Trump’s Fiscal Brainstorm: Cut Taxes for the Rich

 

This year’s US presidential election campaign differs radically from past patterns, including in the departure of the Republican nominee from many of the policy positions traditionally taken by his party.  Examples are his lack of support for international trade, military alliances, or the institution of marriage.   But when Donald Trump released some positions on tax policy recently, the differences with Hillary Clinton’s proposals fell very much along usual party lines.  His is the kind of tax policy that has long been favored by Republican presidential candidates and congressmen:  tax cuts that overwhelmingly benefit the rich and that are not accompanied with any plans to pay for them.

Should we pay attention to campaign platforms?

Of course there are reasons for hesitating to judge presidential candidates by their platforms.  Plans announced in the campaign are often a poor guide to what the president will actually do once in office.  Candidate George W. Bush, for example, promised in 2000 to renounce nation-building adventures abroad, to maintain fiscal responsibility, and to treat greenhouses gases as pollutants under the Clean Air Act.  Needless to say, his administration rocketed off 180 degrees in the opposite direction on these issues.

Mr. Trump, in particular, changes his positions with head-spinning frequency, denying that he said things that he is on record as having said a short time before.   A common tactic is to accuse the media of making up the earlier statements, even when the earlier statements are on tape.  Another tactic is to say that he was only being sarcastic.

Are we supposed to take seriously, for example, his statements during the primary debates that American workers’ wages are too high?   Or that he could and would happily contemplate negotiating the terms of the national debt with creditors, otherwise known as defaulting?   Are we supposed to overlook such reckless statements, and ascribe them to an earlier period when he was “young and irresponsible”?

Compare the zig-zags that Trump has pulled off with the minor shifts that have been sufficient in the past to get other politicians tarred with “flip-flopping”.  Remember, for example, the reaction when John Kerry in 2004 said “I actually did vote for the $87 billion before I voted against it.”   (The earlier Democratic measure that he supported would have paid for the $87 billion in Iraq war funding by reducing Bush’s tax cuts, whereas  the version that he voted against instead irresponsibly added the cost to the national debt.)

In any case, we policy wonks are obliged to try to evaluate the policy plans that the candidates offer.  The alternative is to leave the national discussion focused entirely on the current week’s poll results, reporting unedifyingly whether the candidates are rising or falling among voters classified by various combinations of gender, ethnicity, and socioeconomic status.

How the parties differ

Some positions that a candidate may truly hold don’t deserve the attention they receive because in practice he or she stands little or no chance of being able to bring them about if elected. An obvious case is when their proposals are blocked by the other party if it has a majority in congress.  Another case is international constraints.  Although there is a lot of attention to trade agreements this year, promises by presidential candidates to negotiate a new improved trade agreement are seldom if ever implementable once they get to office.  (The truth is, in international negotiations such as TPP, the US has already gotten about the best deal it can get, one that is much better than most people realize.)

The difference between the two parties lies not in some fantasized ability to reverse the rise in inequality by turning the clock back 50 years on trade, or even on somehow reversing the long-term shift from manufacturing to services.  Rather the difference lies in some very practical live policy issues, particularly some that would reverse the trend that leaves many workers behind.  Examples include universal health care (extending the ACA, i.e., Obamacare, rather than abolishing it), infrastructure spending ($275 billion cumulative, in Secretary Clinton’s campaign proposal), compensation for those who lose jobs due to trade (or other forces beyond their control), and a more progressive tax structure (including expansion of the Earned Income Tax Credit).

Trump’s tax plan

Trump made his most serious attempt at a fiscal plan on August 8.   The tax proposal has four salient features, fairly described as tax cuts for the rich.  There is no indication how the tax cuts will be paid for and every indication that they will sharply expand the budget deficit, as happened when Reagan and Bush enacted record budget-busting policies.   All of this is very much in line with proposals from Republican politicians over the last four decades, all the while attacking Democrats for running deficits.

  • Trump proposes to abolish the estate tax entirely. Bush and congressional Republicans tried hard to do this, and got close, but didn’t quite make it.  Trump, like his predecessors, tries to hide the fact that only the very rich would benefit because the current estate exemptions are so high:  $10.9 million for the estate of a married couple (and half that for an individual).  In the most recent year available, only 4,700 estates in the entire country, out of 6 million deaths, required the reporting of some estate tax liability.  Trump repeated the old fairy tale of farms or small businesses that have to be sold by heirs to pay the estate tax; but Republicans after all these years are still unable to come up with specific instances of this actually happening.
  • He proposes to cut corporate income taxes very sharply, to 15%. It is true that the US corporate income tax rate is among the highest in the world, at 35%, and that this probably contributes to companies keeping profits overseas, rather than repatriating them to the US.  But as most tax policy experts will tell you, a reduction in the overall rate should be accompanied by base-broadening.  In particular, we should abolish corporate tax deductions such as those designed to encourage corporate debt and oil drilling.  We could thereby reduce harmful distortions in the economy while simultaneously making up revenue.
  • Trump’s proposals to cut personal income taxes have now changed a bit.
    • Before the primaries, his fiscal proposals included cutting the top marginal income tax rate from 39.6 %, the current level, to 25%. Independent analysts pointed out that his tax policies would lose about $10 trillion in revenue over the first decade, a mind-bogglingly big number.  They would rapidly drive to record levels the national debt as a share of GDP, which has been coming down over the last five years.  His most recent proposal is to cut the marginal tax rate for high earners by about half as much, to 33%.
    • A new proposal, apparently added at the urging of daughter Ivanka Trump: Allow tax deductions for the entirety of average child care costs.  Any such deductions benefit only those in high enough tax brackets to itemize deductions (like mortgage interest), which is mostly those who earn more than $75,000.   That is well above US median household income of $54,462 in 2015.

