How to cut government spending

by on June 13, 2011 at 5:22 am in Economics, Medicine | Permalink

Paul Krugman, among many others, raises the Keynesian argument against cutting government spending in a downturn.  Yet cutting spending  is easier to do than these accounts make it seem.  Cut the rate of growth of government spending on health care:

1. It is one sector where supply constraints often bind.  Releasing some of those resources from pursuing government subsidies will lead to their relatively rapid redeployment elsewhere.  For instance if you cut the rate of growth of Medicare spending, some more doctors are likely to start accepting Medicaid patients.  And job growth in the sector is robust, even these days.

2. The policy is cutting a rate of growth, rather than cutting current spending in absolute terms.  This may lead to sectoral readjustment problems for some people who are planning careers in health care, but it leaves current revenue streams intact and indeed it is still likely to grow them by some amount. Fairly often I see Keynesian opponents of “spending cuts” confuse absolute cuts with cuts in the rate of spending growth; the latter involve much smaller Keynesian problems.

3. There is a nice cushion of rents in the medical sector, and that makes it easier to cut spending there too.

4. Spending too much time with aggregate AD and AS curves causes one to overlook some of these cross-sectoral distinctions.

5. We also could and should cut farm subsidies, which go largely to agribusiness.  It’s part of the Keynesian argument today that wealthy corporations are just sitting on their cash.  I don’t buy that as stated, but if it will convince Keynesians to call for an immediate end to farm subsidies, so much the better.  We now can cut farm subsidies altogether and the rate of growth of government spending on health care; that’s two areas right there.

6. Let’s not forget defense spending.  Not all of those cuts need be a Keynesian disaster.

7. It is the so-called “discretionary spending” where Keynesian arguments are most likely to hold.  Not surprisingly, that seems to be the area where we are most determined to cut spending.  Silly Americans!  Given that, is our government an institution you should trust to enact good Keynesian policy more generally?

Not all government spending is created equal, for Keynesian purposes or otherwise.  There is plenty of spending we could cut without creating a Keynesian disaster, even if you accept the Keynesian framework straight up.

asdf June 13, 2011 at 5:39 am

Businesses are sitting on cash because Paul Krugman is plotting to take that cash through unpredictable new taxes and regulations, at least when he isn’t planning to inflate it away.

When the “right wing” prescription at this late hour is simply to “slow the rqte of spending” — and when this too is controversial — it is clear that we are already hurtling over the cliff. And at the bottom there will be no chalupas, cheap or otherwise.

Alex Godofsky June 13, 2011 at 9:23 am

Why would businesses sit on cash stockpiles if they expected Obama to raid corporate cash stockpiles? Why would businesses sit on cash stockpiles if they expected Bernanke to inflate away their value?

Your logic is incoherent.

Dean June 13, 2011 at 10:31 am

Actually the logic makes perfect sense, if you assume that (a) Paul Krugman is the King of America and has complete control over taxes and regulations or (b) he is a really skilled cat burglar.

Bill June 13, 2011 at 12:20 pm

Alex, Politics is not logic.

Veridical Driver June 13, 2011 at 1:56 pm

alex:

Business usually have months to react to new regulations/taxes. It is usually debated, discussed for a long time, and when it is passed it usually is not retroactive. Thus, when the new taxes/regulation comes down the line, it is much better to have your assets liquid, so that you can reconfigure it to avoid those taxes/regulation, than it would be to commit those resources before you have any idea how to shield them from taxes/regulation.

Bill June 13, 2011 at 2:12 pm

Or, if you are a realistic cynic, you would say: I have this money overseas. The House is later going to reduce my rates on repatriation and insist that it be part of a budget package: I’ll just wait. And, if I do repatriate at a lower rate, I can give my execs a bonus.

Nah, no one would think that way.

Would they.

Emil June 13, 2011 at 4:11 pm

I would.

Veridical Driver June 13, 2011 at 4:23 pm

It doesn’t matter. The fact is, there are practical limitations on the revenue you can make via taxation… and there are costs in jobs for expensive regulations. Doing bad things to the “Big Evil Corporations” has negative effects for the average American, regardless of the morality of doing bad things to the corporations.

No matter how much that corporate CEO may deserve to have his wealth confiscated, in some moral sense, doing so would hurt a lot of small worker-class people regardless of morality.

asdf June 13, 2011 at 8:52 pm

If you have ever actually operated a business you would know that:

1) Cash equivalents do not mean dollars. They can include GLD, SGD, CHF, RMB, and currencies that are likely to have longer term stability than USD. This is how businesses are buffering against Bernanke.

2) If Obama raids stockpiles with new taxes and regulations (such as the 2.6% medical device excise tax) and you don’t have enough cash to pay for these unpredictable future costs, you will go bankrupt. Hence you hoard cash and don’t expand, waiting for the next shoe to drop. This is how businesses are buffering against Obama.

Here’s a great example:
http://www.massdevice.com/blogs/massdevice/analysis-big-players-bear-brunt-medical-device-tax

And for three of the firms in our sample, the tax would have pushed them into the red. Analogic’s $7.5 million tax bill (which we calculated by excluding sales from its security division) would have transformed its $3.7 million net income to a $3.8 million loss. NuVasive Inc.’s $5 million profit would have gone to a $3.5 million loss and Rochester Medical’s meager $100,000 profit would have plunged to a $700,000 loss.

So, this arbitrary new tax in a tough economic climate will push these companies into the red — unless they have savings to tide them over.

Savings. I know it’s a foreign concept. You might look it up sometime.

Bernard Yomtov June 14, 2011 at 10:21 am

Of course, a simpler explanation is that the businesses are sitting on cash because they have few product investments available. Why? Well, maybe because there aren’t that many customers around.

That explanation doesn’t provide any grounds for Obama (or Krugma) bashing, though, so we hear the convoluted nonsense that Republicans are pushing, and asdf repeats.

asdf June 13, 2011 at 5:47 am

To understand the Krugmanite policy in its full horrific scope one must first understand that Bernanke-style inflation is the ultimate tax. Like a VC capital raise, when the government prints X new dollar in an economy with Y total dollars, it has diluted everyone else down to Y/(Y+X). This arbitrary seizure of assets represents the ultimate tax, which Bernanke and his cronies have perpetrated to the tune of $9 trillion (money.cnn.com/2010/12/01/news/economy/fed_reserve_data_release/index.htm).

Understanding this allows one to understand why Yglesias, Krugman, and Bernanke favor inflation to such an extent: because it is the ultimate tax.

TimKeese June 13, 2011 at 10:21 am

First of all: What inflation?
And don’t say: It’s just around the corner. It’s been “just around the corner” for the last 3 years or so.

You seem to think that people are like deer caught in the headlights when inflation comes along. I recall that people were very agile in the 70’s; most found ways to avoid the worse and even profit from inflation.

An inflation rate of about 4% – what we had in the Reagan 80’s – allows the Fed to raise rates to keep the inflation under control. And when the economy heads into a slump, the Fed has room to lower rates and encourage more spending, thereby boosting the economy.

Jim June 13, 2011 at 12:44 pm

>>because it is the ultimate tax.

Great point. If you print money, you get money. And to whatever extent prices rise nationwide, the NYT will blame corporate greed. And Dem voters will believe it.

A close runner-up, however, is the fuel tax. And of course the Holy Grail of government, the carbon tax. Same result: people pay more for everything, but the government escapes blame.

>>First of all: What inflation?

Yeah, right. As long as you don’t eat or drive, prices have been pretty much constant for awhile. Great point.

Bill June 13, 2011 at 2:18 pm

Jim, There is this thing called OPEC. It is a cartel. Cartels restrict production to raise prices. Guess what they did. They would do it to you whether or not they liked you, your fiscal policy, or your monetary policy or your political party. And, your analysis on oil seems to ignore a the loss of oil from country that starts with L and ends with A as well as turmoil in the Mideast. But that doesn’t matter. There is not enough residual supply or reserves to threaten OPEC. OPEC is a carbon tax.

Rahul June 13, 2011 at 3:09 pm

Has OPEC been successful as a cartel? Doesn’t game theory show that most cartels fail. Ergo would oil prices have been a lot lower today had it not been or OPEC?

J Thomas June 13, 2011 at 4:52 pm

Rahul, game theory proves that most cartels break down eventually, in the long run, in theory. Similarly we can say that most corporations eventually go bankrupt.

Is there a point there?

asdf June 13, 2011 at 8:46 pm

MIT’s Billion Prices Project scrapes prices from large numbers of web stores and archives them over time. They thus have an empirical measure of inflation that shows a pretty dramatic spike across the board:

http://bpp.mit.edu/usa/

And of course, Krugman was denying that inflation would happen (https://www.nytimes.com/2009/05/29/opinion/29krugman.html) before he began calling for it and saying a high inflation target is a good thing (http://krugman.blogs.nytimes.com/2010/11/02/why-inflation-targets-need-to-be-high-wonkish/).

Just like he denied that death panels were happening (https://www.nytimes.com/2009/08/14/opinion/14krugman.html?_r=1) before he said that the solution to health care costs involves “death panels” (http://krugman.blogs.nytimes.com/2010/11/14/death-panels-and-sales-taxes/).

