Econ-troversy no. 1: Cowen vs. Baker (read, discuss and vote)
Yesterday Tyler Cowen [University of George Mason] and Dean Baker [CEPR] offered opposing analysis and views regarding Keynesian economics and the effect that proposed military and healthcare budget cuts in the US are likely to have on unemployment. Below are key passages from their columns (Cowen’s and Baker’s). Who is correct? Read, discuss and vote. The debate and the poll will remain open until 25 February. Only comments that engage with the discussion will be posted. The voting box is at the bottom of this post.
Here are Cowen’s main arguments:
UNLESS lawmakers act by March 1, the budget sequestration process will start cutting government spending automatically — reductions that would amount to $1.2 trillion by 2021. Congress and the White House agreed in 2011 to the sequestration, and many people see it as a kind of political gimmick.
But I believe that it can turn out to be a very good thing — and that most of these cuts should proceed on schedule, though with some restructuring along the way.
One common argument against letting this process run its course is a Keynesian claim — namely, that cuts or slowdowns in government spending can throw an economy into recession by lowering total demand for goods and services. Nonetheless, spending cuts of the right kind can help an economy.
Half of the sequestration would apply to the military budget, an area where most cuts would probably enhance rather than damage future growth. Reducing the defense budget by about $55 billion a year, the sum at stake, would most likely mean fewer engineers and scientists inventing weaponry and more of them producing for consumers.
In the short run, lower military spending would lower gross domestic product, because the workers and resources in those areas wouldn’t be immediately re-employed. Still, that wouldn’t mean lower living standards for ordinary Americans, because most military spending does not provide us with direct private consumption.
. . . . . .
THE Keynesian argument suggests that spending cuts do the least harm in economic sectors where demand is high relative to supply. Thus, the obvious candidate for the domestic economy is health care, and the sequestration would cut many Medicare reimbursement rates by 2 percent. We could go ahead with those cuts or even deepen them, because America has had significant health care cost inflation for decades.
We already have huge demand in our health care system, along with a corresponding shortage of doctors. And the coverage extension in the Affordable Care Act will add to the strain. In this setting, cutting Medicare reimbursement rates wouldn’t result in fewer health care services over all.
Here are Baker’s main arguments.
If we are looking to Keynes then the argument is straightforward, if we make cuts to the budget in a period of high unemployment like the present, then we are throwing more people out of work. These people will not be re-employed elsewhere, or if they are, they will be displacing other workers. (Btw, it’s not clear why the word “recession” appears in the paragraph. The point is simply that we would have slower growth and fewer jobs, there is no magic recession threshold in any Keynesian text I have seen.)
This Keynesian argument that cuts leads to unemployment in a depressed economy applies regardless of whether the spending is for good or bad purposes. In other words, even if we cut $100 billion from the governnment Department of Waste, Fraud, and Abuse, which does nothing but write reports and throw them in the garbage, it would still slow growth and raise unemployment. The problem facing the economy right now is demand, demand, and demand. If you reduce demand, you hurt the economy.
In the longer term, when the economy does get back to something resembling full employment, it will be helpful if we can eliminate wasteful areas of government spending. Of course it would also help the economy if we can expand useful areas of government spending. But that is not particularly a Keynesian story. I assume that almost anyone would agree with these propositions even if they might draw the lines differently between wasteful and useful.
Anyhow, the reference to Keynes is a bit peculiar here. If Cowan thinks he has argued for cuts that are consistent with the Keynesian view, he is mistaken. The idea that cuts in areas of relatively strong demand like health care will have less effect on employment is at best true in only a trivial sense. Wages are not rising especially rapidly in this sector, it is not as though we have any reason to believe that there would be large numbers of additional hires to replace workers who lose their jobs due to government cutbacks, even if the impact might be marginally less than cutbacks in other sectors.