The Democrats would love to be able to accuse Trump of designing his tax cuts so as directly to benefit him, his family, and people like them.   It is harder to make this accusation because the candidate still refuses to release his own income tax records (unlike all previous candidates since Richard Nixon).  There is no shortage of guesses as to what it is that Trump must be trying to hide.  One good guess is that in some years he has paid no taxes at all, by taking advantage of loopholes already available to big real estate developers.  If so, his annual tax bill can’t be cut further.  But he would still gain from the elimination of the estate tax.

How to pretend that tax cuts = fiscal discipline

Basic arithmetic says “government outlays minus tax receipts equals the budget deficit.”  Republican presidential candidates have seemingly had trouble understanding this equation since 1980.  They propose large specific tax cuts without specific spending cuts, and yet claim they are going to reduce the deficit.  The outcome was the record increases in budget deficits during the terms of Ronald Reagan and George W. Bush.

Trump’s tax cut proposals follow in this tradition of fiscal irresponsibility. The budget plans are still too vague — particularly with respect to discretionary government spending, social security and Medicare – to allow an informed estimate of their impact on the federal deficit and national debt.  But the candidate may be subjected to pressure to become more specific as the date of the election draws near.

Trump may look to his predecessors’ strategies for guidance.  It is worth recalling the four magic tricks that politicians calling themselves fiscal conservatives have been using for 35 years, evasions to facilitate making fiscal promises with a straight face.  These tricks are often deployed in sequence, one succeeding another as they fail to work.

(1) The “Magic Asterisk.”   The candidate promises to balance the budget at the same time as cutting taxes by spending cuts that are not specified but supposedly will be in the future (“future savings to be identified”).

(2) “Rosy Scenario.”  One can forecast an increase in tax receipts if one forecasts an increase in the national rate of growth of income.  One PhD economist has finally signed on as an adviser to the Trump campaign (though he has apparently yet to talk to the candidate); he has suggested that under a Trump presidency the American GDP growth rate will magically double.  This is the same tactic adopted by Jeb Bush during the primaries, and many other politicians before.

(3) The Laffer hypothesis.  But why should growth double?   Reagan, Bush, McCain, and other candidates signed on to the proposition that their proposed cuts in tax rates will spur economic activity so much that total tax revenue (the tax rate times the economic base) will go up rather than down.   Although this “Laffer proposition” has been disproved many times, and the economic advisers to those three candidates clearly disavowed it, the temptation to square the budgetary circle by making this claim is too strong to resist.  Watch for Trump to come out with it.

(4) The “Starve the Beast” hypothesis.  Finally, after the other justifications for big tax cuts turned out wrong, Presidents Reagan and Bush fell back on the theory that, even though tax revenue had in fact fallen rather than rising, this was a good thing after all: it would politically force congress to approve spending cuts.  But these are cuts that the president himself never gets around to proposing.

Perhaps it is inevitable that candidates at the platform-making stage wish away such real-world constraints as congressional politics or international realities, leaving voters disappointed after taking office by failed “promises”.  But politicians shouldn’t be able to wish away the constraints of arithmetic — not when the promises reflect the same failed sleight of hand that has been tried and exposed so many times before.

Posted in 2016 Presidential Campaign, Fiscal, Tax | Tagged , | Leave a comment

Trump Jr.’s Pants-on-Fire Allegation of Manipulated Jobs Numbers

When asked July 24 about US unemployment numbers, which have fallen steadily since 2010, Donald Trump Jr., replied “These are artificial numbers. These are numbers that are massaged to make the existing economy look good, to make this administration look good when, in fact, it’s a total disaster.”  His father has made similar statements.

PolitiFact asked a variety of experts about the quote.   Their bottom line:  the quote from the younger Trump was a “Pants on Fire” lie.  The truth is that presidents don’t and can’t manipulate the jobs numbers.  No White House has even tried — at least not since Richard Nixon made a heavy-handed attempt in 1971 to interfere with BLS staffing.  After that, extra firewalls were put in place.

Here is my own full response to PolitiFact’s question regarding the Trump claim:

The statement is 100% false. The employment numbers come from the Bureau of Labor Statistics (part of the Labor Department).  In this administration, like every administration, those who produce the employment statistics are long-time nonpolitical professionals. The Secretary of Labor does not even know what the numbers are going to be when they are announced every month (the morning of the first Friday of the month).

Allegations that the official government numbers understate unemployment are sometimes based on a claim that some higher measure (which, for example, includes discouraged workers who have given up looking for a job, or part-time workers), should be used in place of the ones that get the most attention in the press.  But these other measures are also made publicly available by the BLS and the press is free to write about them as much as they want.

The important thing, of course, is to be consistent across time in which measure you use.  It wouldn’t be right to switch from looking at the conventional rate to a measure that includes discouraged workers just because you don’t like the incumbent president and want to make things look bad for him.