Standard leftist tactic: deny that X is going to happen, call the damn wingnuts paranoid for predicting X, and then say that X is actually a good thing.

But yeah, TimKeese — “what inflation” indeed.

E. Barandiaran June 13, 2011 at 7:10 am

Your # 3
“There is a nice cushion of rents in the medical sector, and that makes it easier to cut spending there too.”
is relevant to most government services and programs. You should know that because you can see it in state universities. Total compensation to most government employees (including university professors) and transfer payments to a majority of beneficiaries of most government programs (including many college students) can be cut with no effect of both the supply of government services and the intended goals of the programs. In addition to the losers’ rebellion, the main obstacle is that you cannot cut salaries and benefits evenly across all services and programs. Indeed, an inept government can hardly cut them right and timely, but some day the only choice will be to cut them evenly across the board.
Concerning # 4, it’s a pity that you and some other economists are still discussing Keynes and his legacy, but it’s a clear reflection of both the poverty of macroeconomics and the emptiness of progressives that desperately hold on to power. Larry Summers’ column on FT and WP is another good example of such poverty and emptiness.

E. Barandiaran June 13, 2011 at 8:27 am

Some progressive macroeconomists should follow these other progressives into rehab-for-all
http://dailycaller.com/2011/06/12/rehab-for-all/

Tyler, hope you still have time to organize a summer clinic for progressive macroeconomists, far from DC or Jackson Hole.

Andrew' June 13, 2011 at 9:06 am

Not to mention our crisis is partly due to our overspending in the future, which the Keynesians absolutely refuse to even look at.

This is similarly why I’m not a believer in the debt-ceiling sky is falling story. Before you say “But if we can’t borrow to roll-over debt then…!!!” keep in mind that the whole point of the exercise is to cut spending to ensure the financial viability of the government, so if I were a bondholder I might be sweating, but I’d be sweating about both sides of the extreme, not just the one.

Dean June 13, 2011 at 10:35 am

I’m a Keynesian, and I’m all for cutting future spending. I just don’t want to do it now, this year, when employment is already so low. The debate in Congress has already settled on the need for future cuts; the issue now is conservatives demanding immediate cuts and progressives wanting to put off cuts for another 2-4 years or so.

E. Barandiaran June 13, 2011 at 11:44 am

Please tell me, what do you mean when you say you’re a Keynesian?

Andrew' June 13, 2011 at 11:50 am

So commit to some future cuts now, then, right? As Tyler is suggesting.

Bill June 13, 2011 at 12:42 pm

Or, some tax increases as the economy recovers, like we should have done in 2006.

Rich Berger June 13, 2011 at 4:52 pm

Why tax increases in 2006, when the deficit was on track to vanish had the financial crisis not hit? Absent that the deficit would have been close to zero for FY2008.

Why are tax increases the panacea? Do you wish to pay more?

Bill June 13, 2011 at 5:10 pm

Rich,

On track to vanish? Would you like me to post a link showing the Bush projections and the actual revenue. I will if you challenge. Please challenge.
And, furthermore, the cuts were to be for ten years; projections after that showed that the deficit would widen if they continued. Please dispute that as well.

TallDave June 13, 2011 at 5:22 pm

I must have missed all the clamoring for spending cuts by Keynesians during better economic times.

But I’m sure it was there, because otherwise Keynesianism is just a convenient recessionary fig leaf for insatiable statism. And I refuse to believe that.

Rich Berger June 14, 2011 at 11:38 am

Here are the projections by the OMB in July 2005 which shows the deficit continuing to shrink (they actually were even lower for FY 2007 than projected). It wasn’t until the financial crisis hit in FY 2008 that the projections headed south. I think the deficit was tending toward zero otherwise. And I never understand why revenue would not continue to rise (absent the crisis, which is what the tax rate cut/tax rate expiration projections were based on) if taxes were not raised. If you continue the tax rate structure as is, why do you need extra taxes, unless you are contemplating extra spending?

Finally, from the always instructive Ironman at Political Calculations, a look at what the Obama regime hath wrought (wreaked?) – Here

Bill June 15, 2011 at 6:53 pm

Rich, Why did you use 2005 report.

Here are the reports from a group called Chartporn.org

1. The first shows the effect of Bush’s tax cuts in the past and going forward: http://chartporn.org/2011/06/14/what-is-causing-the-deficit/

2. I will post a link to a second Chartporn chart that tracks presidential economic reports of the president as to whether the tax cut would mean to the deficit. #1 above shows it all, however.

E. Barandiaran June 13, 2011 at 9:48 am

In his column, Robert Samuelson reviews what some macroeconomists have been saying about the recovery and concludes
“So modern economics has been oversold, and the public is now disbelieving. The disillusion feeds stubbornly low confidence. Because psychology is so important, the good news is that if the economy surprises on the upside, the boost to confidence could accelerate the recovery. The bad news is that if the recovery continues to disappoint, the discrediting of mainstream economic thinking will grow. The resulting intellectual void will summon forth new ideas. Some may be good, but others — though superficially appealing — will be fringe or lunatic.”
If Tyler decided to organize a summer clinic, I’d suggest him to focus on how to reduce uncertainty rather than on how to accelerate the recovery. We know something about the former, but too little about the latter, particularly in the presence of too much uncertainty. Also, I’d suggest him to hire Ricardo Caballero –who, as Samuelson mentions, has a sensible view of what economists know (despite the many times that Ricardo has been tempted by some of his professors and colleagues to rely mainly on macroeconomic models, he seems to remember lessons learnt 30 years ago in Chile).

Andrew' June 13, 2011 at 11:53 am

That’s an interesting point. For lack of a better term, the Keynesians keep pooh-poohing the uncertainty idea and keep saying it is just demand. But if it were just demand, wouldn’t investors know that demand will return at some point and begin investing for it? Does timing uncertainty in the absence of structural uncertainty cut it?

Pat L June 13, 2011 at 6:20 pm

Uncertainty of what, though? I would wager that the people who feel most uncertain at present are the unemployed and the heavily indebted. I’m not even sure what it means to say that uncertainty and demand are opposite explanations. Uncertainty causes people and businesses to try to save more and spend less; in other words, it manifests as a lack of demand. If people had jobs and businesses had customers, I suspect they would feel a lot more optimistic.

J Thomas June 13, 2011 at 2:54 pm

Concerning # 4, it’s a pity that you and some other economists are still discussing Keynes and his legacy, but it’s a clear reflection of both the poverty of macroeconomics and the emptiness of progressives that desperately hold on to power.

What is your problem? Keynes described one of the ways that an economy can fail. He prescribed ways to recover from that failure. He was right.

Now we find that there are other ways economies can fail too, and we need to pay attention to them and find ways to recover from them.

That’s no reason to throw away what we learned from Keynes, and when you propose a way to recover that is known to be a keynesian failure, you should be ashamed of yourself.

Apart from our theoretical deficit, we have the problem that Congress is deadlocked, and also we have no real hint of progress reachinga agreements with our major trade partners including particularly china and canada.

A lot of these problems would disappear if we could arrange a new world war, preferably without nukes. We get rid of subsidies etc except for those we think help the war effort. Whole industries collapse that aren’t needed for the war effort, and we applaud. Consumption down, production up. Draft a lot of the MDs and make civilian health care a relatively low priority. Inflation up, but rationing reduces consumption more than wages, which are encouraged to go into savings bonds. Unemployment is way down because anybody who doesn’t have a priority job gets drafted. R&D up, particularly military R&D.

And then after the war, assuming we don’t lose, we pick up the pieces. The status quo has been destroyed. We rebuild the civilian economy along new lines because there’s no particular reason to rebuild them the way they were. International trade has been disrupted and that starts up along fresh lines too.

The Gordian knot approach to political gridlock. I don’t recommend it, but it’s the default approach when nothing else works.

Marian Kechlibar June 13, 2011 at 4:47 pm

I don’t believe that the USA is able to lead conclusive, victorious wars anymore. Technically, it is, but the population lacks the stomach for that.

Winning a war means killing a lot of the enemy forces, including a significant share of civilians. You can’t do things like “Firebombing Dresden” anymore, as the bloody footage will hit American TV screens and blogs within hours.

Plus, the US do not tolerate high losses of their own infantry anymore either. The Iraqi campaign is considered bloody, even though the absolute # of lives lost over the 7 years is roughly equal to the losses sustained by the British during the first 5 hours of Battle on Somme, 1916.

In such situation, the US political leadership is forced to water the war down to half-hearted drone campaign, preferrably over the most desolate mountains of Earth, where most journalists just will not go. Any semblance to Afghanistan?

Rahul June 13, 2011 at 5:10 pm

Great points. Often unappreciated.

J Thomas June 13, 2011 at 6:00 pm

Marian, the USA was in the same spot before WWII. We did tiny half-hearted invasions of Mexico etc, to no big effect, and we could not begin to run a real war.

But after Pearl Harbor it was no problem. We took great big casualties and we blamed them on the enemy and it toughened our resolve. We had no objection whatsoever to foreign civilian casualties.

