This is not the government spending of WWII
By Holly A. Bell
On October 23, 2012, the Institute for New Economic Thinking (INET) hosted an economics discussion with Paul Krugman and Joseph Stiglitz. The moderator of the discussion asked the Nobel Memorial Prize in Economic Sciences winning economists what the solution to our current recession is. Paul Krugman quickly spoke up and said that much more government spending was needed to pull us out of the recession. Both Krugman and Stiglitz began to justify this position using the example of how government spending that supported World War II pulled us out of the Great Depression. Specifically they laid out the history as follows:
1) Two factors that lead to the Great Depression included a significant household debt bubble and a structural economic shift from a rural agricultural economy to an urban industrial economy.
2) The economy actually began to recover 2-years before U. S. involvement in WWII as the government started to spend money as part of the ramp-up to the war. The U.S. was building equipment and supplies.
3) The U. S. joined WWII and we now had two-income households that allowed debt to be paid down and savings to increase.
4) The war ended and the G.I. Bill allowed returning soldiers to enter trade schools, colleges, and universities to gain the skills they needed to complete the economy’s transition from agriculture to industry.
Stiglitz admits this recovery was not intentional, but happened ‘quite by accident’. However, both Krugman and Stiglitz believe we can intentionally repeat this type of recovery with the right macroeconomic policies. Their take-away from the Great Depression/WWII recovery example is that government spending was the triggering event and the reason for recovery. Hence, significant government spending is the answer to our current recession. I must admit I am more than disappointed by the inability of such ‘elite’ economists to see the differences between the spending that occurred prior to and during WWII and today’s government spending. Here’s why they are wrong:
Government Spending vs. Investment
The government spending leading up to WWII was being used to produce actual goods. These goods were not only being used by the U.S., but were being sold, for a profit, to our allies. This was an investment in real and potential income. The government was, in many ways, acting like a business. They also employed a tremendous amount of labor.
Today’s increased government spending is not being used to produce goods and services that can be sold for a profit. It is being used to support unemployment compensation, temporarily bail out companies like GM that eventually file for bankruptcy anyway, provide subsidies for renewable energy companies like Solyndra that have never produced anything generating a return, and to provide cash for banks who won’t lend it out for fear they won’t pass their ‘stress tests’ and/or because they are still trying to make up for revenues lost as a result of mortgage defaults.
Government spending is not generating the returns it did as we came out of the Great Depression. In fact, return on government spending has been negative since 2009. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009 each dollar of new debt SUBTRACTED 45 cents from GDP!
Plus, a significant portion of the money is ending up in the hands of CEOs and banks, the very elite and ‘wealthy’ people the current administration blames for our woes. The share of government spending reaching labor is very small so we will not see the labor driven recovery that occurred during the Great Depression and WWII from government spending. There is a difference between government spending for the sake of spending and government investment.
Pent-Up Demand
While the government’s investment in WWII created two-income households, allowed for the paying down of debt, wage rate inflation, and increased savings, it also created pent-up demand, as there was a shortage of consumer goods. When consumer production returned, households used their savings to create a boom in purchasing. The government did not need to spend because individuals were able to. This pent-up demand and high savings rate does not exist today, and is not being solved by government spending. The U.S. also came out of WWII as the only major industrialized country whose industrial infrastructure remained intact. As a result we became a major exporter as Europe and Japan rebuilt.
Today’s environment is very different. The developed world is no longer the primary source of goods production. We have transferred our production power to the developing world and have taken on the role of innovator and consumer. However, when manufacturing moves overseas, research and development often goes with it eroding our current competitive advantage in innovation. We are also transferring production knowledge to countries that have no regard for patents, trademarks, or other intellectual property rights and are willing to counterfeit goods. The current structure of our economy doesn’t look much like the post-Depression, post-WWII era.
Structural Differences
After WWII, the education returning veterans received helped the U.S. economy make the shift from rural agriculture to urban industry. We are now seeing a shift from industry to technology and service. This has resulted in two primary types of jobs in the U.S.: low paying service jobs (retail, food service, etc.) and high paid technology jobs that include technology service. This shift is considerably more difficult than the agriculture to industrial production shift for two reasons. First, there is a considerably higher level of education required to work in technology. While industrial workers could be successful with a certificate program and an apprenticeship, technology workers generally require a Bachelor’s degree or higher. The education process takes a lot more time than the previous WWII shift. The second problem is that a smaller percentage of the population has the aptitude for the required education than for industrial education. The academic rigor is much more intense and while it may be politically incorrect to say so, we cannot expect that everyone will be capable of making this educational shift.
