heart of the inequality problem: The redistribution of wealth and income to the top has greatly reduced productivity and income growth, to the point of depression. The financing of a stunningly substantial portion of the increased wealth at the top with government credit has greatly amplified the inequality problem, and it has created what has become an intractable budget crisis.
Simply put, here is what has happened: Our government, and the entire bottom 99% of income earners, have been pressed to the task of further enriching the top 1% with money borrowed by the federal government, implicitly agreeing to eventually pay for that enrichment. Wealth of such a magnitude could not have come directly from existing bottom 99% income and wealth, but the bottom 99% has effectively been given an open-ended deferred payment plan: We have been allowed to pay off later our “debt” to those few high within the top 1% whom we have made inconceivably wealthy.
To be sure, the top 1% does contribute some tax revenues, but they are increasingly depositing vast sums (conservatively estimated at about $8 trillion) off-shore, out of reach of U.S. taxation; and their corporations, which are now operating with an ever-growing array of First Amendment rights, are optimizing the social and political power of their money here while they are “legally” declared to be “citizens” of some other country that will not require as much taxation on the earnings they collect here. They do not pay enough taxes here to prevent the interest on the government’s debt from growing exponentially, and that interest has for decades provided a perpetual annuity for the holders of government bonds.
These powerful few are poised for a potentially complete takeover of the U.S. government. Among the thugs in their employ are those who would “shrink” the U.S. government until it is small enough to “drown in the bathtub” (Grover Norquist). However else we may choose to describe this obscene program, it is a prescription for the increasingly less gradual decline, and the ultimate destruction, of the United States and its economy. Let me put it somewhat more mildly:
From the standpoint of maximizing tangible productivity and optimizing social welfare, a more mismanaged economy can scarcely be imagined.
The perception of this reality exists mostly to the Left of Krugman’s perspectives, for he has not recognized any such economic implications of income inequality, which, in his 2012 book End This Depression NOW!, Ch. 5, he wrote off as a “political” problem with no macroeconomic consequences. The Discomfort Zone to the Left of Paul Krugman is, indeed, a vast territory.
The Reign of Ideology
This blog is replete with the details of the critique of neoclassicism and its fanciful ideological offshoots, so I’ll just summarize them here. The core tenet of neoclassical faith is that market economies will always, following a downturn or crisis, return fairly rapidly to a state of full employment “equilibrium.” This belief grew out of the static classical image of an economy in full employment, with current income either spent on current consumption or invested in “capital stock” for additional production. Because economic outcomes are said to be governed by “laws,” moreover, they are presumed to be fair and equitable. There is no such thing as unreasonable inequality.
This ideology, although growing out of the static classical model, conflicted directly with the ideas of classical economists who maintained that wealth distribution was not a result of natural law, but of Society’s choices (e.g., John Stuart Mill) and who observed that much of income and wealth was “economic rent” — payments to landowners whose mere ownership of land contributed nothing to the production of tangible wealth (e.g., Adam Smith, T.R. Malthus, Henry George). With the development of capitalism in the mid-19th Century, corporations began to take over most or all of the means of production, and “rent” increasingly became an element of “profits” which, like land rents, necessarily declined over time (Karl Marx). The only way to keep profit levels up, over time, was to distribute less value down.
New arguments emerged to respond to these well-established contradictions to the perfect efficiency presumed in the neoclassical system. For example: (a) Preserving economic “freedom” will protect incentives for investment and growth, while effective market competition will continuously provide optimal efficiency (e.g., Milton Friedman); (b) Attempts to reduce inequality by redistributing income and wealth back into the active economy would entail a “trade-off” with the optimal efficiency and growth provided by the “invisible hand” of Adam Smith (e.g., Arthur Okun); and (c) Inequality is only the addition of growth at the top with no diminution of the income or wealth of anyone else (e.g., Martin Feldstein’s “magic bird” argument).
Friedman, Okun, and Feldstein were active in the 1960s and 1970s, and influential in the movement to marginalize Keynesian economics. An outgrowth of Okun’s trade-off and Feldstein’s magic bird arguments was the “trickle-down” myth that dominates political discourse today: Simply put, it is the idea that income and wealth transfers to the top create growth, as the “job creators” automatically expand their investments. A related idea, the “austerity doctrine,” is that if central government, to balance its budget, refrains from taxing the rich, but instead cuts back its spending, the economy will grow. These perverse ideologies simply deny both Keynes’s “principle of effective demand,” the truth of which has been repeatedly verified ever since the Great Depression and WW II, and the fundamental logic of the risk/reward assessments underlying investment decisions.