Posted in 2016 Presidential Campaign, Employment, Fact-check, Labor Markets & Jobs, Obama Administration | Tagged , , , , , | Leave a comment

Brexit, Trump, and Workers Left Behind

Observers have pointed out many parallels between the June referendum on Brexit in the United Kingdom and Donald Trump’s presidential campaign in the US.  One parallel is that both the British movement to leave the EU and the Trump campaign for the American Republican nomination achieved success that few had expected, particularly not the various elites.  In both cases, the general interpretation is that the elites underestimated the anger of working class voters who feel they have been left behind by economic forces in a fast-changing world, and in particular by globalization.

Another parallel is the centrality to both campaigns of promises that are close to logically impossible, and the consequent inevitability with which supporters will feel betrayed when the promises do not come true.  In the United Kingdom, one of the promises that cannot be kept is that if Britain left the EU it could somehow still keep the same trade access to its members, while yet reducing immigration by curtailing free mobility of persons.  Another promise that cannot be kept is that the £350 million ($465 million) supposedly sent to the EU each week would be reallocated to the cash-strapped National Health Service.  On my side of the Atlantic, Trump says that he will bring back the manufacturing jobs that have disappeared. Secondly, as most Republican candidates do, he promises to enact big tax cuts while simultaneously reducing the budget deficit or even the national debt.

It is true that, for some years, most national income gains have been going to those at the very top, with many workers having fallen behind.  Apparently this inequality and globalization, and the perceived connection between the two, play a large role in the anger among many workers that we see in the Brexit and Trump campaigns.  It is far from clear that either trade or migration is in fact among the top reasons for widening inequality. But that is the way many see it.

It is certainly true that globalization produces both winners and losers.  How can the concerns of angry workers be addressed?

A fundamental proposition in economics holds that when individuals are free to engage in trade, the size of the economic pie increases enough that the winners could in theory compensate the losers, in which case everyone would be better off. Formally it is a case of what economists call the Second Fundamental Welfare Theorem.   (The proposition requires that there be no market failures like monopolies or pollution externalities.)

Skeptics of globalization may understand this theorem and yet, quite reasonably, point out that the compensation in practice tends to remain hypothetical.   Some of the skeptics suggest that we should recognize political reality, take the failure to compensate losers as given, and so work on trying to slow down or roll back globalization.   But an alternative would be the reverse strategy: to take globalization as given and instead work on trying to help those who are in danger of being left behind.

The second strategy is the sensible one, not the first.  For one thing, it would be difficult to roll back globalization even if we wanted to.  Presumably the policies would include attempting to renegotiate NAFTA or TPP (or, for Britain, the EU), or dropping out of the World Trade Organization, or else unilaterally imposing tariffs and quotas even though they violate existing international agreements.  Even leaving aside the negative effects of trade wars on economic growth, anything that a president does would be very unlikely to bring trade back down to the levels of 50 years ago, and still less likely to bring the number of steel jobs back up to the levels of 50 years ago.   Globalization is a reality.

That we can’t turn back the clock on globalization is understood fairly widely.  But a second point is less often made.  In the context of US presidential elections, the choice between the two parties is less a referendum on globalization than it is a choice whether to adopt the specific policies that would help those who are in danger of being left behind.   Much is new and different in the 2016 election, but not that.

Policies to help those who are left behind [or, in clinical theoretical terms, to compensate the losers] are precisely where the two parties disagree.  They most effective measures, as I see it, are ones that Hillary Clinton and Barack Obama, like his predecessors, try to push and that the Republicans try to block.

The main program to help specifically those who have lost their jobs due to trade is Trade Adjustment Assistance.  But why help only the small number of workers who have identifiably lost their jobs due to trade agreements?  Wouldn’t it be better to help those who have been left behind regardless if the cause is trade, technology, or something else?  Sensible policies to do that include wage insurance, an expanded Earned Income Tax Credit and universal health insurance, among others.  Also: a more progressive payroll tax structure, universal quality pre-school, and infrastructure investment spending.  These are all policies favored by Democrats.  Most have been opposed by Republicans. [Still, one hopes that even if a second President Clinton once again had to deal with a Republican Congress, the two might be able to find common ground in the EITC and infrastructure investment.]

Not long ago, it was possible to admire the sort of political equilibrium achieved by the British electoral system.  The two largest parties tended to be led by relatively competent and consistent leaders who represented relatively well-demarcated stances on the issues: right-of-center in the case of the Conservatives and left-of-center on the part of Labor.  Voters could make their choices based on the policy issues.  Under a parliamentary system, the victorious prime minister could work to carry out the policies that he or she had campaigned on.  It compared favorably to the ever-worsening gridlock of the American system, where presidential initiatives could and would be blocked by congressmen from the opposite party, even when the initiatives were consistent with philosophies that they themselves had espoused in the past.

To state the obvious, the British system has broken down.   Some of those competent leaders eventually made fatefully ill-advised decisions: Margaret Thatcher’s poll tax, Tony Blair’s support for the US invasion of Iraq, and David Cameron’s decision to hold the Brexit referendum. What is now left is a mess.  It is hard to discern much clarity or consistency in the new crop of English politicians.  When the next election is eventually held, the voters could well be asked to choose between parties that do not correspond in any clear way to the relevant policy decisions that Britain must make, mainly whether to seek to negotiate a relatively close association with the EU or to cut off completely.