Part of it was the censorship. Part of it was the war fever. I remember looking at an old Look magazine that had a full-page photo from a strike. A union organizer had been stabbed by a bayonet, and they had a hospital photo of his buttocks with a 3 inch stab wound in them, looking pathetic and funny. They had a poster contest, and the winner was done by a young war widow, it had a yellow japanese officer with a buck-teeth sneer, the caption was KILL MORE JAPS.

They allowed unions but forbid them to strike. In theory workers who struck were fired and lost their draft deferments, but in practice there were a whole lot of small wildcat strikes that were resolved quickly.

If we had had a reasonable chance to start a world war after 9/11 do you think we would have hesitated? But there was no enemy.

If we could find a credible enemy, all it would take would be something like Pearl Harbor or 9/11 and the whole country would go crazy. We could lose, say, all of saint petersberg in florida and it would improve the economy while starting the war. Truthers might argue for 50 years whether we knew the attack was coming or something, but that wouldn’t make any difference to anything.

We lack the stomach for small wars with no obvious point where we are the big bully. We’d turn in a microsecond for an important war that was justified.

Paul Johnson June 13, 2011 at 4:59 pm

Just try cutting faculty salaries and benefits at public universities. We will teach our students about the legacy of Pinochet the murderer and the benefits of the “new protectionism” against Chile. That will cut your fruit, vegetable, and flower exports faster than you and your buddies can spout “Chicago-school” dogma.

E. Barandiaran June 13, 2011 at 6:02 pm

All Chile is trembling. The Americans are leaving! No more trade! No more investment!
Sorry but I’m quite busy talking to my friend in China Investment that has to figure out how to invest $100 billion around the world (oh, wrong number, make it $ 1 trillion). He now enjoys good Chilean wine every day.

For boring Keynesians: I suggest that you discuss how to accelerate the U.S. recovery with those proposing a return to the gold standard. You may replay WWII to ensure the re-election of a failed president –after all, any good Keynesian knows that after 1937 comes 1941.

foosion June 13, 2011 at 7:25 am

1) There are basically two ways to cut government spending on healthcare – shift costs to individuals or reduce healthcare costs by making healthcare more efficient. Cost shifting will most likely increase healthcare costs (see the April CBO report), which doesn’t seem very helpful. I don’t know of anyone, healthcare providers, who opposes the second (other than those who would repeal the ACA without replacing it with something better).

4) It would be nice to try stimulus. Alas, the federal stimulus has been offset by cuts at the state and local level. Businesses aren’t hiring because there isn’t enough demand for their products and services. Cutting govt jobs cuts jobs.

To say that business is sitting on cash because they’re afraid someone will take their cash doesn’t begin to make sense. One might ask business why it’s not hiring – the main answer is the economy / lack of demand.

5) Does anyone support farm subsidies other than agribusiness, farm state politicians and fellow travelers.

6) Cutting defense spending is popular.

7) The pie is essentially insurance programs, defense spending, debt service and discretionary spending.

DaveyNC June 13, 2011 at 8:17 am
Dan Weber June 13, 2011 at 12:07 pm

Cost shifting will most likely increase healthcare costs (see the April CBO report), which doesn’t seem very helpful.

It seems completely helpful if the problem is “the government is spending too much money.” By definition it is helpful.

Rahul June 13, 2011 at 3:52 pm

Yes, but what’s the morality angle to that definition of “helpful”?

J Thomas June 13, 2011 at 2:59 pm

There are basically two ways to cut government spending on healthcare – shift costs to individuals or reduce healthcare costs by making healthcare more efficient.

Yes. The second way is obviously better, but there is no top-down way to do it. In general, hospitals etc will tend to use the methods they currently use unless something cheaper is proven to be just as good. If it takes 5 years to prove that the cheaper method is just as good, during those 5 years innovations will be funded by the expensive producers which will claim that they are now much much better. Research to prove the cheaper methods are just as good will always stay 5 years behind.

The first method, transferring costs to individuals, has the advantage for Republicans that people with below average income will not be able to afford the health care that is not funded otherwise, and as they die off it will shift the votes toward Republican.

Rahul June 13, 2011 at 3:14 pm

there is no top-down way to do it.

Sure there are.

A few ideas:

Castrate the FDA and medical licensing boards.
Reduce patent protection for drugs.
Remove barriers to immigration by doctors and nurses.

J Thomas June 13, 2011 at 6:17 pm

Castrate the FDA and medical licensing boards.
Reduce patent protection for drugs.
Remove barriers to immigration by doctors and nurses.

Why do you think any of that would reduce costs?

As we have seen in other contexts, when cost goes down, sales go up.

The only way to reduce costs is to ration medical care. The fewer dollars of medical care that’s provided to voters, the less it costs.

Dan Weber June 13, 2011 at 3:46 pm

There is good evidence that doctors do what brings in the most money, not what is most efficient.

AlanW June 14, 2011 at 12:10 pm

“There is no top-down way to do it.”

Hundreds of pages in the PPACA are devoted to creating “top -down ways to do it.” Medicare and Medicaid are the biggest insurers in the country and the president appoints their director. Can’t get any more top-down than that.\

The question is, will the efficiency provisions in the PPACA work? It’s too soon to tell, but several of them look promising – PCMH, ACO’s, bundling, etc. The problem is, few people think they’ll collectively work well enough to actually fix the problem. They’ll bend the curve, but not all the way to flat, and there’s bound to be push-back from doctors as payments shrink. So we still need more ideas.

J Thomas June 14, 2011 at 12:41 pm

AlanW, if you can create medical efficiency top-down, why not everything else? The Federal government can make automobiles more efficient top-down, just tell them what to produce and make them produce it.

And the Federal government can make medical research more efficient top-down. Order them to manage their research more eficiently, and voila! Research is more efficient!

They can make the gasohol program more efficient!

For that matter, they can make the FDA more efficient! Get a new FDA director and get him to make the bureaucracy more efficient.

And don’t leave out military spending. Those new planes that cost $30 million to $300 million each? Do it top-down! They get more efficient and we spend less money!

Or maybe it doesn’t actually work like that.

Tom June 13, 2011 at 7:28 am

To all these “cut spending” types: Explain the economics of doing what the Bush administration did when they came to power in the face of the Clinton administration paying down the debt every year – cut taxes, it’s your money! Give a small tax cut to most people so they will support it and a big, permanent one to the (Republican) donor class.

DaveyNC June 13, 2011 at 8:19 am

I’m a cut spending type and am not about to defend the Bush administration’s love affair with the public treasury. It’s one of the reasons that the Republicans got tossed out in 2008 and led to the rise of the Tea Party movement.

tom June 13, 2011 at 1:25 pm

“Clinton administration paying down the debt every year”

Uh, 1 year in the middle of a huge bubble. Most of that revenue had to be returned in over the next several years ( cover the market losses).

Veridical Driver June 13, 2011 at 2:04 pm

Bush didn’t cut spending, he radically increased spending. In fact, he increased spending more than any other president that proceeded him (only to be outdone by Obama).

Bush didn’t cut taxes, because there is no tax cut without cuts in spending. Bush *DEFERRED* taxes, by borrowing.

txslr June 14, 2011 at 3:14 pm

Clinton enjoyed a windfall of federal revenue from capital gains taxes on the internet bubble. Not a good financing strategy for the U.S. government.

W.E. Heasley June 13, 2011 at 7:55 am

“It’s part of the Keynesian argument today that wealthy corporations are just sitting on their cash. I don’t buy that as stated….”.

Yes, “sitting on cash” is pure politics. Firms deploy strategy and “sitting on cash” is not a strategy that firms deploy. Firms do not merely “sit on cash”. However, the accumulation of cash is related to/a by-product of other strategy being deployed by firms.

Right Wing-nut June 13, 2011 at 10:06 am

Specifically, expansion. When a firm accumulated a warchest, it generally means that they are about to either acquire another firm (possibly TBD), or to expand their business WITHOUT borrowing money. And you wonder why the libs hate them…

Bill June 13, 2011 at 10:17 am

Wouldn’t you agree that agricultural price supports are an inefficient way to give income support to poor farmers? Isn’t there also a distortion from these price supports: high corn prices compress the earnings of pig farmers and cattle farmers.

TallDave June 13, 2011 at 4:46 pm

“The beatings will continue until the investment climate improves.”

dictateursanguinaire June 13, 2011 at 7:55 am

Looks like you have constructed a bit of strawman, methinks, that posits “Keynesians” as some homogeneous group who oppose all cuts to all programs at all times, and are somehow against sensible waste reduction. But the party line Democrat position includes both cuts and boosts to certain areas and no political position of any kind (at least in theory) supports rentiers (though corporatist policy in practice often does.) I’m sure I lean quite a bit left of you but I agree with most of this post; what you’re saying either implicitly misrepresents your perceived opponents in debate or it’s just kind of boring/obvious. I’m assuming the latter since you don’t seem like the type to argue in bad faith although frankly this stuff is all pretty noncontroversial and not-new, even to someone with very little formal economics training.

Bill June 13, 2011 at 8:38 am

I read that 58% of discretionary spending is on the military and you can add 4% for the VA to that

So the comment: “Let’s not forget defense spending. Not all of those cuts need be a Keynesian disaster.” seems strange in two respects

That comment is like: “Let’s not forget the elephant in the room.”