No ‘Look-Alike’ Model
While there might be some legitimate reasons for the government to invest in the U.S. economy either directly through spending or indirectly through tax incentives, using the case of the Great Depression is not a valid argument. The situational and economic structure similarities just don’t exist. We are in an economic situation we have never seen before; there are no “look-alike’ models that justify our current model of ever increasing government spending.
Holly A. Bell is a business professor, author, analyst, manager, and blogger who lives in the Mat-Su Valley of Alaska. You can visit her website at www.professorhollybell.com or follow her on Twitter at @HollyBell8
Thank you for this very enlightening explanation 🙂
My thinking had been exactly along the lines of those economists, but I could not put my finger on why that would or would not work.
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Directly related to how the government and private equity funds are misspending the currently easily available capital. By Clayton M. Christensen:
http://www.nytimes.com/2012/11/04/business/a-capitalists-dilemma-whoever-becomes-president.html
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Thanks James, I read the article this weekend. I agree, there\’s plenty of capital in the system.
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This is very poorly-reasoned. Not worth the attention it’s receiving by virtue of appearing on Hacker News.
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This write up is not very factual, particularly with regards to the historical references. I would be reluctant to argue macro economic theory with Krugman and Stiglitz personally. Perhaps you need to get some more actual factual data in there and check your references are using statistically valid methodologies. There are indeed massive problems when trying to apply human constructed models to actual reality, I disagree with economists often but try to be informed, would not want to misinform.
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Holly,
Interesting observations. I have to confess that I have biases against Krugman because I think he’s too quick speak. I thought Stiglitz’s book on globalization was very well reasoned and he has a lot of practical real experience as well, so I’m less critical.
I would really like the shadow of WW2 to stop obscuring our way forward. The key factors that made that era special are once in a lifetime factors. Everyone knows this. We are in uncharted waters today. That being said, with no prior experience, we need to not be afraid to be a little wrong. It’s our mental models that need updating. I won’t pretend that economics is something I have a lot of experience in. Anyone can read Greg Mankiw’s blog. I just would like to recognize our new world and be less dependent on past mental models. It’s starting to feel like Ptolemy’s theory. Just an outsider’s view.
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For the sake of argument, I’ll grant you the structural differences you highlight. They are not very well documented, but I think you may be on to something. Do you think, then, that austerity is the correct approach? Should we cut government spending in the manner advocated by teabaggers and their ilk? Or perhaps, since you identify a set of structural obstacles to a substantial positive elasticity of GDP growth to additional increases in government deficit spending, would you advocate *targeted* deficit spending, say, to support the re-hiring of public sector employees (teachers, cops, first responders) laid off by fiscally strapped state and local jurisdictions? Or ways to see that additional deficit spending goes into wage subsidies for workers, or higher levels (more dollars) of weekly unemployment compensation, thereby increasing the purchasing power of millions who are in otherwise straitened circumstances, and, by multiplication, stimulating private consumption and investment? Just asking.
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Bill: Thanks for your comments. I\’m sorry it has taken me so long to reply, but I\’ve been engaged in one of those \”dawn til dusk\” projects over the past week. If you look at the article James posted above, it does a great job illustrating that there is plenty of money in the private sector. The problem is that fear and uncertainty play a part in why that money is being \”sat on\” rather than invested in the economy (by this I mean spent in ways that create jobs/increase GDP). So the question that no one seems to be asking is: How do we get that capital moving and increase the velocity of private money? The government\’s answer is to tax it away from the capital holders. The problem I have with that strategy is that government spending is very inefficient, plus transfer costs erode some of its value. So how do we get the private sector to get it moving?
The answer is that we need to create a stable fiscal and regulatory environment. I believe the first step is to reduce deficit spending through government cutbacks. This creates more certainty about the fiscal health of the country. This is not the typical \”Tea Party\” argument, but one based on creating an economic environment that is conducive to private investment. Private capital needs certainty. However, cutting spending will not be enough, we need to treat capital gains as ordinary income. This has the added benefit of providing incentives to get the capital moving, as there will be no tax incentive for keeping it idle (this is not to say I don\’t understand the importance of saved money in the economy, but we need the velocity of money up). We also need to come up with a simple and stable tax policy and get serious about regulatory reform.