Krugman has repeatedly denounced the trickle-down myth, as in the second quotation above, but has treated it as a plausible factual proposition lacking real-world verification, not as a logically unsound idea. And he has not yet clearly rejected the corollary proposition that higher taxation at top incomes diminishes growth, by reducing investment incentives. This reverse trickle-down myth fails for the same reasons.
Inequality and Growth
In my last post, I discussed Standard & Poor’s recent conclusion that income inequality reduces growth (“How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide,” August 5, 2014, here). I provided evidence of the validity of this conclusion. It’s enormous significance lies in establishing that the distribution of wealth and income is the basic determinant of prosperity and decline, and that falling growth is a huge problem that cannot be countered by merely stimulating demand and employment.
Those of us in the Discomfort Zone, including Reich and Stiglitz, have explained for several years, in terms of Keynes’s “marginal propensity to consume,” that aggregate consumption declines when income concentrates because wealthier people spend a lower percentage of their income on consumption than do middle class and poor people. This wisdom has been lost on neoclassical economics, which has discarded Keynes’s principle of effective demand and rejected Keynesian “demand-side” economics in favor of full reliance on “supply-side” ideas.
In the context of America’s extreme inequality, this Keynesian reality should now be intuitively obvious: How in the world could the U.S. maintain the same level of consumption, and therefore production and income, after the income share of a mere 1% of the population increased from 9% (1979) to almost 25% of the income (2007)? The income share of the other 99% is correspondingly reduced, and aggregate consumption and growth necessarily declines substantially, as shown in my previous post. Martin Feldstein’s opposing “magic bird” hypothesis would require that, somehow, higher inequality itself magically expands the money supply. Regardless, the ultimate proof lies in the facts of experience:
This graph shows the decline since 1968 of the U.S. GDP ten-year rolling average growth rate. The curious factor here is the long period (about 1975-2005) of roughly 3% annual growth. The decline to about 1.5% average growth after the Crash of 2008 is substantial, and it has stumped mainstream economists, who have termed the trend “secular stagnation,” or “the new normal.” The most likely explanation for the Crash itself seems to be the collapse of effective demand driven by the steadily increasing income inequality, and perhaps by some degree of exhaustion of the support to the active money supply given by the creation of federal debt. This entire topic is rife with important research topics.
Even small swings in the GDP growth rate, which varies within a narrow range, can be quite significant. During the period after WW II when prosperity was rising and income inequality declining, GDP growth averaged over 4%. By the mid-1970s, the average growth rate had declined to about 3%, where it remained until the Crash. The U.S. population is now growing only about 0.7% annually, close to the slow population growth in the depression years, and down from 1.2% growth rate of the 1990s, “a decade of economic expansion” (The Guardian, December 31, 2013, here). But the 1990s was also a decade of rapid income inequality growth as well, with real median income growth well below the 3.0% average GDP growth. The average of 1.4% aggregate growth since the Crash, as computed by Standard and Poor’s, likely represents declining per capita income for most of the bottom 99%: Yet another area brimming with research topics for Raj Chetty’s legions of “scientific” economists for whom, he says, the mysteries of growth “remain elusive.”
As a rough rule of thumb, we can probably think of aggregate GDP growth rates of 4.0% and higher as representing prosperity, 2.0% and below as reflecting depression, and 2-4% as representing average prosperity. The Crash of 2008 marked the end of period of steady average prosperity (rapidly increasing inequality supported by government debt) and the beginning of a gradually deepening depression. The new depression era has been a bizarre period with high inflation for top 1% luxury items — yachts, penthouses, antiques, fine art, etc. — generated by surplus financial wealth (see “Welcome to the Everything Boom, or Maybe the Everything Bubble,” by Neil Irwin, New York Times, July 7, 2014, here) and the more modest inflation below the top 1% for everyday consumer products, generated not by excessive consumer demand but by monopolistic market power, through excess profits.
