He wants us to raise taxes because of “the deficits”, conflating the government’s fiscal deficit with the country’s current account deficit. Aside from sewing the sort of confusion that educators should be pledged to dispel, this argument recycles the discredited “twin deficits” hypothesis of the 1990's. Our external deficit, according to this view, is the product of our lack of savings, particularly public savings. (The fiscal deficit is a deduction from our national savings account.)
Been there, disconfirmed that. Over the course of the 90s the fiscal balance went from negative to positive, but the current account balance went down, down, down. Here’s how it looked:
Both the fiscal and current account balances are expressed as percentages of GDP, with bigger deficits pushing south. Except for a few years in the early 2000's, the two balances move in opposite directions. Shrink the government deficit (or squeeze out a surplus) and watch the current account drop. Of course, simple correlations like this are just the beginning of the story, but even fancy manipulations don’t turn this negative relationship into a positive one.
As I’ve argued before and at greater length, while everything affects everything else, the current account determines savings to a far greater extent than the other way around. The trade deficit is a drag on incomes, made up by the borrowing we do when the money comes back to us in the capital account. That transmission mechanism is obvious and visible. What about the effects of savings on trade?
There are only two routes. Either low savings leads to higher GDP (Keynes) and therefore a higher trade deficit, or it raises interest rates, which boosts the value of the dollar, which feeds the trade deficit. The first is empirically marginal at the present time: the US trade deficit is not driven by faster growth rates here compared to abroad. Even if it were otherwise, fixing trade by inducing a recession is curing a disease by killing the patient. The second route is counterfactual at two crucial points: domestic savings (low) do not drive interest rates (low) in the US, and interest rates do not drive the value of the dollar. Both are controverted by the willingness of foreign central banks and sovereign investment funds to buy dollar assets, thus far without limit.
So there is no compelling economic argument for obsessing on savings.
The political case is even weaker. The Democrats have become the party of sacrifice. They worry about Social Security (yes, that’s mentioned in Frank) because it will become a net draw on savings ten years out, so we have to “fix” it. We have to raise taxes because the fiscal deficit (currently within the Maastrict limit imposed on the Eurozone) is bad for savings. It’s all about savings, and it’s all wrong.
My suggestions: (1) Deal with the current account directly. If we cannot get international cooperation on the dollar, create a system of tradeable import permits. Take urgent action to cut the demand for petroleum, good for our trade balance and the earth’s carbon balance. Take an honest look at industrial policy. (2) Accept a fiscal deficit of 2-3% of GDP, as long as it makes sense as a national income stimulant, and as long as a substantial portion of public spending goes to investment in people and technology. (3) Finance large increases in public investment and energy transition by drastically cutting military spending. With a more modest military we could make more alliances, fewer wars and enjoy greater true security.
9 comments:
The latest Dem to go bonkers is Edwards, who was reported in the Saturday WaPo as denouncing Hillary for her "failure of leadership" in offering her ideas on "how to change social security." He has bought the Obama line and is supporting raising the income cap for taxes, which will not happen in reality without doing benefit cuts or privatization to bring Republicans on board.
So, Edwards has drunk the social security hysteria kool aid along with Obama, which I agree with Peter is ultimately linked to this savings issue.
Barkley
Too bad about Edwards. We know the sources of the bad advice being given to Obama. Time to start looking into Edwards team.
As to National Savings, it would be interesting to see someone examine the implications of the Social Security Low Cost alternative on the sustainability of a fiscal deficit of 2-3% of GDP. Currently the models are building in increases of about 2% of GDP for Social Security and I believe about three times that for Medicare. If Low Cost or something close does come about then much of the projected burden goes away.
The probability of Social Security solvency, when it is discussed at all, generally falls into a closed frame of "Social Security is in Crisis' with some countering. 'No it is not, and here is why'. But it rarely gets outside that frame. People will often often say things like "If California were a country it would be x'th biggest in the world". Well California enacted a budget that drew on a prior year balance of $10 billion, added $95 billion in projected revenues, for total resources of $105 billion, offset by $101 billion in projected cost. Big numbers certainly, but lets compare them to Social Security. Social Security started the rear with a $2.1 trillion with a T prior year balance, projected income of $782 billion, projected Cost of $594 billion, and a projected year end balance of $2.24 trillion. Moreover up to the date numbers show revenues to be understated, we are already over $2.2 trillion as of Oct 31st, we could well add some 30-50% of California's revenue by years end. California's budget gets pretty heavy attention even in the national press, plenty of national economic reporters could cite the numbers. Well I have here a Social Security budget that has 7x the revenue, 6x the cost, and more than 440x the reserves than California, and by all evidence to date numbers that few if any reporters understand with any confidence at all. If Social Security was a country where would it rank?
Social Security Income excluding Interest falls behind Cost in 2017, Social Security Income including interest falls behind Cost in 2023. Unless it doesn't. Social Security surpluses peak in 2013 at $262 billion and then slowly decline and become less and less a prop to the Unified Budget. Well maybe, that is what the Intermediate Cost assumption tells us. Under Low Cost assumptions the surplus in 2013 is $307 billion, a swing of $45 billion. If we take the ten year period from 2007 to 2016 we see one model (IC) showing an increase in holdings of $2.0 trillion to a total of $4.45 trillion, while another model (LC) increasing holdings to $4.83 trillion. Which is to say that within the term of the current 10 year note we could have an extra $380 billion come in. Well that is a hell of a big player in the bond market. Worried that China will stop buying Treasuries and maybe start selling down its portfolio? Well I got a buyer right here, his name is Mr. Low Cost.