And, why is a defense cut a “Keynesian” disaster more or less than any other cut? And I thought this blog didn’t follow Keynes so why should it matter?

Are you Keynesian when it only comes to defense?

Bill June 13, 2011 at 8:46 am

Here is the link to the 58% number in case you question it. http://thinkprogress.org/security/2011/06/09/241065/defense-secretary-nominee-leon-panetta-says-the-huge-defense-budget-isnt-causing-our-deficits/ I am sure there are other ways to account for this, but the number is high so let’s not ignore it.

Cliff June 13, 2011 at 11:42 am

Did you miss that the whole post is about Keynesians?

Bill June 13, 2011 at 12:51 pm

Cliff,
Keynesian spending only applies to defense.
Didn’t you get Tyler’s point in #6: “Not all of those cuts need be a Keynesian disaster.”

Cliff June 13, 2011 at 3:58 pm

You are not making any sense.

Bill June 13, 2011 at 6:20 pm

Cliff, Sorry I can’t help you.

Dan Weber June 13, 2011 at 12:17 pm

Yes, the military is a big part of “discretionary” spending.

http://en.wikipedia.org/wiki/File:2010_Receipts_%26_Expenditures_Estimates.PNG

But the point of the labels “mandatory” and “discretionary” isn’t that one is better than the other, or more sacred, or anything like that. “Mandatory” spending should be thought of as automatic spending, such that if Congress doesn’t act, it still gets authorized.

Even if you cut all “discretionary” spending to $0.00, you are still going to face serious budget problems in 20 years. Or, if we act now, we might be able to save some of our “discretionary” programs, like the Dept of Justice, NSF, HHS, and disaster spending.

Bill June 13, 2011 at 12:46 pm

Dan,

Regarding mandatory and discretionary: No one projected in 2000 when they did the tax cuts that there would be all these persons retiring and drawing on social security which had been running a surplus.. Really, no one saw this coming.

Tax cuts from 2004 forward are what are discretionary, or should I say, lacking discretion. $2.5 trillion and counting.

Ron Potato June 13, 2011 at 5:28 pm

Yeah that 3% tax cut is the real reason the government is overwhelmed by pensions, health care, and military spending.

Bill June 13, 2011 at 6:21 pm

Ron, You can add some wars, some Part D, a few more tax cuts.
$2.5 trillion to date on just the Bush tax cuts.

Sid F June 13, 2011 at 9:00 am

If you change the “fee for service” nature of health care spending the sector will cut spending all by itself and will not need help from government.

The problem in cutting spending that would have a minimal impact on the economy is not economic, it is political as post here shows.

http://dismalpoliticaleconomist.blogspot.com/2011/06/what-cutting-federal-budget-means.html

John Voorheis June 13, 2011 at 9:10 am

There is a distinct difference between politicians who want to “cut spending” and politicians who want to “cut spending that primarily benefits Democratic constituents*”. If the current majority in the House was composed of the former, then Tyler’s arguments might be useful. But, alas, even a cursory look at the state of play in Republican politics suggests that essentially the entire caucus is composed of the latter, and they care much more about the “benefits Democratic constituents” part than the “cutting spending” part.

*And, yes, that means poor people, black people and women.

Cliff June 13, 2011 at 11:43 am

Poor people are Democratic constituents? Evidence, please.

Tom June 13, 2011 at 1:28 pm

Any election since 1960.

Ron Potato June 13, 2011 at 5:29 pm

It’s called the FSA: Free Shit Army

Veridical Driver June 13, 2011 at 2:11 pm

Redistributing *TO* your constituents *FROM* people who aren’t your constituents is the entire basis of the welfare state. You have simply decided that it is “progressive” when you do it, and “corrupt” when your opponents do it.

I oppose what the Republicans are doing… but that is because I oppose the welfare state and wealth redistribution in and of itself. But what they are doing is the accepted norm of any welfare state.

TallDave June 13, 2011 at 5:01 pm

That’s sort of like the complaint that income tax cuts benefit the well-off, which is inevitable given that only half the country pays any income tax and 90% of income taxes are paid by the top 5%.

The opposite is true for government spending — Democrats dominate the public sector, the prisons, and the poor — one’s propensity to vote Dem is generally inversely proportional to one’s income (though admittedly the correlation isn’t all that strong, especially next to public sector unions and convicted felons). So spending cuts will generally impact Dems.

One area in which spending is done mostly on Democrats that we should obviously stop is the tens of billions of dollars we waste to apprehend, adjudicate, and incarcerate nonviolent criminal offenders. If there was ever a time we could not afford the coercive utopianism of the moralist police state, it’s today. And I doubt the objects of the State’s attention would object, be they Dem or GOP.

J Thomas June 14, 2011 at 6:06 am

That’s sort of like the complaint that income tax cuts benefit the well-off, which is inevitable given that only half the country pays any income tax and 90% of income taxes are paid by the top 5%.

Is that true?

So, we could eliminate taxes on the bottom 95% and it would only reduce revenues by 10%?

Increase taxes on the top 5% of taxpayers by a mere 11% and we’d get it all back?

Let’s do it!

Failing that, we could eliminate the income tax on wages below $200,000 by making that a tax paid directly by employers. In the process we’d close a lot of tax loopholes. And a whole lot of people would be better off. They would not have to worry about income taxes, apart from their non-wage income. A whole lot of them would owe no tax. The IRS would have less work to do.

And a whole lot of employees who get upset about their income tax, who imagine that the money belonged to them before the government took it away, wouldn’t feel so personally involved.

It’s a win all around.

txslr June 14, 2011 at 3:03 pm

I’m confused. Do you not believe the numbers? Is that what you’re getting at? In 2008 the bottom 50% of households paid 3% the income taxes. The top 10% paid 70% of the income taxes. The top 5% paid (in 2008) about 59% of all federal income taxes. The income tax system in the U.S. is highly progressive.

J Thomas June 14, 2011 at 11:07 pm

Txsir, your new numbers are not as hopeful as before.

If we eliminate income taxes completely for the bottom 50% that’s only 3%. That would save the bottom 50% some paperwork, and save the IRS some paperwork, and not cost much. An extra 3% for the top 50% wouldn’t be such a big deal either.

That isn’t nearly as great as eliminating all income taxes for the bottom 95%, but it’s something.

Let’s do it.

TallDave June 15, 2011 at 12:31 pm

The bottom 50% who would owe no taxes would still have to file because of EIC, deductions, etc.

I misremembered on the 5%/90% numbers, though. Mea culpa. More like 70% for the top 5%, 87% for the top quarter.

It’s tempting to think we can just raise rates on the top 5%, but keep in mind in some states they already pay something like 60% total marginal rates. Another 11% takes away more than a quarter of their remaining marginal after-tax income.

Brian June 13, 2011 at 9:13 am

Wrong on the farm subsidies. They primarily go to people who own farmland.* And these people are primarily active and retired farm families. To be clear, I agree that the subsidies should be eliminated immediately. These farm families, while not fabulously wealthy, are probably on average in the top ten percent of US households in terms of net worth.

*This is not about who receives the checks, it is about the economics of commodity markets and the residual asset (cost) to which the subsidy ultimately flows. It is similar to the idea that the home mortgage interest deduction does not ultimately subsidize home buyers, but home sellers, and even more ultimately, residential property development land owners.

Rahul June 13, 2011 at 2:15 pm

Agree with Brian. Republicans cutting farm subsidies seems unlikely. American hinterland and rural farmers are a big chunk of the loyal Republican vote-bank.

People always harp on Medicare as a cost cutting target. Fair enough. But farm subsidies and defense ought to get a wee bit more attention:

Federal expenditure in FY2010 on Medicare + Medicaid = $793 Billion
Direct and indirect estimate of agricultural aid = $180 Billion
Defense Spending = $ 689 Billion

I’d say we surely need spending cuts but go after Ag subsidies and Defense more often than healthcare. An equivalent cut on Defense spending hurts the median American a lot less than an equivalent cut on Medical spending (I suspect; but is a hard to prove assertion).

txslr June 14, 2011 at 3:10 pm

Your comparisons are misleading. For FY2010 defense spending is nearly 90% of spending for medicare and medicaid, but defense spending can remain relatively stable over the coming years whereas the amount committed under medicare, medicaid and social security will expand dramatically with the aging of the population. Cutting defense by more than it is already being cut will not make a dent in that unfunded liability. Talk of cuts in defense spending is a diversion.

J Thomas June 15, 2011 at 7:20 am

Clearly, we need to decrease our medical spending. We can’t let it keep increasing, it’s already too high.

And clearly, we also need to decrease our military spending. We can’t let that keep increasing either, it’s also already too high.

Talk of cuts in defense spending is not a diversion. It’s necessary.

steve June 13, 2011 at 9:24 am

I’m curious what you have in mind when you say that not all cuts to defense spending need to be a Keynesian disaster. Probably true but I’m having trouble picturing the argument and the specific spending cuts envisioned.

Cyrus June 13, 2011 at 9:25 am

Releasing some of those resources from pursuing government subsidies will lead to their relatively rapid redeployment elsewhere.
For physicians over 50, elsewhere very well could be, depending on the physician’s inclinations, Doctors Without Borders, or the golf course.