Growing inequality must be understood as separating the aggregate economy into two ever-increasingly independent economies, and failure to see the aggregate economy in such distributional terms leads to political error. For example, an editorial from The Orange County Register, “Student loans only inflate the U.S. debt,” was recently reprinted in The Albany Times Union (August 23, 2014, here), and it began:
Perhaps we should not be surprised that the Obama administration’s solution to a problem of high debts is to incur even more debt. This was the thinking with the economy as a whole, which has languished for more than five years since the official end of the 2007-09 recession, and now the administration is doubling down on this strategy to address student loan debt.
The editorial correctly notes that the more than $1.1 trillion of student loan debt is “the worst credit risk of any major debt category.” The author could only think of the cost to taxpayers, however, blaming the Obama administration for extravagant spending, with no awareness of the relevance of income and wealth inequality to the issue.
Here is the neoclassical mistake: The taxpayers who should be footing the education bill are those who have been enriching themselves at everyone else’s expense for three decades, depleting student resources and thereby directly causing the enormous student debt. Nor was there any appreciation that the enormous “bubble” may soon pop, creating still more inequality and reduced growth, if this debt is not properly managed by the government. Declining education, like declining health care, decaying infrastructure, failing municipal governments, and environmental decline, and so forth, is a direct consequence of the impoverishment of America caused by rising inequality.
As explained above, the controlling factor is Keynes’s groundbreaking “principle of effective demand.” Keynes excluded income and wealth distribution from his full employment model in 1935, and the data needed for a distributional application of Keynesian macroeconomics has only recently become available: It’s worth reading a key passage from Keynes’s crucial Chapter 3, “The Principle of Effective Demand,” (Sec. II), updated to include [in brackets] references to inequality:
This analysis provides us with an explanation of the paradox of poverty in the midst of plenty. For the mere existence of an insufficiency of effective demand may, and often will, bring the increase of employment to a standstill before a level of full employment has been reached. The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.
Moreover the richer [more unequal] the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor [highly unequal] community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy [the wealthy segment of a highly unequal ] community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until . . . its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.
But worse still. Not only is the marginal propensity to consume weaker in a wealthy [more highly unequal] community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate.
This should resonate with anyone familiar with what has been happening in the U.S. since 1980. Notice that Keynes appeared to assume that full employment would be a sufficient response to the “paradox of poverty in the midst of plenty.” Extreme inequality, however, introduces the circumstance where money diverted from commerce to idleness and hoarding at the top vastly exceeds the shifts in the propensity to consume associated with the business cycle.
Notice, too, that the last two sentences of this quotation actually describe the anatomy of a depression. It describes what Paul Krugman calls a “liquidity trap,” but as Polly Cleveland has deftly noted, the liquidity trap may more accurately be described as an “inequality trap.” Above all else, it describes an economy shrinking deeper into depression. Keynes failed to note only that an inequality cycle will continuously worsen if the circumstances giving rise to it are not corrected.
Inequality and Debt
The federal debt now exceeds $17 trillion, and following graph, which I constructed more than a year ago, shows that the national debt has been rising faster than GDP since 1980:
Here, GDP (income), top 1% net worth (wealth) and the national debt are shown from 1982 through 2010, and GDP and the debt out to 2012. The national debt has grown steadily, exponentially over the last 20 years, until 2010 when it was poised to reach the level of real GDP. (NOTE: I have no definitive explanation of how CBO has computed the debt at only 73.6% of GDP in 2014 and 79.2% in 2024, but see the discussion of forecasting issues, below.)
Because the national debt is the major source of the rising concentration of wealth, and because income is concentrating high within the top 1%, top 1% wealth is also necessarily growing faster than GDP. Before the Crash of 2008, top 1% net worth reported to the Census Bureau (i.e., excluding unreported off-shore wealth) had grown by about $19 trillion. Remember, this stunning development is almost entirely due to the tax reductions on top incomes.
Politically, the effort by Republicans to regain control of the Senate in 2014 and to regain the presidency after 2016 entails the time-honored strategy of blaming the president for current economic woes. That strategy is likely to work, even though the national debt was over $10 trillion when Obama took office (Treasury Direct, here), and interest has been compounding in perpetual annuity during the “Great Recession,” drastically reducing bottom 99% incomes and exacerbating the deficits ever since. Here’s a chart of the growth of the debt (as a percent of GDP) by administration (Wikipedia, here):
Debt grows exponentially, all else equal. So this chart shows the Reagan/GHW Bush years to be the worst from the standpoint of federal borrowing in excess of GDP growth. During the Clinton Administration the “dot.com” boom enhanced GDP growth and government revenues, and taxes on top incomes were increased, so debt as a percent of GDP declined. The GW Bush years were marked by extensive spending on the Middle East wars, collapse of the dot.com boom, and massive tax cuts for the rich, so debt as a percent of GDP again rose.