In some familiar ways the American political system has also deteriorated in this election cycle, bringing past trends to a reductio ad absurdum.  But the American political situation at the moment has an advantage that the Brits lack: ability for voters to choose what is to be the national policy orientation. The Democrats still favor policies like wage insurance and universal health insurance and the Republicans still oppose them. So American voters in 2016 are still able to make the relevant choice, either for or against policies that deal with the reality of globalization by helping those who are left behind.

Posted in 2016 Presidential Campaign, Europe, International Trade, Trade | Leave a comment

A Way to Save the United Kingdom

I see a possible way out for the trap that Brits now find themselves in, a way to keep Great Britain great.

  1.  The Scots, under Nicola Sturgeon (First Minister of Scotland), would decide immediately that they will hold a new referendum on independence.  This referendum would state explicitly that if the United Kingdom decides to stay in the EU then Scotland will stay in the UK, but if Britain leaves the EU then Scotland will leave the UK.  The decision to hold a referendum on conditional Scottish independence would be approved by the Westminster parliament.
  2. That referendum would create a constitutional crisis in Great Britain. This constitutional crisis would genuinely justify a second UK referendum on whether to leave the EU (Brexit), in a way that mere second thoughts after the June 23 outcome do not otherwise justify.  Historically, the “Great” was added when Scotland joined the union.  It became the “United Kingdom” when Ireland joined.   Symbolically: those patriotic Englishmen who campaigned on the Leave side were (mostly) waving the Union Jack.  If Scotland were to leave, it would be the end of the Union Jack — where the cross of St. Andrew stands for Scotland, the cross of St. Patrick stands for Northern Ireland, and only the cross of St. George stands for England.
  3. In this second Brexit referendum, the Remain campaign will pick up votes of those committed to preserving the UK intact — in addition to any who have now learned that the leaders of the Leave campaign cannot fulfill promises made regarding immigration, trade, and budget savings.   Perhaps the outcome will come out pro-EU this time, which is what happened in the past when other European countries reversed initial anti-integration referenda, in both Ireland and Denmark.  (If the EU were willing to make further concessions to the UK that would also help, of course; but it cannot be expected to do so.)
  4. This plan would be pursued by a coalition of four: Sturgeon, some new anti-Brexit Tory leader, some anti-Brexit Labor politician, and Tim Farron (of the Liberal Democrats).  During the period of uncertainty over Scotland, the prime-ministership, the leadership of these three British parties and indeed the very existence of the parties would remain also uncertain.  This political crisis further justifies the fundamental rethink.  At some point there would be a new general election, fought along Remain/Leave lines.  As part of the Remain campaign, its leaders should spell out policies to improve living standards for those who feel they have lost out to globalization and European integration.
  5. Meanwhile, many continental EU leaders will demand that the UK invoke article 50, to start the process of actually leaving.  But the UK parliament would nevertheless refrain from doing it, until the referendum process has played itself out.
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Does the Economy Really Do Better Under Democratic Presidents?

Hillary Clinton has been saying that the US economy does much better when a Democrat is president than when a Republican is.  When the press goes to fact-check the claim, they can be forgiven for having  a presumption that it can’t be 100 per cent true.  After all, if it were completely true, then wouldn’t we all already know it?

Well, there is no other way to say this: The claim is 100 per cent true.

The qualifier is that the president is only one of many influences of what happens to the economy.   Luck of course plays a big role.  Hillary’s speeches don’t include footnotes making this obvious point.  But that doesn’t justify a rating of only “half true” for Clinton’s claim, as some fact-checkers proclaim.  And the surprising reality is that the difference in economic performance between Democratic and Republican presidents is sufficiently systematic that it cannot be statistically attributed to mere chance alone.

The gap in economic performance

She says (e.g., June 5, 2016), “It is a fact that the economy does better when we have a Democrat in the White House.”  What is the evidence for this claim?

A timely and careful statistical study was published in April in the American Economic Review[106(4): 1015-45] by Alan Blinder and Mark Watson of Princeton University:  “Presidents and the US Economy: An Econometric Exploration.”   The starting point, the central fact, is that the rate of growth of GDP has averaged 4.3 percent during Democratic administrations versus 2.5 under Republicans, a remarkable difference of 1.8 percentage points.  This is postwar data, covering 16 complete presidential terms—from Truman through Obama.  If one goes back further, before World War II, to include Hoover and Roosevelt, the difference in growth rates is even stronger.

The results are similar regardless whether one assigns responsibility for the first quarter of a president’s term (or the first few quarters), to him or to his predecessor.

Of course many political actors in Washington influence the course of events.  Blinder and Watson find that the economy does a bit better if the Democrats have appointed the Federal Reserve chairman or if they control the Congress.  But these conditions are not necessary for the central result:  it is the party of the presidency that makes the big difference.

Furthermore, over the 256 quarters in these 16 presidential terms, the US economy was in recession for 1.1 quarters during the average Democratic presidency and 4.6 quarters during the Republican terms, a startlingly big difference.  These gaps in performance are highly significant statistically.  The odds that they are the result of mere chance are 1 in a 100 or less.