Zach June 13, 2011 at 9:45 am

“Let’s not forget defense spending. Not all of those cuts need be a Keynesian disaster.”

My pet idea is a standing army of nuclear engineers, construction workers, etc. In peacetime, build and operate civilian nuclear power plants (although operation could be privately contracted). In wartime, go to war. If you dedicate 20% of the military budget to this annually, you’ll wipe out a ton of CO2 emissions in short order (like, an actually meaningful amount). Cut the size of the army without doing much damage to preparedness for some hypothetical, massive conflict and get over the fact that private investment doesn’t operate on the 50-year timescale needed to justify spending on new nuclear construction. Obviously there’s the whole issue with domestic military deployment, nuclear power now being under DOE, and the fear of atoms, but we’ve more or less crossed those bridges already.

Anyway, this is Keynesian stimulus, effectively cuts the size of the military, and tackles global warming in a serious way.

I’m guessing there are some studies on this, but I’m no economist — what’s the effect on GDP when a missile is manufactured here and used to blow something up in Libya? How does that compare to other military spending? I know a lot of employees of contractors aren’t American, but don’t know how large a fraction contracting expenditures go to wages and purchasing things manufactured internationally.

Rahul June 13, 2011 at 2:18 pm

Isn’t that similar in principle to what the Swiss have been doing for centuries? A small standing army and a relatively large reserve? Deterrence is everything.

Zach June 13, 2011 at 2:37 pm

Yeah; this is somewhat different than compulsory military service, though. In theory, Sweden has a trained army of millions (although they just stopped compulsory service), but no one fears them. I’m talking about taking some fraction of the military and basically giving them a civilian job that benefits the public during peacetime — like the Army Reserve but with a higher level of readiness. Another side benefit of this is that you’d build nuclear plants at old military establishments that are either too rural to have much value or too polluted to turn over to the public as long as they’re near water.

Rahul June 13, 2011 at 2:43 pm

I’m not sure of your assertion that no one fears Sweden. It just has never been tested much.

Similarly for the US. Let’s say we awoke one fine day and found our military chopped to 50% of its current size. Would that change our safety much? Who do you think would attack? China?

Marian Kechlibar June 13, 2011 at 2:57 pm

China almost certainly won’t attack the USA.

But, in your scenario, China would plausibly attack Taiwan. And Japan might well decide to switch orbits from the American one to the Chinese.

Ron Paul will undoubtedly argue that keeping overseas alliances is not in American interest, but I think that realistically, once the USA built these alliances, it should better keep them.

Zach June 13, 2011 at 7:21 pm

Oh I totally agree re: a 50% cut. The actual result of an overnight 50% cut would be a Keynesian meltdown, right? The economic consequences would be worse than the military ones. Mostly I’m saying that we can keep the force size the same this way because it will placate folks who don’t want to shrink it for pugilistic or patriotic or economic reasons, but give the active duty force something more useful to do (and obviously I don’t think these folks sit there twiddling their thumbs between wars as is — this would imply a larger active duty force and less reliance on reserves).

spencer June 13, 2011 at 10:23 am

I always been a strong believer in the old sayingthat any economic concept that you can not explain to your father-in-law will eventually be proved wrong.

So will someone please tell me how to explain this:

if you cut the rate of growth of Medicare spending, some more doctors are likely to start accepting Medicaid patients

spencer June 13, 2011 at 10:40 am

I’ve long believed in the old saying that any economic concept you can not explain to your father in law will eventually be proven wrong.

So wold someone please explain how this works:

if you cut the rate of growth of Medicare spending, some more doctors are likely to start accepting Medicaid patient

txslr June 13, 2011 at 11:33 am

That one hauled me up short as well. The best I can figure, the idea is that doctors will have to do SOMETHING, so if you make it less profitable to see Medicare patients, they’ll start seeing more Medicaid patients. The problem is, doctors are already seeing fewer and fewer Medicare patients because they can’t get back the marginal cost of treating them, but they do the same for Medicaid patients. If your tailor can’t make back the marginal cost of the clothes he makes, he doesn’t start giving them away. He quits.

Rahul June 13, 2011 at 3:04 pm

But are we actually seeing doctors quit? Is there empirical evidence that medicine is any less profitable today than before?

TallDave June 13, 2011 at 5:07 pm

This is why they have very long wait times for surgery in the EU, doctors awarded by lottery in Canada, mini-riots over access to dentists in the UK…

Price controls lead to shortages.

Zach June 13, 2011 at 10:09 pm

Since this is an economics blog, it’s worth pointing out that waiting times are a good thing (to an extent) if you’re trying to control costs. If you have waiting times for nonessential procedures, you’ll save money because (1) some people will weigh the cost of waiting against the value of an unneeded but somewhat beneficial procedure and (2) some diagnoses will change making the planned procedure unnecessary (and some folks will die because of something else). As long as we’re going to pay for universal healthcare for seniors, veterans, and the poor, waiting is a good thing unless it hurts health outcomes or increases costs.

Obviously this is like Keynesian stimulus or the Laugher Curve — more waiting isn’t always better; the Goldilocks Principle. Some Canadian provinces have longer waiting times than they’d like for some procedures (although they’ve made a lot of progress and the problem’s not nearly as bad as many pretend or think it is), but the goal isn’t to bring waiting times to zero.

Price controls can lead to shortages, but our lack of functioning market is empirically worse since we pay twice as much for worse care than other very similar countries.

TallDave June 14, 2011 at 12:26 pm

Well, sure, that’s why waiting times are called “rationing.”

Price controls can lead to shortages, but our lack of functioning market is empirically worse since we pay twice as much for worse care than other very similar countries.

This is one of the most pervasive myths about HC. In fact, Americans get the best health care in the world. The problem is that better level of care has small marginal value — it’s relatively cost-inefficient. But of course, this is true of nearly all medical care — every additional dollar a healthcare system spends is less efficient than the previous dollar. Do you really need that MRI, that organ transplant, that diabetic foot? It’s always cheaper to do less. If you want really efficient medical care, move to a impoverished African country that has anitbiotics, vaccines, and little else — the increase in LE from those two things is bigger than everything else combined.

Rahul June 13, 2011 at 3:30 pm

spencer:

Ever tried Arrow’s impossibility theorem on your father-in-law? How did that go?!

mick June 13, 2011 at 11:51 am

Krugman’s nobel is like Obama’s, except no one gets the irony.

Rich Berger June 13, 2011 at 12:20 pm

Over the long-run, mandated spending must be reined in – the Ryan plan is oen roadmap for getting control of entitlements. Like a tanker, this baby is not going to turn on a dime and the effects of a gradual course change will take time to appear. In the short run, it is important to cut the discretionary spending by a significant amount. From what I can tell, discretionary spending is currently about $1.3 trillion. Cutting that across the board by 8.3% saves $100 billion. a 10% cut saves $130 billion. Businesses cut spending all the time when things get bad. There is no reason, that government departments (including defense) cannot make do with 8-10% less. Heck, the Dept of Education eats up $77 BN alone. Do we need it? (Cue the usual caterwauling about the Pell grants – we have to have them).

The Obama administration and the Democrats do not want to take this course. They want to continue with the status quo spending and let a crisis develop where they scare a tax increase out of the electorate – start with the rich and work down to everyone else – sorry, there was no other choice, you know.

J Thomas June 14, 2011 at 6:18 am

In the short run, it is important to cut the discretionary spending by a significant amount. From what I can tell, discretionary spending is currently about $1.3 trillion. Cutting that across the board by 8.3% saves $100 billion. a 10% cut saves $130 billion. Businesses cut spending all the time when things get bad.

It is plain from this that you do not understand Keynesian economics. Which means that you do not understand economics.

That doesn’t mean you’re wrong. Even though you don’t understand economics, you could still propose a good course of action by accident. But you need to provide an argument why Keynesian thinking does not apply in this case.

I did that in another comment on this topic. Can you do it? Can you come up with an explanation why Keynesian thinking (which is obviously correct in many cases) fails this time?

Bernard Yomtov June 14, 2011 at 10:30 am

The Ryan plan is a roadmap for creating a hereditary tax-free aristocracy in the US. Nothing else. All other claims about it are false.

Ryan cuts Medicare drastiaclly and hands the savings over to the wealthy in the form of tax cuts. Period. Then he claims that somehow the budget willbe balanced by other unspecified means. He’s a patent medicine salesman, and th efact that conservatives take him seriously proves how devoid they are of any serious ideas.

Chris D June 13, 2011 at 1:01 pm

Which magical unicorn political party is going to significantly cut farm subsidies or defense spending instead of education and the social safety net? Is it the Republicans who would rather the U.S. default on its debt than stop trying to win the Cold War? Or the Democrats who lack the spine to stand up to them?

I often get the impression you’re offering rational policy options to conservatives, which is a lot like putting out a house fire with a squirt gun.

Meets June 13, 2011 at 1:21 pm

Read point 7.

txslr June 13, 2011 at 2:24 pm

You are referring to the Democrats who act as if cutting discretionary spending to 2008 levels would destroy civilization and consign the middle class to slow, painful death? Or who want to slash defense spending but haven’t yet seen a war they weren’t willing to jump into? (Next stop, Yeman?) Or who insist that Medicare won’t break us as long as we look the other way? Or whose contribution to reasoned discourse is a video showing Paul Ryan pushing an old woman off a cliff?

