December 12, 2016
Dean Baker
Truthout, December 12, 2016
Economists are not very good at economics. We repeatedly get reminded of this fact when we see the economy act in ways that catch the bulk of the profession by complete surprise.
The most obvious example is the housing bubble, whose collapse gave us the financial crisis and the Great Recession. Almost no economists saw the bubble or the potential hazards posed by its bursting. But this is just the beginning of what economists got wrong in recent years.
Not only did the bubble and its collapse catch them by surprise, the recovery turned out to be much weaker than almost anyone predicted. Part of this was due to the austerity policies demanded by Congress, but even accounting for these policies, we didn’t see the rapid growth projected by the Congressional Budget Office (CBO) and other forecasters. In 2010, CBO projected average GDP growth of 4.4 percent for the years from 2012 to 2014. The actual number was less than half this amount.
The housing bubble wasn’t the first bubble CBO and other forecasters failed to see. The collapse of the stock bubble, which gave us the 2001 recession, also caught almost all economic forecasters by surprise. In short, the ability of economists to predict the future state of the economy, or understand the present state, is really poor.
This history is relevant in assessing Donald Trump’s plans for infrastructure and tax cuts because much of what economists say about these plans is likely to be wrong. Just to be clear, from what we have heard to date, both the infrastructure and tax plans seem like they are primarily designed to make Trump’s wealthy friends richer.
An infrastructure plan centered on an 82 percent tax credit sounds like a polite way of saying “steal from the taxpayers.” The tax cut plan, which will give the overwhelming majority of the benefits to the richest people in the country, will make inequality much worse. These are not well-designed policies if the purpose is to promote economic growth and help those who have not shared in the economic growth of the last four decades.
But one argument that we are likely to hear against these plans is not true: that we can’t afford them. While the size of the tax breaks and additional spending may actually push the economy beyond its full employment level of output, we need not worry that it will push the government to the brink of bankruptcy.
The result of excessive deficits would be somewhat higher inflation, which will presumably prompt the Fed to raise interest rates. Higher inflation and higher interest rates are undesirable, but this risk is well worth taking.
In spite of the fact that the unemployment rate is a relatively low 4.6 percent, the employment- to-population rate (EPOP) of prime-age workers is still down by more than two full percentage points from its pre-recession peaks. It is down by almost four percentage points from the peaks hit in 2000.
This corresponds to more than 2.5 million fewer people working today than if we had the same EPOP as we did at the 2007 peaks and almost 5 million fewer when compared with the 2000 peaks. These additional workers would be disproportionately Black and Latino, as well as people with less education. Furthermore, the tightening of the labor market would hugely increase the bargaining power of these relatively disadvantaged groups, allowing large segments of the labor force to see real wage gains.
Most economists have, for some reason, accepted that the drops in EPOPs seen since 2007, and especially since 2000, are irreversible. Even though almost no one had expected prime-age EPOPs to drop at the time (none of the official forecasts projected these drops), economists are mostly happy to ratify these drops after the fact and say that nothing can be done. This means, for example, that the Federal Reserve Board would raise interest rates, as it will do this week, to slow the economy and keep the EPOP from rising further.
Since economic arguments are determined primarily by authority rather than evidence, it would be virtually impossible to win an argument with the mainstream of the profession that the economy should be allowed to grow rapidly enough to make the EPOP rise further.
However if the boost to demand from an infrastructure program allows for a further rise in EPOPs, then we will have facts on the ground that will be undeniable. If the prime-age EPOP does actually rise by one-to-two percentage points, or even better, by three-to-four percentage points, then it will be impossible to deny that we could in fact return to the pre-recession or 2000 levels of the EPOP. This could set a new benchmark for policy for a decade or longer.
We saw exactly this process at work in the 1990s. At that time, almost every serious economist insisted that we could not get below six percent unemployment without triggering an inflationary spiral. Fortunately, then Federal Reserve Chair Alan Greenspan was not a conventional economist. He did not accept this argument.
Rather than raising interest rates and choking off the recovery, he allowed the unemployment rate to fall to 4 percent as a year-round average in 2000. This gave millions of workers jobs and pay increases to tens of millions. It also permanently lowered the unemployment targets used for setting fiscal and monetary policy.
Trump may accomplish the same trick with his policies. Republicans are terrified by deficits when a Democrat is in the White House, but they are fine with them when we have a Republican as president. While we must fight many horrible policies on Trump’s agenda, there may actually be a huge dividend if he succeeds in pushing the economy to full employment. This may benefit workers, and especially the least advantaged workers, for many years to come.
