The Budget Thugs: What Do They Know About the Economy?

Reprinted from the Center for Economic and Policy Research (CEPR) under a Creative Commons License

By Dean Baker

Ed Haislmaier, a senior scholar at the Heritage Foundation, made himself famous in this video where he appears to be assaulting people protesting a conference organized by Fix the Debt. While this act of bad temper may be uncharacteristic of the public behavior of this corporate-sponsored crusade to cut Social Security and Medicare, it does reflect the way in which they hope to bully their agenda through the political process.

The line from Fix the Debt, an organization that includes the CEOs of many of the country’s largest corporations, and allies like the Washington Post is that we better have cuts to Social Security and Medicare because they say so. Note that they did not try to push this line in the elections. Everyone knows that cuts to these programs are hugely unpopular across the political spectrum.

The Fix the Debt strategy was explicitly to wait until after the election. They would then go into high gear pushing their agenda of cutting Social Security and Medicare regardless of who won the elections. Remember, we need these cuts because they say so.

It is worth repeating the “they say so” part; because this is the only way we could know that cuts to Social Security and Medicare are necessary. It is possible to tell stories about countries where a meltdown in financial markets forced sharp budget cuts, but there is zero evidence of that for the United States. Investors are willing to lend the U.S. government vast amounts of money at extremely low interest rates. The only reason that we have for believing that financial markets will panic if we don’t have the Social Security and Medicare cuts the Debt Fixers want is because they say so.

For this reason it is worth considering what the Debt Fixers know or don’t know about the economy. This meaning bringing up a still fresh wound; why did none of these people see the housing bubble whose collapse wrecked the economy?

It is important to understand the bubble was not hard to see. Nor did it require much knowledge of economics to realize that its collapse would devastate the economy.

The bubble was an unprecedented nationwide run-up in house prices. For the 100 years from 1896 to 1996 nationwide house prices had on average just tracked the overall rate of inflation. In the decade from 1996 to 2006 house prices rose by more than 70 percentage points in excess of the rate of inflation.

How could anyone following the economy miss this? There are reports on house prices released every month; did none of the Debt Fixers ever look at them during the bubble years?

And there was no explanation for this extraordinary run up of prices in the fundamentals of the housing market. Population and income growth in the last decade were slow, not fast. And there was no corresponding increase in rents. If fundamentals were driving the explosion in house prices then there should have been some pressure on rents as well. And, vacancy rates were hitting all-time highs. How does that fit with a supply and demand story driving up house prices?

The fact that the housing bubble was driving the economy was also not hard to see. Typically housing construction is less than 4.0 percent of GDP. It peaked at more than 6.0 percent of GDP in 2005. Couldn’t the Debt Fixers find the GDP data released every month by the Commerce Department?

Housing wealth was also driving a consumption boom as the saving rate fell to nearly zero in the years from 2004-2007. Did the Debt Fixers think that people would keep borrowing against their homes when the equity in their homes disappeared?

The bursting of the bubble meant a loss in annual demand of more than $1 trillion when the construction and consumption boom both collapsed. What exactly did the Debt Fixers think would replace this demand?

Did they think that firms would suddenly double their investment as they saw their markets collapse? Did they think that consumers would just spend like crazy even as their housing wealth vanished? If they have a theory as to how the economy could quickly replace the demand generated by the housing bubble without large government budget deficits, it would be great if they would share.

The reality is that the Debt Fixers and their allied economists and policy wonks saw none of the above. They were completely out to lunch in their understanding of the economy.

The Debt Fixers and their allies will have to explain for themselves how they managed to miss something as huge and important to the economy as the housing bubble. However missing an $8 trillion housing bubble is not a small mistake. It is the sort of thing that in other lines of work gets you fired and sent looking for a new career.

What would Michelle Rhee, the hero of the “school reform” movement, do to a public school teacher if all their students had huge drops in scores from the prior year? The economic experts among the Debt Fixers all fit this failed teacher description.

