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What Krugman & Stiglitz Can Tell Us

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Paul J. Richards/AFP/Getty Images
The economist Paul Krugman

Five years after the onset of the financial crisis that badly damaged the US economy, the nation remains mired in chronic joblessness. The unemployment rate, stubbornly above 8 percent, actually makes the situation look better than it is. Many millions have given up looking for work and no longer figure in the statistics. Long-term unemployment remains at levels unseen since the Great Depression. Young Americans are entering the worst job market in at least a half-century. For both the long-term unemployed and new job seekers, this sustained absence from the workforce will have permanent effects on both their earnings and their well-being. And not just theirs. We have all lost, and continue to lose, from the prolonged mass idleness of potentially productive workers.

Yet Washington is stuck in neutral. Worse than neutral; it is in reverse. As the last elements of the 2009 stimulus phase out, the initial flood of federal aid has slowed to a trickle. If no agreement is reached before early next year, the trickle will become a huge backward flow, as President Obama’s payroll tax cut and all the Bush tax cuts expire while automatic spending cuts agreed to in previous legislative sessions kick in. Already, Republican leaders are threatening to replay last year’s standoff over the debt ceiling. Meanwhile, state and local governments—prohibited from running sustained deficits, increasingly dominated by anti-spending forces—continue to cut aid to those out of work and slash programs that invest in the nation’s future while laying off teachers and other public workers. Without those layoffs, the current unemployment rate would probably be around 7 percent.

Against this backdrop, no book could be more timely than Paul Krugman’s End This Depression Now! Since the crisis began, Krugman has argued with consistency and increasing frustration that the United States has become caught not in a normal recession, but in a “liquidity trap.” Since interest rates are already at rock bottom, normal measures, such as easy credit, won’t work, and expanded government expenditures must play a central part in boosting anemic demand. Otherwise, the efforts of private citizens to pay down debts laid bare by the financial crisis will continue to hold the economy back.

To Krugman, this is all the more regrettable because it is almost wholly preventable. We know what to do, he argues: increase public spending and make it clear that monetary expansion will continue until the economy fully recovers. Krugman advocates greater federal aid to state and local governments, as well as an aggressive effort to relieve private mortgage debts. He also argues that the Fed has been too timid in setting higher inflation targets to restore expectations of growth. “Unfortunately,” Krugman writes,

we’re not using the knowledge we have, because too many people who matter—politicians, public officials, and the broader class of writers and talkers who define the conventional wisdom—have, for a variety of reasons, chosen to forget the lessons of history and the conclusions of several generations’ worth of economic analysis, replacing that hard-won knowledge with ideologically and politically convenient prejudices.

Krugman is at once ruthless and humorous in taking on these prejudices. Early in the crisis, he started writing about a “Confidence Fairy” invoked by deficit hawks—the notion that credibly tackling the deficit would lead to increased investor confidence and thereby economic expansion. He was equally dismissive of the notion that “bond vigilantes,“ a staple of the Wall Street Journal editorial page, would go after the United States by demanding higher interest rates on loans if the US didn’t immediately slash its deficits. He reserved his greatest scorn, however, for those who predicted that expansionary policies would unleash crippling inflation. This, he insisted, was a “phantom menace.” Weak demand and rock-bottom interest rates have made banks reluctant to lend even with looser money; without such lending and the resulting expansion, Krugman argued, underlying inflation couldn’t and wouldn’t escalate.

A few years later, Krugman has been entirely vindicated in these judgments. Though the US deficit remains large—mainly due to the downturn and policies set in place before it, not the 2009 stimulus—interest rates have not spiked; quite the opposite: they are at record lows. The bond vigilantes and runaway inflation are nowhere to be seen. Economic performance has been unimpressive in the countries that have voluntarily slashed spending, such as the UK and the Baltic states of Estonia and Latvia. As Krugman patiently argues, stalled investment and the pattern of unemployment across different sectors of the economy point again and again to a shortage of demand as the central problem. By contrast, the evidence provides virtually no support for the repeatedly shifting conservative talking points about incipient inflation, business skittishness over regulatory uncertainty, or a sudden collapse in the quality of the American workforce.

