How Can We Get the Economy Back on Track?

On his blog yesterday, Paul Krugman somewhat rhetorically asks, among other questions, “What do we need to do to get the economy back on track?..."

I suspect he has his own views, but here is my quick answer before seeing his: We have several factors that seriously pull down aggregate demand in the U.S. relative to where it otherwise would be. We need to address them.

Here, I just list them:

1. The serious maldistribution of income in the U.S. is a problem. The rich hoard and invest in secondary financial markets if they can't find original investment opportunities. Those with incomes over about $85,000 a year get about half of all U.S. income. The top 1/10 of one percent get six percent of all U.S. income. Unfortunately, the rich now have too much of the income of the U.S. and they spend proportionally less of it on consumption than others so aggregate demand falls.
2. The high and rising productivity of the manufacturing sector and the offshore placement of work and jobs means that many more are unemployed or underemployed who were once in manufacturing because other sectors of the economy cannot fully absorb them. They spend less on consumption than before and aggregate demand falls.
3. The on-going trade deficits mean Americans spend part of their disposable income on foreign goods. To the extent they cannot buffer that impact on their pocketbooks by debt, this reduces their demand for American goods and aggregate demand.
4. Aggregate demand is also reduced by the wealth effect as the value of people's wealth and homes have dropped.
5. As people decide that they need to save more and spend less to pay off or down their debt, that money is directed away from immediate consumption and aggregate demand again falls.
6. To the extent there is rising unemployment and underemployment due to the Great Recession, which has arisen much more out of imbalances in stock variables, rather than flow variables per se, consumption and relative aggregate demand drop.

We need to address these problems directly and fix them. Simply engaging in deficit spending to pump aggregate demand is not going to do the trick because (1) it is expensive, sooner or later, and creates problems with stock variables and balance sheets, and (2) the impact on aggregate demand is transitory; there is a bump up and then aggregate demand largely falls back to where it would have been or close to it.

Deficit spending is no remedy in this kind of situation. It can be if there is a dip in aggregate demand from which we know a recovery will soon follow and we are simply trying to bridge the gap, but that is not our situation now. We are looking off the edges of a cliff.

America has no industrial policy, no serious trade policy and no notion even of an incomes policy. Our leadership is simply out to lunch on these scores, as economists squabble with one another over too much that really does not matter.

We need to formulate the policies we lack and focus on the issues I identify here, so as to fix them or develop mitigating solutions.

Disclosure: no postions

Comments

[socrateazz:]

I agree with all but number 6 That is an excuse to justify wealth in businesses which are mostly losing value because their production is not currently toward increasing business wealth as much as trying to hold the wealth coming in. The good economy I believe is the result of pulling wealth out of companies for the last twenty years and moving it through society. The problem is: Most of that source of wealth is gone and will not be back. The attempt of taking wealth from the people will not be accepted as easily. For one thing the middle class has been inudated by income tax creep. Those close to poverty used to pay nothing. Now they are the source of income. Progressivity at work! If the balance of trade does not even out, there will be no help for US citizens for the wealth has been sucked over seas. Government grows to believe it is essential for their country so it inflates until their is little left for the workers. Dark ages revisited. My take....What goes around comes around. And it is coming fast!

Oct 05 06:16 AM

[aussiereader4:]

An alternative strategy;

1. Real free trade
2. Real freedom of movement across all borders
3. Print money to devalue currency, give it to the unemployed.
4. Universal Healthcare
5. Invest Public money in Public Transport and Energy Infrastructure.
6. Complete financial transparency of companies.
7. Stop wasting money on the military.

Oct 05 06:32 AM

[CautiousInv...:]

There are two conceptual models that are at the heart of the current struggle over economic policy. The conceptual model of 1933/2008 is about government supporting economic growth by boosting income and consumption through its spending; the conceptual model of 1981 is about government supporting entrepreneurship by reducing taxes and regulatory burdens.

Under the present circumstances I could easily support a third model that would expand the second model to include public monies into the private sector under highly specific and qualified conditions. But before we take another step towards extending existing stimulus programs or “crafting” new measures we have to take inventory of where we are and our options going forward.
Clearly, we are still living and suffering from the aftermath of a financial shock with roots in easy money, low interest rates, absurd government policies, greed, unmitigated regulatory failure, abandonment of underwriting standards, a collapse of rating agencies integrity and many other institutional failures. There is overwhelming evidence that we are recovery from a depression rather than a recession; this is a critical distinction.

“Recessions are typically characterized by inventory cycles – 80% of the decline in GDP is typically due to the de-stocking in the manufacturing sector. Traditional policy stimulus almost always works to absorb the excess by stimulating domestic demand. Depressions often are marked by balance sheet compression and deleveraging: debt elimination, asset liquidation and rising savings rates. When the credit expansion facilitates creation of assets bubbles, the distance to the mean is longer and deeper; unfortunately, excesses in one direction lead to excesses in the opposite direction.”