Outcomes close to Low Cost are not guaranteed, though in my opinion more likely than not, but nowhere that I have seen has there been a rigorous attempt to examine the implications of that for either the fiscal or current account deficits. There is an invisible elephant in the room, you can't see him but you can faintly hear his rumblings, $100s of billions and ultimate $trillions are in the balance, and not just over the next 75 years, but within the terms of the 10, 15 and 30 year Treasuries.
$380 billion extra dollars can buy you a whole bunch of Dark Matter. And is a good chunk of National Savings besides.
The current discussion on Social Security within the narrow context of 'Solvent. Or not.' is important. But Solvency has implications that go far beyond Social Security itself.
Oh boy. The first hit I found on Edwards economic advisor' brought up Leo Hindery. A former CEO of Global Crossing. In other words a cable operator who cashed out with $247 million before the scandals hit. Per Wiki he is a big donor to Corporate Dems, a supporter of AIDS charities, and likes to drive race cars. He does have an MBA but his credentials to be lead economic advisor are pretty suspect. I'll be checking further but from a Social Security perspective this guy is almost a guaranteed disaster.
A little more poking around confirmed that Hindery is the guy. Well I guess we'll just have to keep pushing that SS boulder up the hill.
One can be a member of the deficit hawk wing of the Democrat Party without buying into this Obama Soc. Sec. nonsense. I'm against raising payroll taxes but would rather seen higher marginal rates on upper income taxes or fewer tax goodies for capital income. And somehow, I'm just hoping the extra savings does generate more investment and more net exports. ok, I'm praying the FED lowers interest rates - and this works some form of economagic!
Bruce
It's a little worse than "too bad about Edwards."
It says the system is rotten to the core, and the big money has bought the democrats... or maybe only taken them to lunch and dazzled them with Peter Peterson numbers.
It is a very bad sign. Unless the people get to hear the truth and put a stop to this.
The current set of leading Dems is definitely depressing. I confess to having been a fan of Gore running. Well, we know he is not. I have never been keen on hawkish Hillary and was never that much of a fan of Edwards, whom I remember being a centrist Dem at one point, although part of his populism is genuine, despite the blow dried hair and ambulance chasing, etc.
Obama was the one who seemed the most attactive of this lot in many ways, but then he got under Ghoulsbee's, or somebody's, wing and went gaga over entitlements and mandates, blah blah.
The real joke here is that for some time I have given Brad DeLong a hard time that he was pussyfooting around the social security issue because I figured she wanted to follow her hubbie in doing a number on ss and that Brad was angling for a high position in her admin. He may still be, and she may still be the one to do a number on ss, and is not taking an "it's OK," line particularly. But, as of now, she is looking better on this issue than either Obama or Edwards.
And where Edwards dug up Hindery? Who knows? Gag.
Barkley
I'm not sure what this is supposed to prove. No one ever said that the current account and the fiscal balance moved together. The trade deficit is gross investment minus national savings--including both private and public savings (including state and local govt. savings). In the 90s, you had investment going up and non-federal govt. savings going down. That's what it explains the growing trade deficit.
"Sewing...confusion"? What a stitch.
Anonymous,
I partly agree. Increased public savings could be offset by decreases in the private variety or by increases in investment. It’s a multi-sided relationship. Nevertheless:
1. The savings hawks (and this includes most mainstream economists who advise the leading Democratic candidates) think that there are weak links between public and private saving, so that boosting the former should have little effect on the latter, and therefore raise the combined total. To put it differently, they would look at that chart I posted and say, “It’s a good thing we produced a surplus in the late 90s; if we hadn’t think how much worse the current account would have been.”
2. The hawks focus on public savings because there’s more policy leverage. You could do some stuff to promote savings by households, like more tax-deferred plans, changing the default in benefit packages to voluntary savings deductions, etc. But this will not produce much of a swing. And the last thing you would want to do is discourage investment. So this leaves the fiscal balance.
3. My larger economic point is that the fundamental premiss, that national savings minus investment determines the current account, is wrong. It does not hold up to careful scrutiny. There is two-way causation, but the principal effect goes from the current account to savings-minus-investment. Most of it is a matter of simple bookkeeping: the things that foreigners (including CBs) do to return the dollars via the capital account are directly recorded as changes in domestic savings and investment. This applies to the sum of private and public savings, so policy effects on one will show up as offsetting effects on the other. Conclusion: global imbalances constitute a terribly serious problem, but engineering a flood of savings in the US is not the solution.
4. The other point is that savings mania, which is anti-Keynesian at its core, is political poison, even if the flavor is masked by Kool-Aid. Someone who really thinks this way either has to propose deservedly unpopular policies, or has to deliberately confuse and deceive the public. This is one reason why the Democratic candidates can’t convey a sense that they are really leveling with the voters: they’re not.
And as for “sewing confusion”, well, I guess I lost the thread.
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