The Obama years have seen the sharpest increase in the debt/GDP ratio since the early years of the Roosevelt presidency. A different circumstance back then was that heavy borrowing was needed to finance America’s entry into WW II whereas, as noted, the current steep increase results from society’s decision to finance the exponentially increasing income inequality, and the unimaginable, depression-level income and wealth wealth concentrations at the top; after WW II the debt/GDP ratio fell with the redirection of war-time spending toward domestic recovery and infrastructure rebuilding, and the maintenance of very high marginal income tax rates. Over the last 35 years, however, the tax structure that is driving wealth to the top has not been corrected; the Republican Party will not allow reestablishment of the necessary level of taxation.
None of this is expressly recognized by neoclassical economists, however, whose deficient understanding of how the economy works permits them to ignore these tragic developments. It’s an incredibly huge gap between an appropriate distributional economics and this bankrupt neoclassical view — it’s the broad wasteland of the Discomfort Zone.
Reinhart, Rogoff, and Ryan
Consider the case of the study by Carmen Reinhart and Kenneth Rogoff “Growth in a Time of Debt” (GITD) a study seemingly transported to the Discomfort Zone from the Twilight Zone! The authors had run regression analyses of many decades of national income against national government (public) debt for several countries, and regarding the United States they reached the conclusion that as the PD/GDP ratio approaches 1.0, growth declines. This was music to the ears of Paul Ryan, the 2012 vice-presidential candidate and potential 2016 Republican nominee for the presidency. Ryan is on a quest to cut federal spending without increasing taxation at the top.
GITD was the sole economic study cited in his 2012 budget proposal, “The Path to Prosperity.” When errors in the Reinhart/Rogoff study forced them to withdraw their hypothesis, that should have been the end of the austerity doctrine — but firmly-held ideological beliefs die hard. Ryan still hopes to ride the twin fantasies of trickle-down economics and the austerity doctrine to his version of “prosperity.”
While reviewing the graphs presented with the Reinhart/Rogoff study, I noticed something that no one else seems to have noticed: If, as the Piketty/Saez data have demonstrated, depressions are stagnation caused by high levels of income inequality, and if as I maintain high levels of income inequality are also the immediate consequence of high levels of public debt, the Reinhart/Rogoff study should reflect that high income inequality is present at high levels of public debt. In fact, I found it to do just that:
Once it is understood that the public debt has essentially financed the enrichment of the wealthiest Americans, it becomes clear that the increase of the PD/GDP ratio to over 90% today is also attributable to that enrichment. That fact is inherently reflected in the Reinhart/Rogoff data. Here again is the chart of the U.S. results for growth provided by Reinhart and Rogoff in their initial workpaper on their “Growth in a Time of Debt” (GITD) study (here). (Chart omitted: Go to “Finding a New Macroeconomics: (10) Reinhart, Rogoff, and Redistribution,” June 30, 2013, here. )
The Reinhart/Rogoff chart shows that over the 200 or so years covered in their database, growth has been slightly lower on average when the national debt was 30-60% of GDP than when it was below 30%, and lower still when PD/GDP was between 60-90%. It also shows that when the PD/GDP ratios were higher than 30%, the average (mean) of aggregate income growth was lower than the median aggregate income growth; this confirms that a higher level of income inequality is embedded in the GDP data for these periods of higher PD/GDP ratios. And, of course, the income growth (GDP) data at any point of time would reflect the degree of income inequality present at that time. Notably, these relationships are present in the data for all periods, both when debt was growing and when it was declining, and the Reinhart/Rogoff data cover a 200-year period.
For these reasons, that these factors are reflected so strongly in a regression of contemporaneous observations of PD/GDP and growth, as opposed to a time-series study, is really not surprising, despite the many factors that affect growth. But it is telling: * * * The Reinhart/Rogoff corrected study confirms the relationship between growing income inequality and declining growth.
