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October 3, 2006
Stiglitz on global imbalances
In today's NY Times, Joseph Stiglitz takes on the topic of the hour. Most of it you have probably heard elsewhere. This part is not always mentioned:
Imagine that the Bush administration suddenly got religion (at least, the religion of fiscal responsibility) and cut expenditures. Assume that raising taxes is unlikely for an administration that has been arguing for further tax cuts. The expenditure cuts by themselves would lead to a weakening of the American and global economy. The Federal Reserve might try to offset this by lowering interest rates, and this might protect the American economy — by encouraging debt-ridden American households to try to take even more money out of their home-equity loans to pay for spending. But that would make America’s future even more precarious.
Yes, there is a tension between the fiscal and monetary authorities in cases like this. That is an important point to make, and is not always made. Stiglitz has a simple solution, however.
There is one way out of this seeming impasse: expenditure cuts combined with an increase in taxes on upper-income Americans and a reduction in taxes on lower-income Americans. The expenditure cuts would, of course, by themselves reduce spending, but because poor individuals consume a larger fraction of their income than the rich, the “switch” in taxes would, by itself, increase spending. If appropriately designed, such a combination could simultaneously sustain the American economy and reduce the deficit.
"If appropriately designed...," is a deus ex machina. This paragraph, I think even the most adamant proponents of tax increases would admit, makes a number of assumptions. One important one would be that the increase in taxes at the high end of the distribution does not reduce saving even further (since he laments our lack of savings earlier in the piece). It also assumes that the tax change would cause enough new spending by "poor individuals" to offset whatever change in consumption and savings occurs at the high end. I suppose one could postulate a Keynesian model and mathematically determine how to change taxes at different income levels--thus the phrase "if appropriately designed". I am understandably skeptical of either party's ability to do the math and appropriately design the new policy. I would also apply the Lucas Critique to any proposed model.
So the title of the piece, "How to Fix the Global Economy," is perhaps too ambitious. It's not that simple, even at the textbook level. Unfortunately, it is hard to fix the global economy in 1000 words--harder still when you have to expend half of your word budget rehashing the yuan issue. He makes an excellent point on the fiscal vs. monetary conflict but reduces the solution to one paragraph that raises more questions than it answers and makes some rather heroic assumptions about our ability to model the effects of these policies as well as our ability to design and implement them. The debate continues.
UPDATE: The debate does indeed continue. Mark Thoma, Greg Mankiw, and "knzn" all weigh in. Thoma notes that it is the difference in maginal propensities to consume (for individuals with different levels of income) that matters. True. Mankiw argues that average propensities differ, but that "...the evidence for substantially different marginal propensities is much weaker." Being charitable and granting the benefit of the doubt that there may be some difference in MPCs, I'm still left with the feeling that those MPCs (and the differences between them) are not policy-invariant (my original objection invoking the Lucas Critique). I would be very wary of attempts to fine tune progressivity to this objective. If you want to argue for more progressivity for other purposes, that's one thing. But this argument doesn't convince me. (Greg Mankiw makes a similar statement.)
Postscript: In this post, I referred to posulating a Keynesian model. That is not to say that I think that a Keynesian model would be the one I would opt for in addressing this issue, but because it seemed to best fit the argument that Stiglitz was making (the focus on the MPC in formulating tax policy). Just wanted to clarify that.
Posted by William Polley at October 3, 2006 1:46 AM
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Comments
Stiglitz's "simple solution" is a definite non-starter, because conventional taxation imposes an excess burden of about 60%. The only effective remedy is public recovery of land rent as distinct from capital income.
Posted by: georgist at October 3, 2006 4:37 AM
As for the "tension between fiscal and monetary authorities", the Geo-Austrian theory of the business cycle may be relevant. See these articles:
http://www.progress.org/2004/fold334.htm
http://www.progress.org/2006/fold475.htm
http://www.foldvary.net/works/geoaus.html
Posted by: georgist at October 3, 2006 4:43 AM
georgist,
Your second comment was moderated because of multiple links. (Just in case you were wondering what happened to it.)
Posted by: William Polley at October 3, 2006 10:28 AM
Someone made a remark to me the other day that stuck: "Are figures on global trade balances accurate or representative of actual trade anymore? China is actually final assembly point for many products that have more than 75% origins from other countries." We forget that a lot of products stamped "Made in China" use expensive components that are actually manufactured in South Korea, Japan, and often Europe. So is America's trade deficit with China really "with China"? China provides low cost labor for final assembly - so China's value added to that product assembled in China is often times less than 50% for electronics like plasma TV's, DVR's, or Apple's iPod.
Posted by: leaf at October 3, 2006 10:36 PM
An important point was made by Knzn... Is Stiglitz willing to bring about a recession? (This is, of course, granted we'd live in an IS-LM AS-AD world, with mechanical behavioral people, Lucas wen't into History, etc.)
Posted by: Gabriel M. at October 5, 2006 2:24 AM
Stilglitz is right that the starting point to fix the imbalances in the global economy is with the U.S. government deficet. His approach however, of expenditure cuts coupled with increasing taxes on the wealthy and lowering taxes on lower income earners, as the solution is not a solution at all.
Increase in taxes, whether on the rich alone, or other income earners has never solved a deficit problem. More
Posted by: Chuck Robinson at October 6, 2006 5:07 PM
More taxes always leads to more spending not saving. The list of things for government to spend money on gets bigger with more tax revenues. Stilglitz should have concentrated his thoughts on the the biggest impediment to cutting government expenditures: (1) the government's use or lose it philosophy regarding public funds and (2) the lack of willingness to on the part of the private sector to provide the public with products or do public service for less than market value. At times, especially with Defense Department contracts, the taxpayer pays more than market value for public products and service. Remember the $600 ashtrays in Navy aircraft?
Toward the end of every government fiscal year, the executive departments and courts scramble to spend every last dollar in their respective budgets out of fear that their appropriations from Congress for next fiscal will be smaller if they don't spend all of the money in their budgeted appropraitions. So, near the end of the year these agencies of government spends loads of money on beleive or not, pencils, pens paper, trips, conferences, paper clips, etc. the list goes on.
To substantially reduce goverment deficit the use it or lose it philosophy must be out to rest. Angencies should be encouraged to save, rather than spend every dollar it recieves. If at the end of each fiscal year there is money left over, it should not be soen on things just to spend money. That is wasteful and increases the deficit. Each year Congress has to appropriate more and more money to government agencies because they have no momeny left in their budgets. Not because they spent the money on needed items, but because they had a surplus that needed to be used or they'd lose money next year.
When it comes to public contracts, taxpayers should expect that since the contract calls for the need for a public product or service that beneifts the public at large, contractors should provide the product or do the service for less than market value. Profits incentive on public projects shold be lower than for private contracts. Paying less for public captial projects, services for government activities, products for government use would certainly cause a substantial reduction in the deficit. Savings would occur.
Getting rid of the use it or lose it philosophy on government agency spending and reduction the costs of public products and services is a way to save huge sums of public money, without Congress having to make the hard choices about what to spend money on or what government program to cut to save public funds and cut expenditures.
Posted by: Chuck Robinson at October 6, 2006 5:44 PM
Didn't get the rest of your comment, Chuck. Not sure what happened.
Posted by: William Polley at October 6, 2006 5:45 PM
Never mind... your additional comment just came in.
Posted by: William Polley at October 6, 2006 5:47 PM