***** from the current issue of LBO at <http://www.panix.com/~dhenwood/LBO_current.html>
Money
An obsession of this page has been figuring out what's been powering the U.S. economy. Conventional explanations, like the wondrous flexibility of our labor markets, don't convince, since these features haven't changed profoundly from the time when our major economic rivals were outgrowing us. Technological miracles don't persuade either, since there's little difference between productivity growth in the U.S. and the famously stagnant EU - and there's strong evidence that almost all the reported improvement in U.S. productivity figures in recent years can be traced to the computer industry alone. Outside computers, economist Robert Gordon estimates that productivity performance in the late 1990s is worse than the 1972?95 average. To anyone schooled in Keynesian economics, the expansion has been particularly puzzling because it's happened despite substantial fiscal tightening - the budget deficit, almost 5% of GDP in 1992, was transformed into a surplus of 1% in 1999, a massive shift that might have been expected to render an economy torpid.
So what's been driving it? LBO's preferred theory has been the growth in debt. That theory, and then some, is nicely developed in a paper by Wynne Godley, published by Bard College's Levy Institute (www.levy.org). To Godley, the U.S. economy is characterized by seven unsustainable processes. These are: 1) the fall of private savings deeply into negative territory; 2) the rise in the flow of lending to the private sector (with 1) and 2) jointly meaning more borrowing and less saving); 3) rapid growth in the money supply (the trace of all that borrowing entering the spending stream); 4) a rise in asset prices - mainly stocks - at a rate far in excess of growth in GDP or profits (which contributes to confidence, but provides no fresh cash, unlike incomes earned in production - money taken out by selling stock can only be replaced by fresh buying); 5) the rise in the federal budget surplus; 6) the rise in the current account deficit (the deficit on trade and investment income the U.S. is running with the outside world, which adds to our foreign debt); and 7) the rise in U.S. foreign debt (when domestic savings fall, and domestic borrowings rise, the shortfall can only be made up from abroad). In other words, while the U.S. government has grown prudent, the private sector hasn't: both households and businesses are spending more than their income (the income of businesses being profits). *****
And the Wynne Godley paper is available at <http://www.levy.org/docs/sreport/sevenproc.html>:
***** Seven Unsustainable Processes
Medium-Term Prospects and Policies for the United States and the World
Wynne Godley
The U.S. economy has now been expanding for nearly eight years, the budget is in surplus, and inflation and unemployment have both fallen substantially. In February the Council of Economic Advisers (1999) forecast that GDP could grow by 2.0 to 2.4 percent between now and the year 2005, and this forecast has since been revised upwards (Office of Management and Budget 1999). Many people share the CEA's optimistic views. For instance, in his New Year message (Financial Times, December 29, 1998) Alan Blinder compared the United States's economy to one of its mighty rivers--it would "just keep rolling along"; and President Bill Clinton concluded his Economic Report of the President with the words "There are no limits to the world we can create, together, in the century to come." This paper takes issue with these optimistic views, although it recognizes that the U.S. economy may well enjoy another good year or two.
During the last seven years a persistently restrictive fiscal policy has coincided with sluggish net export demand, so rapid growth could come about only as a result of a spectacular rise in private expenditure relative to income. This rise has driven the private sector into financial deficit on an unprecedented scale. The Congressional Budget Office (CBO) is projecting a rise in the budget surplus through the next 10 years, conditional on growth's continuing at a rate fast enough to keep unemployment roughly constant, and this implies that it is government policy to tighten its restrictive fiscal stance even further (Congressional Budget Office 1999a, 1999c). At the same time, the prospects for net export demand remain unfavorable. But these negative forces cannot forever be more than offset by increasingly extravagant private spending, creating an ever-rising excess of expenditure over income.
If spending were to stop rising relative to income without there being either a fiscal relaxation or a sharp recovery in net exports, the impetus that has driven the expansion so far would evaporate and output would not grow fast enough to stop unemployment from rising. If, as seems likely, private expenditure at some stage reverts to its normal relationship with income, there will be, given present fiscal plans, a severe and unusually protracted recession with a large rise in unemployment.
It should be added that, because its momentum has become so dependent on rising private borrowing, the real economy of the United States is at the mercy of the stock market to an unusual extent. A crash would probably have a much larger effect on output and employment now than in the past.
A long period of stagnation in the United States, still more recession, would have grave implications for the rest of the world, which seems to be depending, rather irresponsibly, on the United States to go on acting as spender of last resort indefinitely.
This paper makes no short-term forecast. Bubbles and booms often continue much longer than anyone can believe possible and there could well be a further year or more of robust expansion. The perspective taken here is strategic in the sense that it is only concerned with developments over the next 5 to 15 years as a whole. Any recommendations regarding policy do not have the character of "fine-tuning" in response to short-term disturbances. They ask, rather, whether the present stance of either fiscal or trade policy is structurally appropriate looking to the medium- and long-term future.
A sustained period of stagnation or recession, through its adverse effect on the national income, could drive the budget back into deficit without there being any relaxation of policy, yet to counteract an endemic recession, it will be necessary to relax fiscal policy, making any emerging deficit even larger. Further relaxation of monetary policy could not sustain the expansion, except temporarily and perversely by giving a new lease on life to the stock market boom. While a relaxation in the stance of fiscal policy will ultimately have to be made, this by itself will not be enough to generate balanced growth in the medium term because, as matters stand, this would be accompanied by a continuing rise in the United States's external deficit and indebtedness. There is probably no way in which sustained and balanced growth can be achieved in the medium term except through coordinated fiscal expansion worldwide.
The difference between the consensus view and that put forward here could not exist without a profound difference in the view of how the economy works. So far as the author can observe, the underlying theoretical perspective of the optimists, whether they realize it or not, sees all agents, including the government, as participants in a gigantic market process in which commodities, labor, and financial assets are supplied and demanded. If this market works properly, prices (e.g., for labor and commodities) get established that clear all markets, including the labor market, so that there can be no long-term unemployment and no depression. The only way in which unemployment can be reduced permanently, according to this view, is by making markets work better, say, by removing "rigidities" or improving flows of information. The government is a market participant like any other, its main distinguishing feature being that it can print money. Because the government cannot alter the market-clearing price of labor, there is no way in which fiscal or monetary policy can change aggregate employment and output, except temporarily (by creating false expectations) and perversely (because any interference will cause inflation).
No parody is intended. No other story would make sense of the assumption now commonly made that the balance between tax receipts and public spending has no permanent effect on the evolution of the aggregate demand. And nothing else would make sense of the debate now in full swing about how to "spend" the federal surplus as though this were a nest egg that can be preserved, spent, or squandered without any need to consider the macroeconomic consequences.
The view taken here, which is built into the Keynesian model later deployed, is that the government's fiscal operations, through their impact on disposable income and expenditure, play a crucial role in determining the level and growth rate of total demand and output. The circumstances that have generated a budget surplus combined with falling unemployment are not only unusual but essentially temporary. No decision to "spend" a surplus can be taken without regard for the impact on aggregate demand. In any case, there may soon be no surplus to spend. *****