Here is another fabulous opportunity for scientific research. Indeed, I have suggested running regressions of the PD/GDP ratios against both top 1% income and bottom 99% income.
“Forecasting” in the Blind
So far this post has clarified that the neoclassical supply-side paradigm has thoroughly covered up the basic nature of how the economy works. Income and wealth distribution data have shown us, beyond doubt, that aggregate growth and prosperity depend upon maintaining adequate demand throughout the economy, and that depends upon optimizing the distribution of income and wealth, and that, in turn, depends upon maintaining a sufficiently progressive level of taxation. Neoclassical economics comprehends none of that. Because we continue to drift down into a deeper depression, unable to recover from the “Great Recession,” mainstream forecasters are befuddled, and I’ve been following that befuddlement closely.
Prompted by Krugman’s report on the “mutilated economy” last November, I reviewed the Fed’s angst about long-term unemployment. (“The Neoclassical Boondoggle and the ‘Mutilated Economy,’ Part 1, 11/15/2013), Part 2, 11/16/2013, and Part 3, 11/19/2013). We have seen as well that IMF economists who pitted the proposition that income inequality depresses growth against Okun’s contradictory theory that there is a “trade-off” between inequality and growth found (apparently to their surprise) that Okun was wrong (“Inequality and Growth – Two Sides of he Same Coin,” 3/28/2014). A year earlier, as just mentioned, we watched the Reinhart/Rogoff claim that their study “Growth in a Time of Debt” (GITD) showed that high levels of public debt depress growth backfire when errors forced them to withdraw their thesis. (There are three posts on this topic in the Finding a New Macroeconomics Series, “Reinhart, Rogoff and Reality,” 5/30/2013, “Reinhart, Rogoff, and Ideology,” 6/6/2013, and “Reinhart, Rogoff, and Redistribution,” June 30, 2013.)
In July, I responded to Krugman’s Op-ed “The Fiscal Fizzle: An Imaginary Budget and Debt Crisis” (7/20/2014), in which he declared the entire budget scare to be a false alarm, with “The Fiscal Fiasco: A Real Budget and Debt Crisis (7/23/2014) , and “Breaking News: CBO Infected With Trickle-Down Disease” (7/27/2014). Finally, when Standard & Poor’s, a conservative rating agency, felt compelled to announce its awareness of the growing evidence that income inequality depresses growth, I reacted to Krugman’s cautious, somewhat negative response to the S&P announcement with “Inequality Retards Growth: A New View?” (8/9/2014), and my previous post, “Inequality Suppresses Growth: A Serious Problem.”
Of course, no one has a crystal ball, and CBO in its “Budget and Economic Outlooks” suggests that we not regard its “projections” as forecasts. But we do, because we think they are capable of making at least short-run forecasts. Paul Krugman confirms that expectation when he says (in “The Fiscal Fizzle”) things like this:
The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009. It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow — but the economy is growing too, so the budget office expects the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.
And of course, he relies entirely on the CBO to claim this:
I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled — and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office — which are distinctly non-alarming — as somehow a confirmation of their earlier scare tactics.
All that supply-side “forecasting” can hope to accomplish, however, is guess the degree to which future growth will track the economy’s “productive potential,” which no macroeconomic forecaster actually has any way of identifying. We saw that in spades in our review of Thomas Piketty’s book “Capital in the Twentieth Century,” which attempted to resurrect an antique, controversial production-function model as the “Second Fundamental Law of Capitalism.” (See my post series “Picking Piketty Apart,” including “His Contribution,” 6/14/2014, “His ‘Laws of Capitalism’,” 6/21/2014, and “Time’s Running Out,” 6/23/2014). He candidly conceded that the model could not be used for forecasting, and explained it was only “valid” in the long run, which left me and others at a loss to explain why he decided to write a book about it.
What’s more, income (GDP) data contain a great deal of economic rent, which has zero tangible value. The point is, the only hope for making any predictions for the future is to follow trends in aggregate demand, and supply-side forecasters do not do that. Thus, the entire neoclassical paradigm unravels as we drift deeper and deeper into recession and depression.
What CBO does, it turns out, is first decide how much optimism it can sell, then unveil numbers for a basic ten-year forecast reflecting that degree of optimism. In Its February, 2014 “Outlook”, for example, it projected a rapid return to an indefinite continuation of 2.1% annual growth, even though (by S&P’s calculation) growth has averaged only 1.4% over the last decade. Then it generated numbers for the intervening years which were then presented as if they were the product of some sort of prognostication. In other words, CBO is actually backcasting, not forecasting!