Riiiiight!

figleaf June 13, 2011 at 2:20 pm

“There is plenty of spending we could cut without creating a Keynesian disaster, even if you accept the Keynesian framework straight up.”

Yes! Of course. I’m sure I’m missing something but my understanding from my first quarter of economics back around 1980 was that the point of Keynesian spending was to get as high a money multiplier with your dollars as possible. Thus (in 1980s cold-war terms) Ronald Reagan’s proposal to go massively (massively!) in debt building bombs and not blowing them up was identical in Keynesian terms to digging holes and filling them up. And in fact that massive, intentionally congressional-district-by-district spending spree really did help jack up the theretofore stagflating economy. The only problem being that on average military spending (high-end salaries and cost-plus bidding) has a far lower short-term multiplier than spending the same cash to hire destitute men and women to dig ditches. Ditch diggers would spend 100% of their meager income in immediate, local consumption (thus driving other local employment) whereas MX missile designers and high-union-wage Boeing engineers and Raytheon plutonium machinists had enough surplus income to drop some of it into savings. Not that there’s anything wrong with saving, it’s just that if you’re intention is to run up debt to stimulate consumption giving it to people who’ll just save it is an incredibly inefficient way to “waste” money.

I don’t think anyone but Republicans explicitly want to incur government debt in order to transfer it to (cough, wealthy) people over very long periods of time. But then they’re not exactly Keynesians, they’re just crony capitalists who, more recently, have been admiring Putin, Berlusconi, and Murcoch capitalism as even more attractive.

figleaf

txslr June 13, 2011 at 2:39 pm

There is no Republican who desires, explicitly or implicitly, to incur government debt in order to transfer it to wealthy people. You make the very common error of treating all private wealth as public and labeling the fact that people are allowed to retain some portion of it as a giveaway.

As for crony capitalism, since the Democrats are the ones most interested in directing capital investment and picking winners and losers in the economy, and given the fact that the biggest political contibutors give much more to D’s than R’s, the notion of Republican’s as especially prone to this form of “public-private partnership” is risible.

As for Putin, et al, I have heard Thomas Friedman repeatedly bemoan the fact that the U.S. is not more like China. Could you direct me to a Republican who has spoken so highly of Mr. Putin?

Pat L June 13, 2011 at 6:36 pm

Sorry, you walked into this one:

“I looked the man in the eye. I found him to be very straightforward and trustworthy. We had a very good dialogue. I was able to get a sense of his soul; a man deeply committed to his country and the best interests of his country.” — George W. Bush on Vladimir Putin.

http://en.wikiquote.org/wiki/Vladimir_Putin#Quotes_about_Vladimir_Putin

txslr June 14, 2011 at 2:37 pm

Sorry, that doesn’t do it. Not even close. The original statement spoke of admiring Putin, Berlusconi, and Murcoch (sic) capitalism. At least when it comes to Putin, neither Bush nor anyone else that I’m aware of has done that . But that is exactly what Friedman has done with respect to China, repeatedly.

Saying that you believe that Putin is committed to the best interests of his country isn’t the least bit similar to admiring his brand of economics. Nice try, but next time you spring a trap make sure someone is actually standing in it.

Bernard Yomtov June 14, 2011 at 4:10 pm

On the contrary, that’s exactly what Republicans want to do.

Look at the Iraq War, among other things. Surely Bush knew it was going top cost money – a lot of it. Yet he was willing to borrow to pay for it while cutting taxes for the wealthiest segment of society. You can rail all you want about “letting people keep their money,” but Bush’s policies very clearly increased debt to benefit the wealthy.

As long as government does things that cost money, reducing the share some individual has to pay is a benefit. If we go out to lunch and I pay for you that’s a benefit to you. It’s not just letting you keep what’s rightfully yours. Do you really think we have no obligation to fund the government?

Marian Kechlibar June 13, 2011 at 3:02 pm

From behind the former Iron Curtain, Reagan’s bomb building was instrumental in getting the USSR disintegrated. They could not keep up the pace of the arms race and their badly sclerotic economy crashed to the point that they had to vacate their Central European satellites – which had such psychological impact that their own republic (Latvia, Georgia) mutinied successfully.

But hey, what does liberation of 250M people count? It is mere ditch digging, right?

Rahul June 13, 2011 at 3:06 pm

What about the converse though? Do you think the liberation would not have happened, had it not been for Reagan’s bomb building? The economy was sclerotic anyways and discontent was rising.

Marian Kechlibar June 13, 2011 at 3:15 pm

The economy in Laos or NK stagnates awfully and the totalitarian regimes still go on.

From the Czech point of view, the communist regimes in Central Europe were kept in power (mostly) by strong presence of Russian military. And presence of such military was dependent on the ability of USSR to pay for the expenditure.

The Soviet economy was probably able to pay for grunts with AK-47s on the ground almost indefinitely. It had some un-interruptible source of hard currency from oil and natural gas, which is plentiful in Siberia, and which was already being exported to the West in the 1980s.

But it couldn’t keep pace in a technological race. It is much more expensive to build intercontinental missiles than to feed (miserably) 2-3 million young guys and supply them with small arms ammo to suppress crowds.

Marian Kechlibar June 13, 2011 at 3:17 pm

The previous answer begs for one more article.

… at the end of the day, the Russians spent all of their money on development of military technology to match American one, and they went so bankrupt that they weren’t even able to feed the grunts.

I remember that in 1991, Soviet soldiers leaving Czechoslovakia didn’t get their salaries for 2 years, and they were selling basically everything, including guns and ammo, to the Czechs just to buy bread and shoes.

Bill June 13, 2011 at 6:23 pm

So, you want to pay us back.
We take Czech currency.

J Thomas June 13, 2011 at 6:34 pm

… at the end of the day, the Russians spent all of their money on development of military technology to match American one, and they went so bankrupt that they weren’t even able to feed the grunts.

So they miscalculated. If they had not done that, would anything bad have happened? Would the USA have taken our hi-tech weapons and invaded them? Probably not. They would have survived.

Now the USA is spending somewhere around half of all the world military spending. (it got recalculated when it looked bad, and also the number might actually have changed, but it’s somewhere around there). We have no credible enemy that comes anywhere near our spending. But we continue anyway, while we approach national bankruptcy ourselves.

Reagan tricked the USSR into this blunder. Who’s tricking us into it?

Rich Berger June 13, 2011 at 3:41 pm

I would also add that Reagan further attacked the Soviet economy through decontrol of oil prices, after which oil prices dropped, reducing the Soviet hard currency reserves. He also gave the go-ahead to tightening exports of advanced equipment, which hurt the Soviet economy, and sabotage of the gas pipeline to Western Europe. Stupid cowboy actor!

Bill June 13, 2011 at 6:26 pm

Rich, I agree with you. But, the embargo began under Carter. And, I certainly agree that Russias loss of hard currency from the collapse of OPEC really hurt them.
There is a good Modern European history class taught at either Yale or Berkeley which goes into this in great detail. Can find it at ITunes U.

Rich Berger June 14, 2011 at 6:46 am

There’s a good book that I read that covered this – The Age of Reagan by Steven Hayward. I had forgotten about this until I read the book.

Rahul June 13, 2011 at 2:30 pm

Request to Tyler:

Could we have more posts about the waste and possible spending cuts in defense and agriculture subsidies please? The healthcare horse has been flogged to death already.

txslr June 13, 2011 at 2:46 pm

I, in general, agree. In particular I would like to see someone address the problem of having budgeting drive the nation’s foreign policy rather than the other way around. It is, at the very least, unbecoming to suppose that it would be acceptable to send American servicemen to, say Iraq, Afganistan, Libya or Yeman to risk their lives, but that we might later decide to lose those wars because we can’t bring ourselves to cut mohair subsidies or federally funded cowboy poetry festivals.

Rahul June 13, 2011 at 2:58 pm

I try not to club together Iraq, Afghanistan, Libya and Yemen. The US objectives in Libya and Yemen could have been very well accomplished with an American military of say, 1/10th of the current size.

Any defense cuts, no matter how small, are always blown up to be some sort of impending doom. Over the last 30 years very few US military projects have needed a force as large as it currently maintains (well, let’s exclude the cold war). Conversely most projects that have indeed demanded a large military participation were, in hindsight, not so necessary nor wise after all.

Marian Kechlibar June 13, 2011 at 3:10 pm

“Over the last 30 years very few US military projects have needed a force as large as it currently maintains”

– well, me says: “Si vis pacem, para bellum”.

It is probably better to have force big enough for anyone on the planet to be deterred by it, than to have force only big enough to match your closest potential opponent.

The World War I started precisely because the Germans could realistically challenge the British on the seas. If Britain kept its 3:1 power ratio of the 1880s, the Kaiser would probably have to withdraw from Belgium upon the British ultimatum. But he had just enough force to gamble the risk. (OK, this is very simplified, but the buildup of the Kaiserliche Kriegsmarine played huge part in the German willingness to start and prolong the conflict).

Of course, the right ratio is hard to predict, because force costs money – and also, with such force at their disposal, politicians tend to use it even in situations where it is not strictly necessary.

