Tag Archives: crisis

Economy in Decline (part 1 of a 3 part series)

 

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More evidence surfaces in spite of Bush tax cuts, bank support and lower interest rates.

 

With more bad economic news pointing toward bank failures, business closures and layoffs, politicians on both sides of the aisle are crafting plans to aid the economy.  As the recession teeters on the brink of an even deeper slump, politicians are reaching for ever-larger and less traditional solutions.

The next few weeks will unleash an unprecedented national recovery program.  This three part series will examine the problems, proposed solutions and politics of the economic crisis.

What We Know

 

While Republicans and Democrats certainly have different philosophical beliefs about the causes, both sides agree we are in a severe recession.  The growth rate of the economy has fallen (by 3.8 percent annual rate last quarter) and unemployment is now rising significantly as a result.  This recession is more precarious than many others in that the failings of two specific industries, the financial industry and real estate, have seen extreme shifts and have threatened to slow other sectors of the economy dramatically beyond a “normal” recession.


The financial industry collapse is particularly devastating because it is restricting financing to consumers and businesses, which must further curtail their activity to avoid risking hardship and failure.  The deflation in real estate has undermined American wealth and confidence since so many counted their home as a no-risk asset and investment vehicle. 

Stakes Are High

 

Economists fear that the speed, breadth and worldwide scope of decline could lead to a downward spiral in world economies.  Markers of this decline include extremely high unemployment rates, poor business confidence and long-term economic stagnation with low or negative GDP growth.  The decline in gross domestic product for the U.S. in the first quarter of 2009 is already anticipated to be at a -5 percent annual rate.

The choices for private businesses under stress are limited.  Either downsize and try to weather the economic storm, file bankruptcy and try to maintain operations in a leaner structure, or shut down.  In some cases, the writing is on the wall; in others, it depends on how long the recession lasts.

In the face of this economic distress, the Bush administration moved to support the economy as a whole and the institutions in greatest risk of failure.  Interest rates were lowered to promote borrowing for future business activity.  Taxes were lowered so the public could spend more.  Controversially, banks were given public funds to keep them in business.


What We Don’t Know

 

Unfortunately, neither interest rate cuts, tax cuts, nor bank bailouts have stopped the decline.  It is not just the fact that government action can take many months or years to filter its way through the economy and show up in statistics.  In the immediate term, the banking system continues to fail, the real estate market continues to worsen and the economy stands on the doorstep of a significant period of decline.  

Adding to these larger-than-life issues is the fact that many Americans are facing the reality of large-scale layoffs.

No recovery can occur until the banking crisis and real estate decline have stabilized.  These problems require extraordinary solutions that will be costly, uncertain and politically unpopular.   Yet, only once a permanent fix has been set in place, can the government’s plans for stimulus have meaningful effect.

The next parts of this series will focus on the Obama administration’s banking and real estate fixes, as well as the Congressional stimulus proposals and their effectiveness at returning the economy to health and prosperity.

The Obama administration has promised to present proposals on these issues in coming weeks.

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Our Government in Action — Will Stimulus Succeed?

By Marc Seltzer; originally published on November 17, 2008, at politicsunlocked.com

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Know Your History
The Federal Reserve lowered interest rates back in 2007, with hopes of persuading businesses to borrow more money, bolstering their operations and growth.  Unfortunately, there is a considerable lag time between when rate cuts are enacted and resulting increases in business activity occur.  These rate cuts may have stopped even more dramatic declines than we are currently seeing, but they certainly have not reversed the downward slide in stock prices or business activity leading the global recession.

Consumer and business spending reflects confidence in stable prices, employment and business prospects.  As exploding oil prices sucked up a disproportionate share of family budgets and business profits and as real estate values declined, confidence fell.  Now, with the unemployment rate rising significantly, people are increasingly less confident, and more importantly, spending less, regardless of whether they have a job or not.

Now What?
The talk in Washington and near water-coolers around the country, concerns fiscal policy related to revenue and spending.

There are two approaches:  Lowering taxes to leave money in private hands and government spending to boost commercial activity and jobs.

Polls have found that the middle class tended to pay off debts and save for a rainy day with recent tax rebates, although these rebates were meant to stimulate spending in the economy.  Small tax cuts for a distressed middle class may ease hardship in the heartland, but have not stimulated the economy as predicted.

On the other hand, rebates for the lowest income segment of society are immediately put back into the economy, being used on day-to-day necessities.  Tax cuts for wealthy Americans may promote entrepreneurial enterprise, but were already significantly lowered during the Bush administration.

President-elect Obama campaigned against the widening gap between the richest members of society and the middle class, so it is unlikely he will lower high-end income taxes further.  However, Obama may decide to delay repealing Bush’s tax cuts for the wealthy, so that in the near term, this money could enter the economy directly rather than being paid to the government.

Government spending programs also face a significant delay from the passage of legislation until full implementation.  If we could predict recessions more than a year in advance, it would be highly advantageous to commence most of our nation’s infrastructure spending before recessions and slow public spending when the economy heats up.