Here’s the proof: From its “Budget and Economic Outlook, 2014-2024″ (here), pdf (here) we can extract the following data (in $billions) :
Item 2013 . . . . 2017 . . . . 2022
1. Y-E debt, as a % of GDP  72.1 72.3 76.8
2. Publicly held debt  11,982 14,507 19,001
3. GDP  16,627 20,054 24,746
4. Computed GDP (l 2/l 1) 16,619 20,065 24,740
 Table 1-1, p. 9
 Table 1-2, p. 12
The numbers check. There is no reason to suspect, reading these numbers, that CBO isn’t using algorithms that project either publicly held debt or GDP as dependent variables. However, when we go back two years and look at data from “The Budget and Economic Outlook: 2012-2022″ (here) pdf (here), we see that it does no such thing:
Item 2013 . . . . 2017 . . . . 2022
1. Y-E debt, as a % of GDP  75.1 68.5 62.0
2. Publicly held debt  11,945 13,509 15,291
3. GDP  15,914 19,708 24,665
4. Computed GDP (l 2/l 1) 15,905 19,721 24,663
Alternative Fiscal Scenario
Item 2013 . . . . 2017 . . . . 2022
1. Y-E debt, as a % of GDP  77.8 84.0 94.2
2. Publicly held debt  12,374 16,560 23,232
3. GDP  15,914 19,708 24,665
4. Computed GDP (l 2/l 1) 15,905 19,714 24,662
 Table 1.7, p. 22
 Table 1.3, p. 10. Note: No separate GDP provided for A.F.S.
. . . . . . . .
The entire outlook revolves around a judgmentally presumed amount of growth that will take place over the next ten years no matter what else happens. In its February 2014 report, CBO presumed a GDP of $24.7 trillion in 2022. This is up slightly, but still rounding to $24.7 trillion it used in its January 2012 outlook two years earlier.
Incredibly, this GDP number was not allowed to change, whether the debt was seen as rising to $15.3 trillion or to $23.2 trillion! This preposterous approach renders the entire “outlook” meaningless and nonsensical. The amount of debt is integrally related to GDP — at a very minimum, income tax revenues vary with GDP, so an additional $8 trillion of debt needed in the A.F.S. automatically implies a gigantic decline in GDP, and the associated need for more borrowing.
This approach is fatally pernicious: For any given higher A.F.S. level of “projected” debt, GDP is necessarily lower than presented in the report.
There is no indication that CBO believes debt might go up because the federal government will grow substantially, or that if it did there would be no stimulus, and the constant presumption of GDP growth invalidates the figures for debt as a percent of GDP. But Because CBO is backcasting from a presumed GDP ten years down the road, its numbers simply bear no relation to what may happen in the next few years, and will obscure the likelihood of impending crisis.
CBO has conceded it made as optimistic an assumption for growth as it could for the next ten years. But it’s only playing “pin the tail on the donkey,” then waiting around to see what actually happens. In the meantime, from the perspective of its economic “outlook,” no actual changes in the rate of growth, no amount of decline in income or consumer and investment demand, are allowed to modify the ultimate expectation of growth built into the GDP presumed for the end of a decade. [Note #1]
CBO might protest that it is constantly revising it projections to reflect real changes in economic conditions. It appears not, but if so, that is all it is doing. It should stop pretending to see ten years into the future, certainly not 35 years into the future, and then disclaiming its work as non-forecasting.
Some immediate points:
- It’s unclear why the amount of public debt, which now officially exceeds $17 trillion, is reported at much lower levels by CBO; This needs clarification. [Note #2]
- Regardless, CBO has no handle on the growth rate of debt because it does not account for changes in spending and demand, only potential production;
- Its assumption of 2.1% annual growth instead of 1.4% or less is unfounded, admittedly optimistic, and dangerously over-optimistic because we’re in an unacknowledged depression;
- CBO’s long-range “Outlook” in July of 2014 said debt would reach 100% of GDP finally in 2039. In 2012, Reinhart and Rogoff reported it was almost already there;
- Although we do not need to worry about the debt itself causing decline, we now know that the inequality caused by the high level of debt does, and the escalating inequality spiral will continue to depress growth even more rapidly than would the operation of Keynesian dynamics alone.
