Tuesday, July 28, 2009

Recession and recovery

In this week's cover story Newsweek wants you to know that the recession is over and the recovery has begun. To write the article the magazine enlisted Slate columnist Daniel Gross, author of a book about the benefits of economic bubbles and general propagator of economic nonsense. That Gross is so often wrong may be due to apparent lack of any formal training in economics.

I'll leave aside the question of whether the recession has ended -- a matter I'll defer to the experts on -- and instead concentrate on Gross's review of the Obama Administration's measures to assist the recovery, which he endorses but struggles to defend:
The Obama administration's strategy rests on what some might call industrial policy or excessive government intervention—or even creeping socialism. I call it "the smart economy." It means eschewing the blunt economic instruments we've always used and focusing resources and rhetoric on strategic sectors: renewable energy/green technology, infrastructure, broadband, and health care.

It means making investments to run vital systems more intelligently and efficiently, thus creating a new infrastructure on which the private sector can work its magic. This philosophy, legislated in the $787 billion American Recovery and Reinvestment Act, holds that a mixture of targeted investments, tax credits, subsidies, reforms, and direct purchases can preserve or create jobs in the short term, improve America's economic competitiveness in the long term, and catalyze private-sector investment.
This is far too kind. Spending taxpayer money on particular economic sectors in a bid to promote growth is a failed approach both from theoretical and practical standpoints. If energy, broadband or health care really are the next big thing that will generate growth then help from the government isn't needed since investors will already be putting their money there (unless of course you think the government is smarter than the private sector in identifying money-making opportunities). Practically we already know this isn't true given the struggles, for example, of the renewable energy industry both here and in other countries.

Similarly, describing the stimulus package as the expression of a particular philosophy is a bit of a stretch given that the legislation is an incoherent mish-mash. It's a mixture because it contains a grab-bag of goodies that has something for everyone. Are tax breaks for movie producers what is needed to move the economic forward? It also begs the question of why the stimulus is still needed if the recovery has already begun.

Gross is puzzling because after he lauds the ability of the public sector to create jobs (with money from the private sector) he later concedes that "the White House says less than 10 percent of the employment impact from the stimulus will take place during 2009." Frustratingly Gross freely admits many of the problems with the current approach even as he endorses it:
Energy Secretary Steven Chu may be a Nobel Prize–winning physicist. But as his department sifts through loan applications for different types of alternative-energy projects, will he prove to be a good venture capitalist? Should loan guarantees go to projects that use traditional solar panels or thin-film solar that can be stamped onto building materials? And while they do create jobs, many alternative-energy projects aren't particularly labor-intensive. Wind farms don't require armies of workers to maintain them.
In order to square this circle Gross offers up the following:
The U.S. government does have a pretty good long-term record of midwifing new industries, and creating new commercial infrastructure that spurred massive private--sector investments. The state-funded Erie Canal, which led to massive growth in upstate New York and the upper Midwest, was followed by privately backed waterways. Congress built the first telegraph line from Baltimore to Washington in 1844 before entrepreneurs were struck by "lightning," as the telegraph was called. The first transcontinental railroad was heavily financed and subsidized by Congress in the 1860s—and helped trigger a half-dozen copycat lines.
Essentially he has to reach back to the 1800s and even then comes up with the Erie Canal -- which most people would concede is an appropriate infrastructure project -- the $30,000 telegraph demonstration project and the transcontinental railroad. Now, it seems to me that railroads at the time did not require any subsidies given their huge popularity, and the transcontinental project was funded more as a monument than actual transportation project. If you look at the wikipedia description of the railroad you find the following:
Each railroad was subsidized $16,000 per mile ($9,940/km) built over an easy grade, $32,000 per mile ($19,880/km) in the high plains, and $48,000 per mile ($29,830/km) in the mountains. To allow the railroads to raise additional money Congress provided additional assistance to the railroad companies in the form of land grants of federal lands. They were granted 400-foot right-of-ways plus ten square miles of land (ten sections) adjacent to the track for every mile of track built.

...Because of the nature of the way money was given to the companies building the railroad, they were sometimes known to sabotage each other's railroads to claim that land as their own. When they first came close to meeting, they changed paths to be nearly parallel, so that each company could claim subsidies from the government over the same plot of land. Fed up with the fighting, Congress eventually declared where and when the railways should meet.

...Both railroads soon instituted extensive upgrade projects to build better bridges, viaducts, dugways, heavier duty rails, stronger ties, better road beds etc. The original track had often been laid as fast as possible with only secondary attention to maintenance and longevity. Getting the subsidies was initially the primary incentive, upgrades of all kinds were routinely required in the coming years.
Not sure this is an example of a great initiative.

Gross then, after arguing in favor of subsidizing rural broadband -- including an anecdote about a grandmother selling items on Ebay -- makes this concession:
To a large degree, the U.S. economy must now cope with an era of lower expectations. Road building isn't a recipe for full employment, green technology won't displace fossil fuels in this decade, the benefits of universal broadband may be overblown, and the dysfunctional health-care system won't shift overnight from a headwind to a tailwind. The recession may be over, but there's likely to be plenty of tough slogging ahead.

Does that mean the smart economy is a waste? Absolutely not. Declaring the stimulus a failure five months after its passage is a little like calling the results of a marathon at the second-mile marker. Virtually all these investments are necessary. They will make the economy and specific industries smarter. They are intelligent economic and political strategies.
Gross commends the current approach but then says not to expect too much from it. But how then are we to judge if it is a success?

Towards the end of the article he then offers up this:
By definition, it's almost impossible to know what the next disruptive, discontinuous great leap forward is going to be. On several occasions, Lawrence Summers has remarked that when he was involved in the big economic summit Bill Clinton held after winning the 1992 election, he didn't recall hearing many mentions of the words "the Internet."
Well, yes, it is extremely difficult to predict the "next big thing" and neither Gross nor the government possess any noted powers of clairvoyance. The entire article is a muddle, a strange mixture of advocacy of government activism combined with concessions of its inherent weaknesses and warnings against expecting very much out of this approach. Maybe it's just hard to defend the indefensible.

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