The two Princeton economists find superior results by other measures as well, including the change in unemployment during the president’s term and the performance of the stock market.  The unemployment rate fell by 0.8 percentage points under Democrats on average and rose by 1.1 under Republicans, a significant gap of 1.9 percentage points. Perhaps better known than the other economic statistics, returns in the S&P 500 have been higher under Democrats:  8.4% versus 2.7 % for a differential of 5.7% (though this differential is not as significant statistically, because stock market prices are so volatile).  Also the structural budget deficit is smaller under Democratic presidents (1.5% of potential GDP) than Republicans (2.2%). But the authors mainly focus on GDP.

Could it be chance?

One does not need to understand fancy econometrics to understand how unlikely it is that chance alone could have produced such big differences in outcomes.  Economists use sophisticated econometrics when publishing an article in the AER, the top peer-reviewed journal; but sometimes simpler calculations are more effective.  Consider some very simple facts, which anyone can easily check for themselves.  The last four recessions all started while a Republican was in the White House. If the chances of a recessions starting during a Democrat’s term were equal to that of a Republican’s term, the odds of getting that outcome would be (1/2)(1/2)(1/2)(1/2), i.e., one out of 16.  Just like the odds of getting “heads” on four out of four coin-flips.  Not especially likely.

Still, four data points constitute a very small sample.  So let’s go back ten business cycles.  By my count nine of the last ten recessions have started under Republican presidents.   The odds of the Democrats doing that well just by chance are about 1 in a hundred.  (Anyone can easily check the recession dates for themselves, at the site of the NBER Business Cycle Dating Committee.)

An even more startling fact emerges from a review of the last 8 times when an incumbent from one party handed over the White House to a president from the other party.  In four of these transitions, a Democrat was succeeded by a Republican; each time the growth rate went down from one term to the next.  In four of the transitions, a Republican was succeeded by a Democrat; each time the growth rate went up.  No exceptions, as Blinder and Watson point out.  Eight out of eight.  What are the odds of this happening by chance?   The answer is the same as the odds of getting heads on 8 coin tosses in a row:    ½ times itself 8 times, which is 1 out of 256.  I.e., ¼ of 1 percent.  Very unlikely.

Fact-checkers

Given the strength of these results, it is surprising that Hillary Clinton’s claims have been rated as only “half true” by some media, including the Pulitzer Prize-winning PolitFact. Its source appears to be a particular fact-checker in Arizona.  (I feel a personal stake in setting the record straight, because I am inexplicably quoted as supporting this finding that the claim is only “half-true.”  I had told the Arizona interviewer that the claim of a performance gap was clearly true, even though finding the gap was not the same as proving its cause.)  The “false balance” syndrome strikes again.

The first half of the Blinder-Watson paper reports the aforementioned numbers showing the difference in how the economy has behaved under the two parties. This difference seems incontrovertible.  The second half of the paper tries econometrically to identify causes for the gap.  Here the authors are less successful, because it is inherently a much harder task.  The precise reasons  for the surprisingly big differential are unknown.

They find some evidence of four or five factors that may together explain 56% of the gap between growth rates under the two parties:  oil shocks, productivity growth, defense spending, foreign economic growth, and consumer confidence.  It is impossible to know whether some of these five factors may have been influenced by the policies of US presidents.  We know still less about the channels that might explain the remaining 44% of the gap.  Thus it is impossible to say to what extent specific policies adopted by presidents are responsible for the difference in economic performance.

This is the reason that the fact-checkers give for rating Hillary’s claim as only half true.  But her claim was that the gap in performance exists, not what were the specific causal channels.  The claim that a gap exists is not the same thing as a claim to have identified the policies that contributed to the gap, let alone a claim that they explain the entire gap.

The fact-checkers also make much of a finding by Blinder and Watson that, contrary to widespread assumptions, fiscal and monetary policies are not more “pro-growth” (i.e., expansionary) under Democrats than under Republican presidents, and therefore can’t explain any of the performance differential.  But, in the first place, presidents make lots of policy decisions beyond fiscal and monetary stimulus, including energy, anti-trust, regulation, trade, labor, foreign policy, and much more.   There is no way to test econometrically this myriad of policies.

In the second place, leading Republican politicians claim to believe that easy money and highspending hurt the economy rather than helping it.   At least, they claim to believe that when they are out of office, and especially if the economy is weak, as in the post-2008 environment.  (When they are in office, they tend to find that they rather like spending money, even if the economy doesn’t need it.  Remember, for example, when Vice President Richard Cheney reportedly said “Reagan proved that deficits don’t matter.”   It should not be news that Ronald Reagan and George W. Bush cut taxes and increased spending, whereas Bill Clinton acted to bring the budget deficit down.)

Regardless, let’s be clear about the central finding.  Hillary Clinton’s claim that the economy does better on average when a Democrat is in the White House is true, judging from past history.  And the difference is large enough that it cannot be attributed to pure chance.

 

Posted in 2016 Presidential Campaign, Clinton, Conservatives and Liberals, economics, Fact-check, Hillary | Leave a comment

Addressing Commodity Price Volatility in Algeria & Morocco

I recently visited Algeria and Morocco.  Like so many other developing countries, they are dealing with the sharp decline in global commodity prices that has taken place over the last few years.  In meetings in Algiers and Casablanca, I offered four concrete ideas for policies to help commodity-exporting countries deal with global price volatility.  The four proposals, very briefly, are: (1) hedging with options (as Mexico does), (2) commodity bonds, (3) countercyclical fiscal institutions (like Chile’s), and (4) central bank targeting of a currency-plus-commodity basket.

