Stimulus Doesn't Add up

Joseph Stiglitz is a Nobel Prize winner for economics (2001) and a very influential economist. We should expect more from him in the way of good analysis. But like his other Keynesian compatriots (e.g. Paul Krugman, Martin Wolf) he writes cogently but is so driven by ideological goals that his analysis falls short of anything that one might actually call macroeconomics. In his recent article in the Financial Times (The American labor market remains a shambles, page 9, Tuesday, March 13, 2012), Stiglitz continues baying at the moon about macroeconomic stimulus. I have written numerous times in this blog about the risks of continued stimulus several years after the end of the US recession. I won’t repeat all that here but suffice it to say it behooves me to explain and defend my obnoxious allegation that such great economists fail to come even close to connecting the dots.

In this article, Stiglitz admits there has been a recovery in the US and comments that we have had several recent occasions of green shoots. Clearly this amounts to a recognition that all is not as fragile in 2012 as things were in 2008. But then Stiglitz brings up the risk factors – explaining adroitly how this recovery and expansion phase pales in terms of past ones in the US.  Stiglitz raises the correct issue – there is a concern that we have adequate policies to deal with an economy that simply won’t create jobs or output as fast as it used to. In the body of his article – and this is the frustrating part – he mentions some very real risks yet his own policy recommendation seems to avoid treating  these monsters in favor of mumbling a worn out Keynesian mantra – drill baby drill. No – just trying to see if you were still awake. The Stiglitz-Keynesian mantra is for continued big deficits, bigger debt, and a central bank that accommodates all that with more and more money.

Here are some of the trends and risks he singles out in his article:

• ·         Extrapolating current employment trends it could take 13 years to reach full employment in the USA
• ·         It will take sustained output growth of more than 4% to pull the unemployment rate down.
• ·         Even after deleveraging we should not expect the consumer to go back to previous rates of spending.
• ·         Over-building in housing leaves that sector unable to pull demand up sufficiently.
• ·         States and local governments have financial problems that prevent them from leading an upsurge in spending
• ·         Redistribution of income towards higher income individuals (who spend a smaller portion of their incomes) retards consumer spending. Wages not keeping up with inflation have exacerbated the redistribution of income.
• ·         The Great Recession reflects a transition from manufacturing to services.
• ·         Risks faced by the American economy include the European downturn, complacency in the US which prevents adequate government support, and that we are content with an unemployment rate above 7%.

From this he concludes…”the economy will almost certainly need more stimulus if it to return to full employment any time soon”.

It is telling that nowhere in this list of trends or risks is a worry about the negative impacts derived from sovereign risk associated with rising government deficits and debt. Equally noteworthy is how he fails to provide any connection between this very worthy list of trends/risks and his policy prescription for more stimulus.

It makes me think of the patient who sees his doctor about a knee problem and explains that she has been recently running 15 miles a day to prepare for the next Ironman race. The doctor says, young lady, I recommend that you take 6 aspirins with a spoonful of JD each day. While it is true that this medicine might have some impact on the pain it totally ignores the question of what is actually causing the knee problem – too much running. If this doctor has an improper relationship with Bayer or the Jack Daniels Company, then we might understand why he would give such bad advice. Of course, if the doctor is running for office then maybe he concluded that the patient would feel happier until the next election without giving her the tough advice to forget the Ironman.

Stiglitz’s advice is no different.  Like drugs the stimulus could have a short-term remedial effect. And like the drugs the bad advice could lead to long-term negative consequences.  An economist might say the risk of the stimulus is tolerable if it leads to some improvement. But surely this reasoning misses the point. If one does not attack the real causes of the knee problem or of the labor market’s under-performance, then we are certainly destined to stimulus addiction. Make no mistake that Stiglitz is advocating more stimulus. Those are his words.  I do not favor a strong and fast movement toward austerity in the USA. But many times in this blog I have explained why continuing the same level of stimulus or expanding it is the wrong thing to be doing now. 

Whether it is changes in age distribution, shift to a services sector, productivity, globalization, leverage, housing excess capacity or whatever – we get nowhere today if we do not address those issues head on.  Addressing these issues has nothing to do with more stimulus. Addressing those issues is what it will take to create the growth that will improve employment opportunities in the US.  And addressing those issues is why things are not likely to improve quickly. What is so devastating about Stiglits’s weak analysis is that it raises expectations about something that cannot and will not happen. These trends and risks that he mentions have been building for decades and the solutions will take time to work. Yes, we want the patient to have a good outlook and be positive about the future. But false confidence is wrong and will be counter-productive.

Stiglitz has every right to his opinion. But it is frustrating when a senior and prize-winning economist’s analysis is so superficial. The Financial Times has sophisticated readers and deserve to read a more thoughtful analysis of cause and effect. As in the doctor example wherein his poor prescription arose from an unethical relationship with drug companies or a populist approach to medicine, one wonders what promotes this lack of good economic analysis on the part of such an important economist.