Rahul June 13, 2011 at 3:41 pm

I’ll just point out that the size of the US army right when WW-II started was about 200,000 soldiers. That was tiny. It was smaller than the Romanian army and barely in the largest 20 armies of the world.

Huge peacetime forces on eternal standby for doomsday aren’t always necessary.

Marian Kechlibar June 13, 2011 at 3:44 pm

I know that the US army was tiny in 1938. Actually, the Czechoslovak army was stronger in numbers.

Then again, USA of 1938 wasn’t as dependent on the international trade as today (especially when it comes to oil), and the British Navy still bore the main burden of keeping the sea free and safe.

J Thomas June 13, 2011 at 6:42 pm

- well, me says: “Si vis pacem, para bellum”.

It is probably better to have force big enough for anyone on the planet to be deterred by it, than to have force only big enough to match your closest potential opponent.

Surely that’s better if you can afford it, and if you are wise enough not to misuse it.

But look at the USSR, they tried to deter us and the attempt broke them. They failed because they spent too much preparing for a war that never came.

So I say, “To prepare for war, first run a strong peace-time economy.”

txslr June 13, 2011 at 4:28 pm

You may not WANT to club those operations together, but the fact remains that they are going on simulaneously, so clubbed together they are. A military much smaller than the one we have would not be able to carry them out. Indeed, it is not clear that the one we have can, even before cutting another $400 billion from the defense budget.

It may seem to you that the wars that have required a large military have been neither necessary nor wise, and I may agree or disagree, but surely you aren’t suggesting that the best way of making these types of decisions is simply to make going to war impossible? The system we have (or thought we had until the current President decided to go to war in Libya without the approval of Congress) may not be perfect, but at least it is a democratic, deliberative process which allows us to wage war or not, as we determine necessary according to the situation at the time. It is far from clear to me that making that decision in advance of the facts by dismantling the military today would lead to better outcomes.

Regarding the size of the U.S. military prior to the Second World War, it is inconceivable that the Japanese would have attacked Pearl Harbor and that the Germans would have followed the attack by declaring war on the U.S. if the our military had been as formidable as it could have easily been. Likewise for Britain and France. The failure of the Allies to maintain a military that matched the size of the threat led to the bloodiest war in human history. Hardly a powerful argument for slashing the defense budget.

JasonL June 13, 2011 at 2:47 pm

Non Economist here:

Something I don’t quite understand about the debate – we know that the fed has increased the monetary base but evidence seems to suggest that lending isn’t happening. We are seeing that the greater supply of money has not induced greater velocity. Okay, but don’t we have some levers to pull there – like stop paying banks to sit on their reserves?

With that in mind, that there is this big pile of inert cash sitting out there already, how does government spending stimulate demand? A temporary spending program can’t possibly be the reason someone goes out to get a loan or the reason the bank will now lend when it wouldn’t before, can it? I don’t quite follow how these two policies are supposed to interact.

J Thomas June 13, 2011 at 11:47 pm

With that in mind, that there is this big pile of inert cash sitting out there already, how does government spending stimulate demand? A temporary spending program can’t possibly be the reason someone goes out to get a loan or the reason the bank will now lend when it wouldn’t before, can it?

OK, there are some subtle ideas here.

First, let’s imagine a world where everything worked right. With a giant distributed computer system or a telepathic hive mind or something, every day all the people reveal what they want to have today and tomorrow and next year and so on, and they show what they’re ready to create, and the system matches all that up and makes the stuff and distributes it, every day. It would be nice, wouldn’t it? But we don’t have that.

So let’s change it around a little bit. Nobody knows what everybody will want, so we make stuff we think people will want, partly based on what they wanted before. And since we don’t really know how much they’ll want, we try to make a bit extra just in case. It’s better to work a little harder making stuff that doesn’t get used, than to not have enough, right? Plus there will be some wastage anyway because accidents happen and the weather is not reliable etc. So everybody works harder than they would if they knew everything ahead of time.

Now let’s make another change. We don’t know how much stuff everybody deserves. We don’t want people to sit around with their hands in their pockets while other people work hard. So we have money. You trade what you make for what you want, and you get whatever deal you can get. You don’t know how much to make, and perversely you get the best deal when there’s a shortage of the things you make, and the worst deal when there’s a surplus.

Now let’s have people who want to prepare for their old age, or for other reasons they don’t want to get stuff now, but instead want to put it off until later. They could buy stuff that keeps a long time, and trade it later. But they don’t know what the market will be like later. So they should store away more stuff than they expect to need, just in case it isn’t worth as much when they need to sell as they expect. The supply of things that last needs to be larger than you’d expect. But the more that people have stored up, the more likely the exchange value will go down rather than up. And there can be costs to storing stuff too….

So we get all these uncertainties to account for, even before anybody invents money. Life is hard.

Money provides a medium of exchange, so people don’t have to trade for beef jerky or whatever. And it provides a store of value, so people can save it and spend it later. These two different functions interfere with each other. Ideally, whoever controls the money supply should constantly watch all the prices and keep the money balanced so that on average prices don’t change much. That’s good for everybody on average, although I like it when the value of money goes up when I have a bundle and then goes down when my money is gone and I’m selling stuff. On the other hand if the money supply increases slowly enough that people don’t complain much, the money-controller can buy stuff with the surplus which is a nice perq.

Ideally, when someone wants to save money, they could just give it back to whoever mints the money, and he will track it and give it back to them when they want it. That way the money-producer gets a sense of how much money is out of circulation. But instead we have a complex system in which people who save cash give it to bankers who then lend it to whoever they can find who wants to borrow, and anybody who wants to track the money supply has to ask them what they’ve done. Bankers expand and contract the money supply at will, provided they can find enough debtors to lend to. Their job is to make money by lending, and they change the money supply as a side effect. All very complex and ad hoc. Basicly nobody knows what’s going on and it’s nobody’s business to manage.

Now another complication. More than a hundred years ago we decided that somebody ought to manage the money supply. And instead of giving that job to the Treasury, it was given to a special clique of bankers who are responsible to bankers first and to the federal government second. They affect the money supply in indirect ways, voluntarily coordinating to some extent with the Treasury and with blocks of banks and with foreign central banks. Nobody can predict what they will do. If somebody could successfully predict what they will do, that somebody could make money from it, usually in ways that do not help the Fed. So, while in theory they are supposed to help the banks and help the government, in practice they behave kind of randomly.

So OK, here we are. The economy is not doing well. Normally, if you thought there would be a lot of inflation, it would be a good time to borrow. You borrow money now and pay it off later with cheaper dollars. But if you don’t want to spend money now, and you don’t foresee getting more inflated money later, what good does it do you to borrow? Normally if interest rates are low and you expect inflation, you might get a loan and buy land, whose value will go up. Then you sell the land for a lot of inflated money and use some of it to pay off the loan. But land is still pretty expensive, and could fall a lot more. Try that trick now and you could lose your collateral.

And you don’t borrow money to start a business, not this year. This is a good year to cut back your spending, because you might make less next year and need a little to tide you over. And of course, the more people cut back their spending, the less reason there is to hire people and pay them to make things.

So the Keynesian theory is that government can spend to replace consumer spending. The more the government spends, the more that businesses will make stuff to sell to government. They hire people, who spend their money too, and the more people want to buy the more people will have the chance to work to make stuff, and the faster the economy develops. For awhile people won’t be sure things are improving so they won’t borrow money to help them cash in. They’ll fund expansion out of profits instead. But then they watch and see that the guys who borrow money to expand faster wind up with a bigger slice of the market, and more and more people try that. After awhile the economy grows without needing a lot of government consumption.

If the government is going to be buying stuff, it might as well buy stuff that’s good for us. Build roads and bridges and the Internet and so on. Maybe build a government-run stock market that isn’t crooked. The more good they do, the better the money’s spent. But if they just send money to all the taxpayers that’s a start at increasing demand, because poor people spend their money and rich people mostly don’t. So the more money poor people have, the faster the recovery from the depression.

One way to recover from that kind of depression is to tax the rich and give the money to the poor. The rich can get it back by selling stuff to the poor, and around and around it goes. But at the moment that’s considered immoral.

More later.

J Thomas June 14, 2011 at 5:10 am

The Keynesian depression isn’t the only kind of depression. It depends on positive feedback — the more people out of work, the less business there is and the less reason to hire people. There are others.

What if people simply save too much. Banks and government look for good investments. They invest in new technology etc, but there isn’t enough demand to justify that investment. So they sell to foreigners, and they invest in foreign businesses. Their own people continue to save. They manipulate exchange rates so that foreign markets look like they are worth selling to, even when they are not. Perhaps they have a big real estate boom and buy each other’s houses at increasing prices.

Eventually there is a crisis and many of the investments go sour. People realize that their savings are worthless. They feel poor and they cut their consumption. They look for better ways to save, which include things like buying gold and burying it in their back yards. This can go on for a long time — everybody wants security, they want to save for the future, but it’s hard to save when the economy is so bad.

Maybe that’s what happened to Japan. Maybe that is about to happen to China. And here’s the USA, having to deal with China’s problems. China invests more than they should in anything that looks profitable. Then they sell below cost to us. We can’t compete. We shouldn’t compete. If we overinvest and sell at a loss to compete with them, it’s no good. If we get out of every business they try to take over, that’s no good either. We’re stuck.

