Wall St. Journal's Mistake

Perhaps the Murdochs and the WSJ editors are distracted by their News of the World difficulties. Or maybe there was a lapse in building security at the Journal's headquarters. Whatever the cause, it appears that a sane person somehow got into the place, and wrote most of today's (September 8, 2011) lead editorial.

This editorial raises in an intellectually valid fashion, the question of why the Obama stimulus failed to work. "Failed to work" is itself, of course, a controversial concept. According to Paul Krugman and many other observers, the stimulus did work, to the extent that it could, but fell short of hopes because it wasn't large enough. The Democrats generally argue the unverifiable case that the stimulus did work, preventing more jobs from disappearing. On the other hand, the results have certainly been disappointing. They have not been what President Obama clearly expected, and have fallen far short of what the public needed. In that sense, at least, I think most people could agree that the stimulus failed.

I think that a serious debate about Keynesian economics in the face of this experience is very worthwhile. The WSJ editorial is based on two somewhat anecdotal academic studies from George Mason University (a largely right wing think tank), which it takes to suggest that the stimulus money did not create nearly as many jobs as projected, and that some of the money went to highly unproductive uses. In my terms, if we take the study findings as believable and generalizable, it suggests that this was one government spending program that accomplished less than projected, and that at least some of it was actually wasteful. What a shock!

I think that a more serious question should be considered: namely, whether Keynes's idea about the psychological impact of government spending is still workable today. The fundamental idea behind Keynes's spending proposal was psychological. A depression, he noted, created the public perception of an endless downward spiral of demand. The desire for production disappears, and credit dries up. Only the government can invest. If it does so, it can lift the public depression, creating demand and hope. As animal spirits revive, so does private investment and consumption. Rising tax revenues then pay for the credit that the government used.

But Keynes was writing in a day when information was far more limited than today, and more controlled as well.  The elites who guided economies in his time were close mouthed and relatively homogeneous in outlook. Those conditions no longer prevail. As we have seen during Obama's Presidency, the psychological impact of the stimulus package was immediately undercut by Republican and conservative opposition, which got more publicity and attention than the stimulus itself.  While there clearly was some effect as jobs got saved and new spending materialized, I bet that a study of public attitudes would show that the psychological effect on which Keynes was relying proved far weaker than anticipated.

It may also be the case that intervening factors overwhelmed Obama's efforts. The economy did in fact appear to be recovering through late 2010, albeit more slowly than hoped. At that point, however, two major changes in the environment took control of events. One was the success of Republican propaganda and opposition to Obama, leading to the Tea Party and Republican control of the House in 2011. The other was the eruption of the sovereign debt problem in the EU.

With the Republican opposition granted veto power, Obama's poor skills at deadly political combat ensured a crippling standoff, bringing public policy solutions to a halt. It was no longer possible to pursue policies that would repair deficiencies in the stimulus program. In fact, a highly regressive and economically disastrous set of policy proposals came to the fore. In many states, constrained by constitutional requirements for balanced budgets, there were sharp immediate cutbacks on employment, which the federal government could no longer offset, and also sharp reductions in public employee compensation.  On the federal level, Obama repeatedly made concessions to the Republicans that implemented or set in motion to implement important aspects of their regressive proposals. Instead of stimulus and continued economic recovery, these political changes produced severe cutbacks on government spending and the disemployment of hundreds of thousands of public employees.

Because Europe is an important trading partner of the US, its economic difficulties weigh on US prospects as well. When the euro came into existence in 1992, the politicians understood that in the longer run it would be necessary to strengthen the central government if the euro were to survive. But the politics of the moment being what they were, a stronger central union was not then feasible. All EU countries could borrow on terms that were suitable only for the wealthiest, and so Greece, Italy, Portugal, Spain, and Ireland did exactly that, with the collusion of northern European and American banks. The crisis of 2007 gradually made it clear, however, that many of these loans were worthless, or far less valuable than expected. Europe's creditors, like America's, had lost a huge percentage of their wealth. They were much poorer than they thought. In the US, the creditors turned to the federal government, which bailed them out. In Europe, however, there is no such benevolent savior. The central government is weak, and the constituent elements like the Dutch and the Germans are not too willing to bail out the fraudulent and spendthrift southerners; nor is it clear that they can actually do so. In short, Europe's loss of wealth is similar to that of the US, and they are both experiencing an economic slowdown to account for it.

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