In Rabat, I further discussed countercyclical fiscal policy  and also at the OCP Policy Center did a video interview that included recent global economic developments.

It is easier to suggest ways to insure against a fall in the terms of trade when prices are high, as they were five years ago, than it is to give advice after the crash has already happened.  But I was pleased to learn that Morocco is on the list of countries — which includes also the UAE, India, Indonesia, among others – that have cut hugely wasteful consumer energy subsidies in recent years.   Algeria needs to do the same. It is running a budget deficit of 16% of GDP, most of which can be accounted for by subsidies to energy, food and water.  It is much easier politically to reform such subsidies at a time of falling world prices for energy and other commodities than in normal times.

Posted in Africa and commodities, Commodities, Exchange Rates | Tagged , , , , | Leave a comment

Fiscal Education for the G-7

As the G-7 Leaders gather in Ise-Shima, Japan, on May 26-27, the still fragile global economy is on their minds.  They would like a road map to address stagnant growth. Their approach should be to talk less about currency wars and more about fiscal policy.

Fiscal policy vs. monetary policy

Under the conditions that have prevailed in most major countries over the last ten years, we have reason to think that fiscal policy is a more powerful tool for affecting the level of economic activity, as compared to monetary policy.  The explanation can be found in elementary macroeconomics textbooks and has been confirmed in recent empirical research:  the effects of fiscal stimulus are not likely to be limited, as in more normal times, by driving up interest rates, crowding out private demand, running into capacity constraints, provoking excessive inflation, or overheating in other ways.  Despite the power of fiscal policy under recent conditions, economists continue to lavish more attention on monetary policy.  Why?

Sometimes I think the honest reason we economics professors are attracted to monetary policy is that central bankers tend to be like us, with PhDs, and to hold nice conferences.

The reason that one usually hears, however, is that fiscal policy is “politically constrained.”   This is an accurate statement, but not a good reason for us to give up on it.  Indeed, if the political process gets fiscal policy wrong, which it does, that is all the more reason for economists to offer their contributions.

Of course if one is a central banker, or is advising a central banker, then one must concentrate on the job at hand, which is monetary policy.  But precisely because there is a limit to what central bankers can say about fiscal policy, there is more need for the rest of us to do it.

The heyday of activist fiscal policy was 50 years ago. The position “we are all Keynesians now” was attributed to Milton Friedman in 1965 and to Richard Nixon in 1971.  In the late 20thcentury, most advanced countries managed to pursue countercyclical fiscal policy on average: generally reining in spending or raising taxes during periods of economic expansion and enacting fiscal stimulus during recessions. The result on average was to smooth out the business cycle (as Keynes had intended).  It was the developing countries that tended to follow procyclical or destabilizing policies.

Leaders forget how to do counter-cyclical fiscal policy in the US, Europe and Japan

After 2000, however, some countries broke out of their familiar patterns. Too many political leaders in advanced countries pursued procyclical budgetary policies: they sought fiscal stimulus at times when the economy was already booming, thereby exaggerating the upswing, followed by fiscal austerity when the economy turns down, thereby exacerbating the recession.

Consider mistakes in fiscal policy made by leaders in three parts of the world — the US, Europe, and Japan.

US President George W. Bush began the century by throwing away the large fiscal surpluses that he had inherited from Bill Clinton, and then continued with big tax cuts and rapid spending increases even during 2003-07, as the economy reached its peak.  It was during this period that Vice President Cheney reportedly said “Reagan proved that deficits don’t matter.”

Predictably, the rising debt left the government feeling less able to enact fiscal stimulus when it was really needed, after the Great Recession hit in December 2007.  At precisely the wrong time, Republicans “got religion” deciding that deficits were bad after all.  Thus when President  Barack Obama took office in January 2009, with the economy in freefall, the opposition party voted against his fiscal stimulus.  Fortunately they failed then, and the stimulus was able to make a big contribution to reversing the freefall in the economy in 2009.  But having regained the Congress in 2011, they did succeed in blocking Obama’s further attempts to stimulate the still-weak economy for three years. The Republicans appear to be consistently procyclical.

Greece is the “poster boy” of an advanced country that unhappily switched to a systematically procyclical fiscal policy after the turn of the current century.  Its first mistake was to run excessive budget deficits during the expansionary period 2003-08 (like the Bush Administration).  Then, as if operating under the theory that “two wrongs make a right,” Greece was induced after its crisis hit to adopt tight austerity in 2010, which greatly worsened the fall in GDP. The goal was to restore its debt/GDP ratio to a sustainable path; but instead the ratio rose at a sharply accelerated rate, because of the fall in GDP.

Europeans suffer even more than other countries from basing their budget plans on official forecasts that are unnecessarily biased, which can lead to procyclical fiscal policy.   Before 2008, not just Greece, but all euro members were overly optimistic in their forecast and so at times “unexpectedly” exceeded the 3% ceilings on their budget deficits.  After 2008, qualitatively similar stories of procyclical fiscal contraction, leading to falling income and accelerating debt/GDP, also held in Ireland, Portugal, Spain and Italy.