This means that when we get a whole bunch of seemingly important and knowledgeable people telling us that we must cut Social Security and Medicare because the markets demand it, we have to remember that these are people who just recently were shown to be completely out to lunch in their economic judgment. If the Debt Fixers expect the country to take their pronouncements seriously, they should be forced to answer one simple question: when did you stop being wrong about the economy?

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The End of Loser Liberalism: Making Markets Progressive. He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues.

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2 Responses to “The Budget Thugs: What Do They Know About the Economy?”
  1. RL Crabb says:

    So we got into this mess by borrowing money at historically low interest rates in the hope that a speculative yet unsustainable economy would pull us out of the hole, and now we are told that must borrow money at historically low interest rates in the hope that a speculative yet unsustainable economy will pull us out the hole. Okay.

  2. Don Pelton says:

    RL, that’s a clever and funny way to put it.

    But the humor glosses over some important facts.

    For instance, what caused the “hole” in the first place (the hole you rightly say we need to be pulled out of)?

    The hole was the insufficiency of the demand side of our economy starting in the mid to late 1970s, when for the first time in our history (and because of policy decisions by politicians of both parties) rising productivity no longer created a corresponding rise in worker real wages. Real wages went flat in about 1979 (when inequality also began increasing more rapidly) and have stayed flat since.

    The benefits of rising productivity thereafter accrued almost exclusively to the rich, who — because of this tremendous process of wealth redistribution upward — grew richer at an accelerating rate.

    Worker wages, the usual demand engine of our economy, were no longer growing. The problem then became how to fill that demand gap (the “hole”) … where to find (or how to create) demand to keep the economy afloat?

    First a stock bubble sustained demand for awhile in the mid to late 1990s, followed by a (dot-com) bust in the year 2000.

    Then there was the housing bubble, pumped up by the Fed’s “historically low interest rates,” as you point out. Artificially inflated home mortgage equity, while it lasted, was the favorite working class/middle class ATM supporting demand until 2008, when that bubble burst.

    So what should we do now?

    We could try to reflate the bubble through private borrowing at historically low interest rates and investing again in non-productive financial instruments (to keep the cycle of boom and bust sputtering along continuously). Hair of the dog that bit us.

    Or, we could do it by means of public borrowing at historically low interest rates and investing in infrastructure and job growth as a way to restore the historical lockstep connection between rising productivity and rising real wages. WWII provided the impetus for this solution after the depression of the 1930s.

    It’s worth noting that in the usual cycle of boom and bust … inequality (with its destruction of demand through the impoverishment of the working class) reaches its peak just before the bust phase. This was true in 1928 and true again in 2008 (and, if you look carefully, you’ll probably find that to be the case in most earlier depressions).

    In other words, there appears to be a cause and effect relationship between excessive inequality and the bust phase of the perennial boom and bust cycle.

    This moves the issue of inequality from a “mere” moral issue into the realm of economic practicality and economic well-being.

    Recent economic literature is full of the sharpening realization that extreme inequality in a society is toxic to its economic health.

    See, for instance …

    Inequality and Instability: A Study of the World Economy Just Before the Great Crisis,” by James Galbraith.

    The Price of Inequality: How Today’s Divided Society Endangers Our Future,” by Joseph Stiglitz.

    Beyond Outrage: Expanded Edition: What has gone wrong with our economy and our democracy, and how to fix it,” by Robert Reich.

    The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer,” by Dean Baker.

    Inequality Matters: The Growing Economic Divide in America and Its Poisonous Consequences,” by James Lardner and David Smith.

    It’s also worth repeating that the original hole was the result of deliberate policy decisions (favoring the 1% over the 99%, if you want to put it that way) made by members of both political parties.

    Whether we overcome the current doldrums by more engineered boom and bust cycles or — on the contrary — by intelligent long-range investment in our nation’s productive capacities … continues to be a policy issue entirely dependent on statesmen of good will of both parties making the right decisions in the public interest.

    A modicum of economic literacy — largely now absent — wouldn’t hurt either.

    In other words, we’re probably screwed.

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