Traditional stimulus legislation allocates public money for infrastructure, although bailing out the auto industry could also be seen as maintaining or promoting economic activity.  Spending on defense programs such as FDR’s Manhattan Project or Reagan’s Strategic Defense Initiative, “Star Wars,” also created jobs, as did civilian spending, such as the Kennedy’s Moon Mission and the great dams of the Tennessee Valley Authority.  “Star Wars” led to a boom in civilian software and Internet technologies, which were responsible for a lion’s share of the prosperity and productivity gains in the 1990s.

President-elect Obama gave a hint of his thinking on fiscal stimulus recently, responding to a reporter’s question about aid to the auto industry, “It should be a bridge to somewhere, not a bridge to nowhere.”

The real risk with government spending is not deficit, but waste.  Temporary deficit spending that produces a stronger economy, more prepared to compete in the global marketplace, is well worth the cost.  Infrastructure such as bridges, ports, green technology and alternative energy or even a trained and educated workforce, that advances the productivity and competitiveness of the nation, creates employment and serves the long-range national interest.

However, if the money only temporarily stimulates jobs and spending, but produces no long term productive gains, it will be just a “bridge to nowhere,” the moniker attached to an expensive and unnecessary Alaskan pork-barrel spending project.  Such wasteful spending not only uses up limited resources, but increases the deficit without providing improvement to the foundation of our future economic prosperity.

The Right Direction Now and For The Future

To Senators Obama and Reid and Representative Pelosi:

In the sixties, President Kennedy put hundreds of thousands to work on the space program, putting a man on the moon, aptly symbolizing American leadership, and foretelling United States military superiority and civilian commercial dominance in aerospace and communications for thirty years. The technological advantage American industry gained on the investment could not have been achieved absent the governmental commitment or resources. 

In the eighties, President Reagan funded Star Wars, which achieved little in missile defense, but nonetheless, changed the world, leading to U.S. civilian computer, satellite and Internet superiority and prosperity for another thirty-year period.  The time is again right for government investment in creating the future. 

First, the beginning of a recession is a good time to act, because stimulus is helpful, jobs are at stake, and a government-funded program will immediately instill confidence in long-term labor conditions.  This is far more productive stimulus than refund checks, which do ease family budget concerns, but only  marginally improve commerce.  They do little to support employment prospects and nothing to support long-term wealth creation.

Second, there are many areas, such as pharmaceutical research, Green technologies or military hardware, that require massive investment to achieve their full potential.  No one can claim that research and development in alternative energy or pharmaceutical testing is near capacity.  Both are so financially risky that only a fraction of what could be done is being done, even though the lives of millions and the future economic health of many nations hang in the balance.  As with past science and technology programs, the initial public investment in energy, medical or environmental technology would surely be followed by decades of highly profitable private business applications.

Finally, the arguments against publicly funded investment misunderstand the real problems of government spending and deficit spending in particular.  We can agree that private investment and direction of resources is superior to public, and yet still acknowledge the need for a military, Civil Corps of Engineers, or law enforcement to meet national needs.  In the 1940s, the Government put the nation to work to produce armaments on a vast scale enabling our defeat of Fascism. Some tasks are just too large to be left to the private marketplace. 

The real question is what should public money be used for, and crucially, what should it be used for when we are over budget? 

The answers are not the same.  Most commentators today oversimplify the issues surrounding deficit spending.  They assert that a balanced budget or small deficits are always good and large deficits are bad, with the caveat that deficit spending during a recession is good as it stimulates the economy while spending during high growth periods is bad as it adds to inflation. 

Without more, neither view is adequate. 

Deficit spending is essentially borrowing from the future for the present.  Thus, deficit spending can be thought of as irresponsible, and in some ways unethical, because it uses future resources to satisfy today’s needs.  However, deficit spending only depletes future resources and weaken financial integrity when it does not lead to long-term financial health.  When such spending is for infrastructure and facilitates wealth and revenue in the future, it is neither irresponsible nor unethical. 

Such spending should be judged on the benefit versus risk of success at achieving its goals.  Kennedy’s Sending of a Man to the Moon was a huge risk, but it paid off handsomely in its political, scientific and commercial legacy.  Reagan’s Star Wars research was less of a reach and it paid off, even though the goal of the original research has still not been achieved.

In this light deficit funding for Green technologies would stimulate the economy during a recession and, if successful, would lower energy and environmental costs in the long run.   This is how prosperous periods have occurred.  Improvements in productivity mitigate inflationary pressures while increasing wealth during economic expansion.  

Politically and commercially the benefits are obvious as leadership and wealth will be the rewards to nations that meet the challenges of the future most efficiently and profitably.  Medical research presents similar cost/benefit prospects and military investment, though to a lesser extent, may also be useful given the difficulties we have had achieving military goals in the past decade.

The alternatives pale in comparison.  Giving stimulus to individuals and businesses in the form of refunds or tax cuts at a time of economic slowdown has short-term social and economic value at a cost that is roughly equal to what has to be paid back later with interest.  Investing in roads and bridges provides some job support and infrastructure upkeep, but no dynamic future benefits.  Doing nothing has such great lost-opportunity costs.  On the other hand, investing in the technology of the future will have a modest short-term economic benefit in confidence and jobs, and in the long term, if past is prologue, it will present unimagined opportunity.

Marc Seltzer