Clearly, however, those driving eco- nomic policy in Washington do not agree—and that is what really frustrates Krugman. He laments what he sees as the growing insulation of America’s economic and political elite from the struggles of ordinary Americans. “For middle-income families, even before the crisis,” he writes,

there was only a modest rise in income under deregulation, achieved mainly through longer work hours rather than higher wages.
For a small but influential minority, however, the era of financial deregulation and growing debt was indeed a time of extraordinary income growth. And that, surely, is an important reason so few were willing to listen to warnings about the path the economy was taking.

In this indictment, Krugman is joined by another Nobel laureate economist, Joseph Stiglitz, whose claims are much more sweeping than his. In an argument that dovetails with those of Occupy Wall Street protesters, Stiglitz insists that the huge and growing divide between the richest 1 percent and “the 99 percent” is not just one concern among many, but the defining characteristic of a thoroughly sick economy. We may be the richest nation in the world, but poverty is higher and social mobility between generations lower than in other rich nations. In other respects, our model is bloated: we release far more carbon dioxide and use far more water on a per capita basis; and we spend far more on health care, while leaving tens of millions uninsured and achieving health outcomes that are mediocre at best.

The reason, according to Stiglitz, is that the vaunted American market is broken. And the reason for that, he argues, is that our economy is being overwhelmed by politically engineered market advantages—special deals that Stiglitz labels with a term familiar to economists: “rent-seeking.” By this, he means economic returns above normal market levels that are derived from favorable political treatment. In the most powerful parts of The Price of Inequality, Stiglitz chronicles the blatant tax and spending giveaways to big agriculture, big energy, and countless other sectors. Yet he also pointedly argues that much of the rent-seeking that plagues our economy takes a more subtle form, also familiar to economists: “negative externalities,” or costs that economic producers impose on society for which they don’t pay.

The spectacular profits of the energy industry, for example, rely heavily on the failure of regulation to incorporate fully the social and economic costs associated with environmental degradation, including climate change. Similarly, the increasingly aggressive activities of Wall Street—whether in the marketing of unsound mortgages, the use of excessive leverage, or the irresponsible use of derivatives—create huge risks for the economy as a whole. Yet these risks are largely not taken into account in the prices paid in financial markets. Without effective regulation, the costs are borne by all of us—most acutely by the struggling millions who have been pushed out of jobs.

Weeding out these and other forms of rent-seeking would thus promote both efficiency and equity, and Stiglitz provides a broad list of reform ideas, ranging from strict regulation of financial markets to more effective anti-trust laws. Yet he is most passionate about the need for political reform. Either those at the top will realize that things must change, or, he suggests, the kinds of popular revolts sweeping Middle Eastern nations will come to the United States. “In important ways,” he writes,

our own country has become like one of these disturbed places, serving the interests of a tiny elite. We have a big advantage—we live in a democracy—but it’s a democracy that has increasingly not reflected the interests of large fractions of the population.

Indeed, the most striking feature of these two books by Nobel Prize–winning economists is their emphasis on politics. Economists have traditionally insisted on the primacy of economic factors. In studying growing inequality, for instance, they have focused on economic forces like trade and technological change. Only in recent years (in part through the urgings of iconoclasts like Krugman and Stiglitz) has there been a turn to politics to explain America’s distinctive economic challenges—a reorientation that brings economics back toward its original conception as the science of political economy.

No one can doubt that the American political economy has changed dramatically over the last generation. Perhaps most fundamental is a transformation that Stiglitz and Krugman seem to assume and barely mention: the huge shift in the relative influence of business and labor. The sharp decline of unions outside the public sector (where they are now deeply embattled) has not only affected the bargaining power and compensation of employees in the workplace; it has also greatly weakened the major organized group most capable of defending less affluent Americans in the political arena.