The one factor that any forecaster should be most certain of, at least in the short run, is the amount of debt and debt interest. As my letter to the Times Union reported, even under its optimistic scenario for GDP growth, CBO had debt interest exceeding the entire defense budget by 2021. It further covered up its expected growth of debt interest in the July report. There has to be some reason or reasons why CBO is unwilling to frankly discuss the debt problem any more. Could that reason possibly relate to the reason(s) that S&P suddenly surfaced a week or so later with the warning that inequality depresses growth?
It’s still very lonely here in the “Discomfort Zone to the Left of Paul Krugman.” I know this all seems very complicated to the average untutored mortal, which is why we are susceptible to believing one ideology or another. And we like to believe that we can trust the “experts,” especially those who can boast a Nobel Prize. We also tend to believe that the more radically extreme an idea seems, the more likely it is to be wrong. The Chicken Little story would have a perverse moral, wouldn’t it, if the sky actually was falling?
Well, my Chicken Little story is based entirely on logical and demonstrable facts, and the deniers are beyond redemption. I don’t get off on negativity and pessimism: I have been trained my entire life and career, however, to look for and accept reality. Those of you who insist on forming your opinions on the basis of “argument by authority,” let me remind you that Joe Stiglitz also has a Nobel Prize. You can check with him, but mainly you should decide for yourself. Read, and think, and pay very close attention to what is happening in your world. The truth really isn’t that difficult to understand.
I only hope that I’ve disabused you of the notion that I am a “traitor to the Left.” I don’t have a crystal ball, but I do have a gut feeling that we’re just a stone’s throw away from Great Depression #2.
Shall we not go there?
JMH — 8/27/2014
[Note #1, posted 10:30 p.m. on 8/27] CBO has just today released “An Update to the Budget and Economic Outlook: 2014-2024″ (August 2014, here), which I have yet to thoroughly review. CBO says it has reduced its estimate of the 2014 budget deficit. But on p. 6 it also states: “The agency has significantly lowered its projection of growth in real GDP for 2014, reflecting surprising economic weakness in the first half of the year. However, the level of real GDP over most of the coming decade is projected to be only modestly lower than estimated in February.” That last sentence continues the impression CBO has been giving of actually projecting GDP over ten years (or more) as a dependent variable, obscuring its actual method of forecasting GDP. Note that this report has 2022 GDP at$24,565 billion, just $181 billion lower than its February 2014 projection of $24,746 billion, cited above.
The world (certainly the “conservative” world, here) takes CBO at its word and actually believes (or argues) there is some sophisticated basis for forecasting growth to continue at over 2% for ten years! That, however, is nothing more than neoclassical optimism.
[Note #2, posted 3:00 p.m. on 8/30] Treasury Direct (here) reports “total public debt outstanding” inclusive of “intergovernmental holdings”: E.g., on August 29, the total of total public debt outstanding was $17.7 trillion, and the total of intergovernmental holdings was just over $5 trillion. This explains CBO’s figure of $12.4 trillion for publicly held debt at y.e. 2013.
The impact of intergovernmental debt is not accounted for at all, however, and that is not just a source of confusion (see Michael D. Tanner’s July 23, 2014 report “D.C. Forgets about the Debt” (here) which focuses on “gross public” debt.) Although CBO is not responsible for any public confusion on this, it is noteworthy that CBO assumes that intergovernmental debt has no material budget implications. In the short run, perhaps not, but CBO purports to make forecasts going out 35 years. Here’s the explanation of debt held by federal accounts from the National Priorities Project (here):
Debt Held by Federal Accounts is money the federal government borrows from itself. It results from the Treasury using surpluses from some accounts – for instance, Social Security – to buy Treasury bonds, and thus finance current government spending. Borrowed funds ultimately need to be repaid to the original account, with interest.
The process of borrowing, for example, current Social Security payments for current government spending is problematic, because either this interest will ultimately have to be included in the budget (incurring more taxes or borrowing) or if it is not repaid at all the value will have been taken directly from the Social Security fund, a major tax on Social Security and redistribution of wealth, given our current tax structure. CBO’s narrower definition of the budget problem concedes the loss of this value, and imparts an unreasonably more favorable budget outlook.