With private credit contracting, household savings increasing, consumer spending constrained and money multipliers falling there can be no doubt that we are in the midst of what will surely be a prolonged recovery from a depression. Policies that created unsustainable growth and various asset bubbles are highly inappropriate to addressing today’s underlying problems. Rather than blindly applying fiscal stimulus and more of the same monetary policy, we need to critically examine our circumstances and uncover obstacles to growth and opportunities for growth. We also need to correct imbalances within our economy.

Indisputably the largest obstacle to credit expansion and economic growth is failure to deal with the avalanche of toxic debt plaguing bank balance sheets; banks are hoarding capital and only lending to AAA creditors, preferring to take risks in proprietary trading of stocks, bonds and derivatives. That IMF reports that US banks have only written down 60% of non-performing loans; that banks remain compromised is easily seen in fears to burden them with actuarially sound FDIC fees; reluctance to impose responsible accounting reforms to provide more transparency and better disclosure; artificially low overnight interest rates; and the practice of paying banks interest on excess reserves held by the Fed. There are several models (temporary nationalization, good bank/bad bank) to follow in requiring banks to write-downs impaired assets; the point of this comment is simply to say it should be done without recommending a specific course.

Other obstacles to growth include the need to correct imbalances within the economy; we must replenish our stock of savings, allow interest rates to rise, asset prices to adjust to economic reality and wages to reflect productivity balanced by the forces of supply and demand. We must also purge the system of excesses, malinvestments and unsound businesses. To accomplish these goals, subsidies and economic policies that distort market forces and prices must be removed and regulations that undermine our competitiveness must be repealed. And we must restore incentives to invest to expand employment and create wealth.

With these obstacles removed and realizing that the US consumer is no longer interested in, or capable of, serving as the engine of global consumption, it’s glaringly obvious economic policies must be tilted towards rebalancing the economy and expanding the relative role of both private investment and exports. This is diametrically opposed to recent efforts funded by predations to expand consumer spending through the stimulus bill, C4C and the first time homebuyer credit. Not only are these initiatives not aligned with the trajectory of the consumer and result in poor quality growth/spending, simply bringing purchases forward and leaving a consumption crater in the future, but the first time home buyer tax credit results in the production of additional homes at a time when there is an excess in the stock of housing.

The policies that replace these misguided efforts must flow from the development of a quasi-national industrial policy; we must identify industries and technologies of the future and identify those that best match our capabilities and resources, giving priority to those opportunities with compressed lead times, large employment potential and clear export potential. This study, which might be done by the Boston Consulting Group, must be free of congressional interference and look at our country as if it were a business and the policies as a blueprint for the future; should we fail to embrace this perspective, we will be reduced to a village forever squabbling over an ever shrinking economic pie.

I am not a futurist but some of the technologies believed to be capable of supporting an industry complex include: nano and micro technology, renewable and green energy, battery storage and replenishment, stem cell development, molecular biology and bioinformatics, internet 2.0, enhanced internet infrastructure, robotics, bio-agriculture, life extension technologies, upgrade of electrical grid infrastructure and nano medicines.
Irrespective of the area(s) chosen, the most important point is that we begin to implement a coherent, rational and internally consistent program to expand private investment, employment and exports through providing grants, subsidies, tax incentives and other to incentives to the private sector to develop and commercialize promising technologies. We need a new suite of industries to replace obsolete or non-competitive industries to meaningfully expand employment.

This would be the backbone of our industry revitalization plan but in the shorter-term we could (1) implement a schedule of corporate tax reductions graduated to increase profitability, boost employment and expand investment, (2) assist small businesses obtain credit, (3) freeze cap and trade, (4) kill all proposals to review corporate tax deductions, and (5) suspend efforts to strengthen unions through “open votes”. The reckless handling of the budget and continued mulcting of the people must stop; gaping deficits must be cured through spending reductions easily accomplished upon even a cursory review of department/agency duplication, overlap and waste.

Oct 05 08:16 AM

[chap08:]

"The rich hoard and invest in secondary financial markets if they can't find original investment opportunities"

This is true. We have not suffered from a lack of funds for investment - we have suffered from a lack of good investment opportunities. The reason for this is that we are uncompetitive, and the reason for that is that we have an overvalued dollar.

I take over valued dollars and invest them overseas in cheap and growing companies. I wish I didn't have to do that but until the dollar devalues, the opportunities will be overseas. A lower dollar would increase our exports, decrease our imports, reduce unemployment and start to create demand. We are starting to see some evidence of this happening, but we need more. There are no easy answers but there are answers. A lower dollar is one of them.