Protectionism, anyone? By one school of thought, when China gives us something for nothing we should just take it. They give us stuff and demand nothing in return. We win. Except we do owe them increasing debt, and at the moment they don’t demand anything for it but just use the interest to buy more debt. What will happen when they figure out we are a bad credit risk? That will be bad for them, and bad for us. It’s bad for us now, because we want to work and save ourselves, and we can’t. What can the US government do? Keynesian stuff won’t work. Give money to the poor and they buy stuff made in China — the money gets sucked right out of our economy. It stimulates the Chinese economy instead. Subsidize our own businesses to export more and sell at a loss? Even worse. We have become the tail wagging their dog and we can’t make our own choices until after they crash.

Except — maybe — protectionism of some sort. Perhaps with default. China would hate that. They have a lot of dollars and they could make things bad for us if they decide those are not a good investment. If they admit they have made a mistake, they could hurt us a whole lot. But they haven’t admitted that yet, instead they keep giving us more credit…. They will inevitably see their mistake. But if we try to stop them we will be announcing early that their savings are worthless and they will be angry at us right now. Not in the inevitable future.

Maybe we could somehow persuade the Chinese to save less and spend more? Not likely. They’ve seen hard times and they know hard times are coming again. They need savings to be ready.

Probably there is nothing we can do. But the US government has to do something. After they do something, individual politicians and whole parties will get blamed for the inevitable failure.

JasonL June 14, 2011 at 9:53 am

That was … a lot more answer than I was expecting. I appreciate the effort! I think I basically understand the AD story and some of the key criticisms thereof. It’s just that I don’t understand how the propping up of demand by the government translates to something like a business saying “I better build a new plant to support the completely new market conditions created by cash for clunkers!”

If the problem isn’t lack of money supply, and it isn’t that corporate profits are in the tank (they aren’t), it’s just hard to imagine that a helicopter drop that gets people to go to WalMart is going to help much – no matter the size, and that’s assuming a rosier debt picture than we have now. It seems more like people are unemployed because their former jobs aren’t needed to drive the same overall productivity we had before.

J Thomas June 14, 2011 at 12:02 pm

If the problem isn’t lack of money supply, and it isn’t that corporate profits are in the tank (they aren’t), it’s just hard to imagine that a helicopter drop that gets people to go to WalMart is going to help much – no matter the size, and that’s assuming a rosier debt picture than we have now. It seems more like people are unemployed because their former jobs aren’t needed to drive the same overall productivity we had before.

Yes.

If the problem is Keynesian lack of demand, and if more demand would result in higher employment leading to further high demand, then government spending or government money to poor people, either one, would help.

If the problem is industrial automation that increases productivity without increasing demand, then artificially creating demand will only let the automated factories rev up temporarily.

If the problem is foreigners who sell to us at a loss and who manipulate exchange rates to prevent us from finding our comparative advantage, artificial demand will only increase our foreign debt faster.

If the problem is US business which is subsidised to produce things which would not be produced without the subsidies, depending on imports we can’t afford and exporting subsidised products that the nation sells at a loss, then artificial demand will only dig us deeper.

If the problem is raw material imports, particularly oil, nonrenewable resources that are running out worldwide, and we can’t make products that compete on the world market to get as much of them as it takes to maintain the US way of life, then artificial demand digs us in deeper.

So, how about reducing government spending?

In the Keynesian depression that’s disastrous.

For industrial automation it doesn’t help at all.

For mercantilist foreigners, it precipitates the crisis that will inevitably come someday regardless.

For subsidies, it’s like our wrists are slit and by slowing down the heartbeat we bleed out a bit slower.

For natural resources, it doesn’t help.

Of the two main proposals, the spending approach is one for five, and the cutback approach is zero for five.

What would a solution look like? We would find products that foreigners would pay high prices for. They would be labor-intensive and would generate high wages for lots of americans. Despite the high prices, Americans could outcompete foreigners at making these products. So exports would rise. Employment would rise. Wages would rise. The US economy would be OK.

Can you imagine products like that? I haven’t come up with any yet.

Failing that, we get a much smaller middle class and a much larger lower class; our wage structure becomes third-world. Our lower class turns into more like a third-world lower class that can’t afford importado. Perhaps we would develop local industry that makes stuff for them? Ceramic stoves that burn newspaper or charcoal or wood scrap or plastic scrap? Cheap computers with solar panels for electricity? Cheap medical diagnostic programs that tell them when it’s serious enough to look for real medical help?

Or government could get into redistribution of income big-time. Continually take money from the minority who have income, who deserve to keep it all because they made it all by themselves with no help from anybody, and give it to the irresponsible bums who couldn’t arrange a living wage. Could the government do that? They could probably get the votes. It might depend on how the Army and the Reserves felt about it. They would be the elite who could get into the military, so they might have no compassion for deadbeats who lazed around. Or they might be loyal to their roots. It would depend.

TallDave June 13, 2011 at 5:16 pm

The big problem with Keynesianism is one Tyler knows well — low-hanging fruit.

Establish roads, police, a court system? HUGE benefits! The lowest of hanging fruits.

Education, defense, the Hoover Dam? Somewhat marginal or circumstantial, but generally worthwhile.

Millions for a study to help Chinese hookers drink less, $34B to make the bankruptcy reorganization of an automaker more favorable to unions, a Bridge to Nowhere? Er…

With gov’t spending exceeding 40% of GDP, the fruit is all long gone, even from the top of the tree. All we’re getting for our marginal dollars today is pie in the sky.

Marian Kechlibar June 14, 2011 at 3:48 am

Very good points, but Keynesians won’t probably like to hear that.

Hondo69 June 14, 2011 at 8:00 am

Since I can’t find a job I’ve decided to go on the government dole. After doing some homework I have my application ready.

I am now a Samoan transexual who enjoys Chinese prostitues and will soon start a solar panel company powered by ethanol. Once the big checks start rolling in I’ll vacation in the Caymens, where I will open a bank account to hide my money.

Weeeeeeeeee

Greg Messick June 15, 2011 at 6:47 am

The four major spending categories of the government: health care, social security, defense, and discretionary spending. Of these, government spending on health care is soon to significantly surpass defense spending, which has traditionally been recognized has the greatest expenditure. This may possibly become permanent practice depending on future government policy. By conventional means, the simple idea of adjusting fiscal and monetary policy to cut spending across all categories as needed in the short term, only to be eventually be forced to inject money at a more rapid and aggressive rate further down the road over the long run, is not a feasible or sustainable solution.

This idea of cutting the rate of growth, rather than cutting current spending in absolute terms makes practical sense. After all, the health care industry is a business, aside from being an indispensable resource. Reliance on Uncle Sam to financial support and manage this large task just does not sound like the best idea. We have relied on this for too long, and are now experiencing the unintended consequences. Yes, we are human. And when it comes to change, we definitely do not like drastic change. But it is time to take extreme measures in the face of extreme uncertainties of the future.

To some extent, we are all members of the guilty party, we are all part to blame for letting things get this far out of hand. We need to become less reliant on the government to resolve these issue by conventional textbook means. It is time that we all take more responsibility for our actions and be more proactive in the solution-making process.

AntiOPM June 15, 2011 at 1:08 pm

The Office of Personnel Management is one that could use some cutting, save us all some coins. OPM collects $1.7 billion in for-profit “funds from other federal agencies!”

Source: http://youtu.be/TOYrAquR5EI?hd=1

Hondo69 June 16, 2011 at 5:29 am

How many people do we have taking a hard look at government waste? Some estimates peg this figure at 3 out of every 10 dollars. Others have it higher.

For the sake of argument, if we assume 1/3 of all government dollars are wasted you’d think people would be coming out of the woodwork to fix the problem. But no, our leaders would rather spend their time fighting over increased spending vs. cuts. And that is only because it makes for better sound bites on TV.

Beyond Tom Coburn (and a few others) I don’t hear any politicians harping about cutting waste. That tells me they really don’t care about reducing spending at all.

J Thomas June 16, 2011 at 8:13 am

Hondo69, there’s a proverb that one man’s meat is another man’s poison.

Similarly, one man’s government waste is another man’s bread and butter.

A long time ago when I would come up with labor-saving ideas, a man who had once lived in china would ask me, “Whose rice bowl are you breaking today?”. It was supposed to be from a chinese proverb.

If you want to cut government spending by 30%, somebody has to decide whose jobs and contracts to eliminate. Any chance that will be done by altruists who actually believe they are cutting bad programs instead of good ones? Or will it be done on political partisan lines?

If one political party was completely dominant, then they could get rid of “waste”. They could cut everything the other party wants, which is most of what they think of as waste. They could cut funding to states and districts that held out and elected legislators from the other party. Maybe in time those voters would wise up and realize they’ll get heavy taxes and nothing to show for it until they vote for the winning party.

But without a truly dominant party, how can we possibly define which things are waste and which are wonderful government benefits for deserving contractors and for the general public?

Victor_SG June 17, 2011 at 2:09 pm

End subsidies and corporations will compete each other in a fair manner.

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