Adding to this imbalance is the ever-rising flood of money into American politics, vividly on display in this first presidential race to take place after the Citizens United decision. Commentators wonder whether President Obama can hold even in the resulting money contest. But the impact of big donors and highly partisan outside groups is likely to be at least as great, and more lopsidedly Republican, in the battles across the nation for control of Congress and especially of the House. Like the presidential race, the congressional contests are well on their way to record spending levels, particularly for continuing GOP control of the House.

What’s more, campaign contributions are only a small proportion of political spending. The organized energies of corporations and the wealthy influence every aspect of American governance. These efforts range from direct lobbying of political officials, to drives to shape both mass and elite opinion, to the long cultivation by conservative activists of a Supreme Court majority advancing a more pro-business economic agenda, to the carefully planned use of fiscal crises in many states to mount a frontal assault on public sector unions.

For the Republican Party, the effect of the new balance of organized power has been radicalization. Economic interests that support the GOP have ample money to give, and they give it aggressively. Donors have had enormous success in creating organizations to set and enforce a hard-right agenda. Such organizations include Grover Norquist’s Americans for Tax Reform, influential think tanks like the Heritage Foundation, and state-level lobbying organizations like the American Legislative Exchange Council, financed by the conservative multibillionaires Charles and David Koch. This rightward march is long-standing, but it has only been accelerated by the rise of the Tea Party—itself supported in part by some of the same groups.

The story on the other side is very different. While the shifting balance of money and organization has encouraged Republicans to become sharply more conservative, it has created conflicting incentives for Democrats. Still reliant on their traditional but declining base within organized labor, they have nonetheless sought—with increasing success at least until recently—to develop pockets of financial support within sympathetic corporate quarters. Now that the financial industry has swung back toward the GOP, it is easy to forget that tapping Wall Street donors allowed Democrats to approach financial parity with Republicans in the 2000s. And unlike the GOP, where moderates have essentially vanished, some important groups of Democratic politicians self-consciously describe themselves as centrists (usually, they are also the ones most actively seeking business support). The result for Democrats has been an awkward dance between tepid populism and compromised centrism that has frequently divided the party and muddled its message.

The disturbing effects of these two growing imbalances—between the rich and the rest and between a conflicted Democratic Party and a more united and aggressive GOP—are exacerbated by America’s ailing political institutions. Our constitution was designed to simultaneously make compromise necessary, owing to the separation of powers, and also to facilitate compromise by making sure that individual politicians would not coalesce into hardened blocs. In writing Federalist 10, however, James Madison did not anticipate the rise of hyperpartisanship and money-driven politics or the emergence of the Senate filibuster as a routine method of minority obstruction. The necessity to compromise still applies, but the features intended to facilitate compromise, such as staggered terms of office and the dependence of politicians on highly distinct local constituencies, no longer reliably work. The result is not only gridlock, but (especially on the GOP side) a form of zero-sum conflict in which any action that might be helpful to the other party is by definition an action to be relentlessly opposed.

This immobilization and trench warfare reinforces all the forces pushing toward greater inequality. First, a government that cannot act has no way of responding to disruptive economic change. This is a big part of the story of recent financial excesses, as powerful interests effectively stalled efforts to adapt financial regulations to rapidly evolving markets. Second, gridlock and incessant bickering disgust and alienate voters, feeding confusion, distrust, and disenchantment. As ordinary voters set their sights lower or disengage, they cede political ground to well-organized activists and economic interests.

Finally, gridlock blurs accountability, making it easier for politicians to depart from voters’ priorities. In parliamentary democracies, voters can relatively easily reward or punish politicians. The party or coalition in power, from the prime minister to the backbenchers, must bear responsibility. In the United States, responsibility is much harder to assign—especially now that a party needs at least sixty votes in the Senate to overcome the omnipresent filibuster. GOP leaders know the president and his party are likely to receive most of the blame for poor economic performance, even if the scorched-earth resistance of conservative Republicans is the biggest obstacle to enacting the president’s policies.

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