Oct 05 08:23 AM

[LCACM:]

The analysis by the author is excellent. The challenge is how to get the economists who dictate the national policy to upgrade their thinking. Conventional economic thinking has the goal of maximizing production subject to the resource supply constraints, and totally ignores the fact that due to the industrial / scientific revolutions the amount of goods produced, today far exceeds what the markets can absorb. The goal of new economic thinking should be maximization of jobs rather than production of goods. The following concrete steps can help to achieve to achieve this goal a) require all countries to institute a minimum wage structure to absorb surplus goods being produced. Imagine the surge in demand that would be produced if China/India were to institute a reasonable minimum wage. b) Institute the Export Certificates regimen suggested by none other than the legendary Warren Buffet,to slowly balance trade. Balanced trade is a must to ensure stability of demand. Currently it appears that overproduction by China is creating an economic black hole.

Oct 05 09:20 AM

[ctjaeger:]

"2. The high and rising productivity of the manufacturing sector and the offshore placement of work and jobs means that many more are unemployed or underemployed who were once in manufacturing because other sectors of the economy cannot fully absorb them. They spend less on consumption than before and aggregate demand falls."

Yes, manufacturing jobs have fallen. However, without increasing productivity to the point where it is cheaper to manufacture domestically, the jobs will continue to flow overseas. It is either improving productivity or lowering wages that will keep those jobs in the US.

Also, number 5 appears to be the only nod towards the significant amount of leverage in the economy. All sectors are overleveraged, and the amount of debt on the consumers side of the ledger is outlandish.

Overuse of credit actually increases the disparity in individual wealth. Consumers who are required to put a large percentage of their income into debt repayment are unable to consume or save with those dollars. The "rich" aren't getting richer because of some evil master plan, they are getting richer by virtue of the fact that the average household has waaaay to much debt. The "rich" have adequate liquidity to service their debt, but the average household doesn't. This debt overhang strips the ability of the middle class (or lower) to save and invest for future growth. We're seeing the inevitable fallout of democratic materialism run amok.

The question? Is there a quick and painless way to achieve reasonable deleveraging on the consumer balance sheet? The answer is no. This is a painful process that will affect the consumer for next 5 - 7 years.

Oct 05 09:20 AM

[Glen L.:]

Prof. Krugman would be proud of you, Mr. Corson. He'd give you an A on your essay advocating Keynesianism of steroids. Of course, you're almost as big a blockhead as he is.

You guys just can't see the big picture because you're blinded by socialist pseudo-economics and policy wonk thinking. Aggregate demand, my pretty pink derriere! There will be no recovery until the free market is allowed to function and all the phony pooh-bahs who try to micro- and macro-manage the economy are driven from office, and their sycophants in the mainstream media and the academy finally are forced to resign in disgrace.

Dig it: savings and debt reduction are GOOD FOR THE ECONOMY! Individuals and governments spending beyond their means are BAD FOR THE ECONOMY! What you are advocating will destroy the US dollar... but maybe that's a good thing, after all.

On second thought, keep up the good work!

Oct 05 03:14 PM

[sod:]

Please tell me, someone, what does, "stock variable" mean.

Oct 05 04:06 PM

[Russ Wetherill:]

So the author is basically saying that the problem is Capitalism and the solution is Socialism? Well... I see I have some work to do here.

The author claims that there is a serious mal-distribution of income in the US. What should it be, and who decides? Should the government put together a chart that shows the allowable salary payable for a certain position regardless of experience or performance? Or perhaps the government could just mandate a flat salary for everyone? Would that solve the problem?

The author also claims that the rich hoard their money. Actually, 42% of all discretionary spending comes from the top 10% of wage earners. They actually spend more, not less than average.

Furthermore, the size of the overall global economy is based on the productive efforts of all participants within that economy. That productivity results from individual effort for individual gain. The amount of effort expended is directly proportional to the expectation of some sort of remuneration. Remove that expectation, or diminish it in some form, and the effort will soon decrease as well.

Substantial investment of time and effort is required to attain higher skill levels in any field. No sane individual will trade their most valuable possession, time, for equal pay. Moreover, forcing this individual to work for the same pay as lesser skilled competitors is morally unconscionable. Ever heard of the thirteenth amendment?

If you, as a shareholder or consumer, are unhappy with executive pay at a company, then vote with your feet. There are many companies out there that have limits of executive compensation packages. Of course, many of those aren't all that profitable...

The point is that Capitalism, despite all of its faults, is far better than any alternative. What other system allows a penny-less immigrant to start his or her own business, keep most of what they earn, and create a better life for themselves and their family? By and large, a free economy favors those that put forth the effort and properly punishes those who do not.