The native land of austerity philosophy is, of course, Germany.  The Germans had (reluctantly) gone along with an agreement at the London G-20 Leaders Summit of April 2009 that the US, China, and other major countries would expand demand in order to address the Great Recession.  But when the Greek crisis hit at the end of that year, the Germans reverted to their deeply held beliefs in fiscal rectitude.

At first the IMF went along with the other members of the troika in believing — or at least pretending to believe — that fiscal discipline in the European periphery countries would not greatly damage their GDPs and thus could restore their debt/GDP ratios to sustainable paths.  But in January 2013, Fund Chief Economist Olivier Blanchard released a paper that was widely interpreted as a mea culpa.  It concluded that fiscal multipliers were much higher than the IMF (among other forecasters) had thought, suggesting that the austerity programs might have been excessive.  This conclusion was based on a statistical finding that the countries which had attempted the biggest fiscal retrenchment in response to the crisis turned out to experience the most damage to GDP relative to what the IMF forecasters had expected. Today, IMF Managing Director Christine Lagarde explains to the Germans that Greece cannot achieve the elusive path of a sustainable debt/GDP ratio if it is not given further debt relief and is instead told to run primary budget surpluses of 3 ½ percent of GDP.

Now to Japan, host of this week’s G-7 meeting.  In April 2014, even though the economy had been so weak that the Bank of Japan had been pursuing aggressive quantitative easing, Prime Minister Abe went ahead with a planned increase in the consumption tax (from 5% to 8%).  As many had predicted, Japan immediately went back into recession.  Even though the first arrow of Abenomics, the monetary stimulus, had been fired appropriately, it was evidently less powerful than the second arrow, fiscal policy, which unfortunately had been fired in the wrong direction.

Prime Minister Abe has indicated that he is sticking with his plan to go ahead with a further rise in the consumption tax (to 10%), scheduled for April 2017.  It is easy to see why Japanese officials worry about the country’s huge national debt.  But, as near-zero interest rates signal, creditworthiness is not the current problem; weakness in the economy is.  A more effective way of addressing the long-run sustainability of the debt is to announce a 20-year path of very small annual increases in the consumption tax, calculated so as to demonstrate to investors that the ratio of debt to GDP will come down in the long term.

Developing countries

Not all is bleak on the country scoreboard of cyclicality.  Some developing countries didachieve countercyclicalfiscal policy after 2000.  They took advantage of the boom years to run budget surpluses, pay down debt and build up reserves, which allowed them the fiscal space to ease up when the 2008-09 crisis hit.  Chile is the poster boy of those who “graduated” from procyclicality. Others include Botswana, Malaysia, Indonesia, and Korea.  China’s 2009 stimulus was very countercyclical.

Unfortunately some, like Thailand, who achieved countercyclicality in the last decade, have suffered backsliding since then.  Brazil, for example, failed to take advantage of the renewed commodity boom of 2010-11 to eliminate its budget deficit, which explains much of the mess it is in today now that commodity prices have fallen.

Politicians everywhere might improve their game if they re-read their introductory macroeconomics textbooks.

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Talk on trade: TPP & Trump

The ITC Wednesday released its mandated report on the economic effects estimated to result from the TransPacific Partnership.  As is usual in standard trade models, the estimated welfare gains may sound small: on the order of ¼ % of income.  But that would still be way worth doing.    Furthermore the ITC study, by design, leaves out a lot.  For example, the Petri-Plummer study from the Peterson Institute estimates income gains from TPP that are twice as large, in part because it takes into account Melitz-style opportunities for  more productive firms to expand.

I am quoted twice in the associated press coverage this week. They can be tweetably summarized in one sentence:
(1) US rejection of TPP would signal withdrawal from Asia; (2) US acceptance of Trump would signal withdrawal from the entire world!

(1)   One quote appeared in an Associated Press article (titled “Complex US politics of trade will follow Obama to Asia”):
“Many in Asia have come to think that maybe they can’t depend on us, that we’re withdrawing.  That feeling may be worse in this presidential election year,” says Professor Jeffrey Frankel of Harvard University‘s Kennedy School of Government. “The international relations aspect of this is if we don’t pass TPP, Asians are going to interpret it as a U.S. withdrawal from their region. And they’re going to get closer to China.”

(2) Another appeared in a Financial Times article today (titled “Obama fights back against Trump over US trade deals”):
“It is hard to believe he would really be able to follow through — much of it is illegal [and] contradicts US international agreements,” Jeffrey Frankel, a professor at Harvard’s Kennedy School of Government, said of Mr Trump’s economic agenda. “The global impact of that would be tearing down the entire postwar international . . . order.”  

Posted in Budget, Bush business cycle, Change, Congress, Copenhagen, Crisis debt, Deficit, ECB emission, Employment, Euro, Europe, Exchange Rates, Expansion, Fed, Feldstein, Fiscal, Forecast, G20, GDP, George W. Bush, Gold, Greece, Growth, Jobs, Kyoto, NBER, Obama Administration, Oil, Reagan, Recession, Recovery, Renminbi, Tax, TPP, Yuan | Leave a comment

The Domestic Threat to US Leadership

US President Barack Obama has racked up a series of foreign-policy triumphs over the last 12 months. But one that has gained less attention than others was the passage last December of legislation to reform the International Monetary Fund, after five years of obstruction by the US Congress. As the IMF convenes in Washington, DC, for its annual spring meetings on April 15-17, we should pause to savor the importance of this achievement. After all, if the United States had let yet another year go by without ratifying the IMF quota reform, it would have essentially handed over the keys of global economic leadership to China.

