Home > economics profession, The Economy > Econ-troversy no. 1: Cowen vs. Baker (read, discuss and vote)

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.

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  1. merijnknibbe
    February 5, 2013 at 9:37 am

    Some meta: we’re talking about a lot of things here:

    1. Nominal spending
    2. Real spending, i.e. nominal spending corrected for changes in the price level. This is a complicated concept. You can correct in a ‘technical’ way, i.e. correcting nominal spending on the army for changes in the prices of drones and wages of soldiers. You can also do this in a more macro-economic way, i.e. correcting nominal spending on defense for the consumer price level or the GDP deflator, which will also show changes in the terms of trade between the army economy and the rest of the economy (when prices of drones increase more than the price level while the number of drones bought stays equal, the ‘technical’ way to deflate will show a flat metric of the amounts of drones bought while the macro-economic way will show an real increase!)
    3. Nominal spending as a % of GDP or as a % of total government expenditure or as a % of potential nominal GDP
    4. Changes in nominal spending compared with past levels or (!) projected future levels (the ‘base line’ of Tyler Cowen, remember that government cuts are defined as cuts vis a vis projected spending and not vis a vis historical spending which is not as daft as it sounds: when the number of retired people increases there will be automatic increases of government spending on social security/state pensions which are ordained by law and cuts in these entitlements are very real for people with social security/state pensions). The analytical strenth of using nominal spending as a % of GDP (i.e. also implicitly deflated by the GDP deflator!) is shown by the simple (“Changes since 2000 as share of potential GDP”) graph on the ‘important graphs’ part of the Brad deLong blog, this graph answers many of Tylers questions: http://delong.typepad.com/

    With this confusion as background Dean Baker is entirely right when he states that it is not enough to talk about nominal spending – it is real spending (in combination with the relentless increase of productivity in all countries of the world except Italy and, since six months, the UK) which determines employment: http://www.imf.org/external/pubs/cat/longres.aspx?sk=40236.0.

    But tyler Cowen is right that (a more or less emergent assumption of his ideas) ‘Keynesian policies’ are not well defined at the moment, neither by neo-classicals like (in the end and increasingly) him or by economists with a better grasp of the national accounts.

    It might be better to talk about expansionary policies, aimed at increasing nominal spending in a job enhancing way. And yes, this definition does not exclude, paraphrasing Frits Bos, spending used to coerce the population: http://peemconference2013.worldeconomicsassociation.org/?paper=meaning-and-measurement-of-national-accounts-statistics

    We do not want that. And that’s exactly the reason why the post-war consumer society and welfare state was engineered, after WW II. As expansionary spending does not necessarily has to be government spending. Though government spending might be useful, despite all the ranting of right wing as well as left wing citizens of the USA (infrastructure?). And as long as we keep the Euro we of course badly need an EU-wide pension system, which increases pensions in southern and eastern european Euro countries.

    I vote for Dean. As he is least confused.

  2. Nell
    February 6, 2013 at 11:28 am

    Sorry that there hasn’t been much discussion. I can see why though. There is little ‘meat’ in the two extracts. Tyler Cohen’s main point seems to be that it matters what governments spend their money on, whereas Dean Baker’s point is that in a deflationary environment it doesn’t matter what the government spends on as long as it spends. Both points have validity and on balance I favour Baker because he at least takes note of the current economic environment. Also, Cohen seems to make some pretty sweeping assumptions, like scientists and engineers, specialist fields of employment, would automatically move into different fields with a cut to military spending.
    I agree with Merijn Knibbe – governments need to focus on employment because it is clear over the last few decades that the private sector cannot provide enough jobs and unemployment is not only wasteful of resources its causes hardship and suffering to millions of people.

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