Oct 05 05:47 PM

[bob adamson:]

Another excellent article Mr. Corson. Arguable deficit spending is simply a tool to be used as needed from time to time (and occasionally for an extended period) as part of a larger remedial program; it is never itself alone that program or solution. Thus it was the fiscal component of the stimulus efforts of the past year; efforts that prevented an international investment banking crisis from morphing into a collapse of the banking sector generally and this, in turn, cascading into general collapse of the credit and general economic sectors in quick order. Deficit spending and stimulus generally thus artificially stabilize the economy and create a breathing space for governments and the private sector to build the basis for a sound recovery and a proper foundation for a sound economy.

What might this basis be? Some will argue that the bet of the past 30+ years on globalization, downsizing the public sector, dismantling regulatory programs, low interest and major tax reduction should now be pursued with renewed vigour. While there have been some real gains in the past from the adoption of that aggressive free market approach, it should be clear by now that the current crisis had its roots in the dogmatic adherence to that approach and that there are few in any further gains to be had from going deeper in that direction.

Others, by contrast, will argue for various measures of protectionism, establishing trading blocks, currency manipulation etc. While fear, anger, frustration and expediency may make these measures attractive, do they promise more than temporary gains and don’t they threaten longer term economic deterioration?

What is more promising therefore? I’ll deal with only one area; the nature of the public sector (and only touch on some aspects). It will be counterintuitive to many but might we not be placing too great a load on the private sector; a load that an intelligently designed public sector could more efficiently and effectively perform? Many will accept the notion that better regulation of the banking sector, particularly of investment banking by banks and near banks is warranted and that this entails the establishment or bulking up of institutions to perform this role. Education, public health and a reasonable public safety net will also have general support although argument will occur on the nature and extent of the need. Two further points deserve more consideration.

First, don’t we all lose by mindlessly increasing and decreasing public sector funding in sync with the ups and downs of the private sector business cycle. That cycle has shown great swings and each swing is of shorter duration. What can be more wasteful and destructive than to cut needed public sector programs when they are most needed and then to rapidly reflate the public sector without clear planning and proper management just because government revenues expand again at a later date? In stead, shouldn’t the public sector be an economic counterbalance to the business sector and a stabilizing factor in both the community and local economy? This is not an argument against reduction, redesign or elimination of unneeded, ill designed or ill managed programs. This should occur regardless of the phases of the business cycle.

Second, doesn’t the US in particular over rely on employers to provide, manage and fund health insurance, short term and retirement income maintenance, training and other benefits to employees; benefits that could more efficiently and effectively be assumed to a greater degree by the public sector and provided to citizens generally? Wouldn’t this increase labour mobility and allow private sector business enterprises to focus more on their core business models?

While the forgoing entails a greater tax burden, might not the efficiency savings for the nation as a whole more than offset this cost if this rebalancing of the public and private sectors was well conceived, executed and managed? Isn’t this something that at least should be considered?

Oct 05 07:54 PM

[David Zanoni:]

Yes, what Russ said.


On Oct 05 05:47 PM Russ Wetherill wrote:

> So the author is basically saying that the problem is Capitalism
> and the solution is Socialism? Well... I see I have some work to
> do here.
>
> The author claims that there is a serious mal-distribution of income
> in the US. What should it be, and who decides? Should the government
> put together a chart that shows the allowable salary payable for
> a certain position regardless of experience or performance? Or perhaps
> the government could just mandate a flat salary for everyone? Would
> that solve the problem?
>
> The author also claims that the rich hoard their money. Actually,
> 42% of all discretionary spending comes from the top 10% of wage
> earners. They actually spend more, not less than average.
>
> Furthermore, the size of the overall global economy is based on the
> productive efforts of all participants within that economy. That
> productivity results from individual effort for individual gain.
> The amount of effort expended is directly proportional to the expectation
> of some sort of remuneration. Remove that expectation, or diminish
> it in some form, and the effort will soon decrease as well.
>
> Substantial investment of time and effort is required to attain higher
> skill levels in any field. No sane individual will trade their most
> valuable possession, time, for equal pay. Moreover, forcing this
> individual to work for the same pay as lesser skilled competitors
> is morally unconscionable. Ever heard of the thirteenth amendment?
>
>
> If you, as a shareholder or consumer, are unhappy with executive
> pay at a company, then vote with your feet. There are many companies
> out there that have limits of executive compensation packages. Of
> course, many of those aren't all that profitable...
>
> The point is that Capitalism, despite all of its faults, is far better
> than any alternative. What other system allows a penny-less immigrant
> to start his or her own business, keep most of what they earn, and
> create a better life for themselves and their family? By and large,
> a free economy favors those that put forth the effort and properly
> punishes those who do not.

Oct 05 10:00 PM