The IMF reform was crucial: The allocation of monetary contributions and voting power among member countries had to be updated to reflect the shifts in global economic power in recent decades. Specifically, emerging-market economies like Brazil, China, and India gained a larger role, primarily at the expense of European and Persian Gulf countries.

Obama managed to persuade the leaders of the other G-20 countries to agree to the reform at a 2010 summit in Seoul. The deal’s subsequent approval should have been a no-brainer for Congress, as it neither increased America’s financial obligations nor took away its voting dominance. More important, the reform represented a golden opportunity for the US to demonstrate global leadership, by recognizing that the existing international order must accommodate changing economic-power dynamics.

Instead, Congress attempted to block IMF reform, effectively denying China its rightful place at the table of global governance. “Moving the goal posts” could succeed only in driving the Chinese to establish their own institutions. In this sense, Congressional intransigence may have undermined America’s position in its competition with China for global power and influence.

To most Asians, the US is a more attractive regional hegemon than a China that has been aggressively pursuing territorial claims in the East and South China Seas. But recent US behavior has caused some Asian countries to begin to question America’s commitment to supporting regional security and prosperity.

Against this background, many countries, both inside and outside Asia, were happy to join the China-led Asian Infrastructure Investment Bank, which promised to meet some of the region’s financing needs. The AIIB’s establishment in December was widely viewed as a severe diplomatic setback for the US.

Fortunately, thanks to Obama’s recent string of successes in terms of global engagement, the US now has a chance to get back into the game. Last April, his administration oversaw a breakthrough agreement with Iran over its nuclear program. Moreover, in October, Congress was persuaded to give it Trade Promotion Authority, enabling the completion of the 12-country Trans-Pacific Partnership (TPP). More recently, the US has reestablished diplomatic relations with Cuba, ending a 55-year policy of isolation that succeeded only in giving Cuba’s leaders an excuse for economic failure and handicapping America’s relationships throughout Latin America.

Finally, representatives of the 195 parties to the UN Framework Convention on Climate Change reached an agreement in Paris last December to reduce greenhouse-gas emissions, spurred in no small part by earlier action by Obama and Chinese President Xi Jinping. The two leaders are scheduled to sign the Paris agreement on April 22 on behalf of their respective countries, the world’s two largest emitters of greenhouse gases. Add to that the ratification, at long last, of IMF reform, and the US does seem to be on a global winning streak.

None of these five achievements could have been predicted a year ago. With the Republicans having taken full control of the Congress in November 2014, the overwhelming conventional wisdom was that the administration would be blocked from accomplishing much in its final two years.

Making matters worse, internationalism attracts opposition from the far left as well as the far right. Though trade is the most obvious example, it is not the only one. Beyond opposing the TPP, US presidential candidate Bernie Sanders has historically joined with congressional Republicans in trying to block efforts to rescue emerging-market countries in Latin America and Asia at times of financial crisis. These rescues are invariably called “bailouts,” even when they cost the US nothing – the US Treasury actually made a profit on the 1995 loan to Mexico that Sanders opposed – and help sustain economic growth. Similarly, New York Senator Chuck Schumer joined the Republicans in trying to block the Iran nuclear agreement.

Obama’s recent international successes are not unassailable. Although the IMF deal is done, Obama’s other key initiatives could still be derailed by US politics, especially if the political extremes unite. Congress could reject the TPP, in effect telling Asia it is on its own. It could undermine the emerging relationship with Cuba; after all, it has yet to repeal the embargo. As for the Paris agreement, a federal appeals court will first hear a challenge to the administration’s implementation strategy, the Clean Power Plan, on June 2.

 

Posted in 2016 Presidential Campaign, Europe, IMF Reform, International Monetary Fund, Obama Administration | Leave a comment

No, Japan Does Not Intervene in FX These Days

There has been recent speculation that the Japanese authorities might intervene to push down the yen.  One can see the reasoning.  The yen has appreciated against the dollar by about 9 per cent this year, even though the fundamentals have gone the other way: weak growth and renewed easing of monetary policy.

Saturday’s Financial Times even cites BNY Mellon as saying of the Bank of Japan, “Since mid-1993, they have on average intervened once every 20 trading days in dollar-yen.”   But this is misleading.  The period of frequent intervention was in the 1980s and 1990s.  The Japanese have rarely intervened in the foreign exchange market since 2004.  The last time was in 2011, in cooperation with the US and others, to dampen a strong appreciation of the yen that came in the aftermath of the Tohoku earthquake and tsunami.

The G-7 partners in February 2013 agreed to refrain from foreign exchange intervention, in a US-led effort to short-circuit fears of competitive depreciation (a sort of truce in the supposed “currency wars”).   Intervention will return some day.  But it strikes me as unlikely that the Bank of Japan would intervene now without the cooperation of the US (and other G-7 partners); and unlikely that the latter would agree at the current juncture.

 

Posted in Dollar, Exchange Rates, Foreign exchange, Intervention, Investing, Japan, Yen | Leave a comment