As far as \”targeted\” deficit spending, I see it a little differently. Rather than direct government spending, I would like to see indirect spending through tax incentives. Don\’t like paying ordinary income tax on capital gains? Build a factory, invent and produce a product, expand a business and add additional employees, bring money back from overseas for investment in the U.S., or any other GDP driving venture and pay a lower rate on your returns from those investments for a period of time. The devil is in the details here, but my point is to provide incentives that focus private capital where we need it, and provide an environment that makes those with capital feel safe to invest it in the economy. That does not exist today and the path we\’re on won\’t make it any better.
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Holly, I wish I could say that I was happy or satisfied with your response, but I’m not. Your argument for cutting government spending (an austerity policy) seems to stand or fall on one assertion and its corollaries: that business has a lot of cash that they’re not spending (granted), and that the reason they’re not hiring and investing is because of the uncertainty created by…? And that cuts in government spending will decrease uncertainty (how and why, please) and therefore private sector investment. First of all, uncertainty is a big word, in the sense that it covers a very broad span of meaning. Just what are all these private sector actors uncertain about? That investments and hiring will pay off? Or something else? And how do you know that they’re uncertain? What’s your metric? Polling data, or belief?
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Bill, A few thoughts before I head to the airport for some travel:
When I discuss uncertainty, I refer to a form of Knightian uncertainty, in this case risk that is unmeasurable, unknown, or in flux due to too much uncertainty about the direction of monetary and fiscal policy (including tax policy), and the regulatory environment to name a few, as well as the long-term consequences of such decisions. Uncertainty as measured by Baker, Bloom, and Davis, 2012 (available here: http://www.hoover.org/publications/policy-review/… is very high. They found:
\”1) Monetary policy accounts for about one-third of policy-related economic uncertainty in the period from 1985 to 2011. Concerns related to taxes, government spending, and fiscal policy appear even more important, accounting for about 40 percent.
2) The historically high levels of economic policy uncertainty in 2010 and 2011 predominantly reflect concerns about taxes and monetary policy. Policy uncertainty in these two areas is more than four times higher in the last two years than on average from 1985 to 2011, judging by frequency counts of news articles.
3) Although much less pronounced, we also found elevated levels of policy uncertainty in 2010 and 2011 in several other categories: entitlement programs, health care, financial regulation, labor regulation, and sovereign debt and currency issues\”.
As I discussed in Bell, 2012 (http://www.iijournals.com/doi/abs/10.3905/joi.2012.21.3.055) and measured by Baker, Bloom, and Davis the type of macroeconomic information that creates uncertainty is usually carried by the media in the 24-hour news cycle and tends to create sentiments like fear (or optimism during times of prosperity) that impacts behavior.
When I see an environment in which the velocity of money is falling (research.stlouisfed.org/publications/mt/page12.pdf) while the monetary base is rising dramatically (http://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D=AMBNS) and Federal debt as a percent of GDP is rising (research.stlouisfed.org/publications/net/page17.pdf) this indicates money is being held rather then spent.
In my own discussions with business people around the country (these are individuals I know from my 24 years in business before moving to higher education), the issue of uncertainty as described by Baker, Bloom, and Davis remains a common theme that appears to be driving decision-making. Their uncertainty centers on the issues described by Baker, Bloom, and Davis, but includes concerns about the decisions in each of the areas will impact their business. Its worth noting that certainty will not necessarily cause private capital to start moving again, if it indicates significant negative consequences for the business environment. Going forward my concern is that they will become certain the business environment will diminish their returns on investments and hiring as they fear long-term costs to them will continue to rise. In this case, the pattern will continue and not reverse.
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Another great example of the relationship between political uncertainty and relative stagnation of capital: http://www.businessinsider.com/political-uncertai…
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All I can come up with is, WOW! I can’t believe these responses! Government is not the answer, but the problem. Look at the rest of the world. When Governments try to run the economy, they stifle growth and rack up huge deficits. Our Government will spend us into oblivion to fuel (and manage) the economy, only to bankrupt us as a nation!
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