7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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July 24, 2009

Barry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese

Economic Policy

Barry Eichengreen said he never understood the math of the stimulus:

All Stimulus Roads Lead to China: Now that the “green shoots” of recovery have withered, the debate over fiscal

stimulus is back with a vengeance. In the US, those who argue for another stimulus package observe that it was always

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7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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stimulus is back with a vengeance. In the US, those who argue for another stimulus package observe that it was always

wishful thinking to believe that a $787bn package could offset a $3tn fall in private spending. But unemployment has

risen even faster and further than expected. Combine this with the continued fall in housing prices, and it is

understandable that consumer spending remains depressed. The banks, having been recapitalised only to the extent

necessary to keep them afloat, still have weak balance sheets. Their consequent reluctance to lend constrains

investment. Meanwhile, state governments, seeing revenues fall as a result of lower taxable incomes last year, are

cutting back like mad. If there was a case for additional stimulus back in February, that case is even stronger now...

And then I think Barry takes a misstep:

But the case against additional stimulus is also strong. The US federal deficit is an alarming 12% of GDP, and public

debt as a share of national income is already projected to double, to 80% of GDP. The idea that the US can grow out of

its debt burden, as did Finland and Sweden following their financial crises in the 1990s, seems unrealistic...

At a 3% per year average inflation rate, the trend growth rate of nominal GDP in America is somewhere between 6% and 7%.

The U.S. Treasury can currently borrow at 3 years for a nominal interest rate of 1.62%, for ten years at a nominal interest

rate of 3.72%, and for 30 years at a nominal interest rate of 4.58%. When the growth rate of your economy is greater than

the interest rate you have to pay, that is the definition of "grow[ing your way] out of [your] debt burden--as long as you can

keep your budget in primary balance: keep non-interest spending at or less than your revenues so that your net nominal

debt issues are zero.

Is the U.S. in primary balance? Almost--if you take the CBO's "Alternative Fiscal Scenario" as your baseline, which you

should, it wouldn't take much in the way of tax increases to get us there by 2012. We should, I firmly believe, put those tax

increases in place now: pass legislation with standby triggers so that if we are not in primary surplus by 2012 the surtaxes

kick in. And doing so does not seem unrealistic to me at least.

CBO Extended Baseline:

CBO Alternative Baseline:

7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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The fact is that the approporiate fiscal policy for the U.S, right now is to pass: (a) a bigger stimulus over the next two years,

(b) a standby tax increase to return the federal budget to primary surplus by 2012, and (c) devout and lengthy prayers that

confidence in the dollar doesn't collapse and send interest rates on U.S. Treasuries above the economy's growth rate--in

which case the situation changes from its current value of "dire" to "catastrophic."

But Barry appears to think differently:

[M]ore deficit spending will only stoke fears of higher future taxes and inflation... encourage the reemergence of global

imbalances... not reassure consumers or investors.... [T]he politics all point in one direction. The US Congress lacks the

stomach for another stimulus package.... Disappointment over the effects of the TARP has already destroyed popular –

and Congressional – support for more public money to recapitalise the banks. So, even those who find the economic

logic of arguments for fiscal activism compelling must acknowledge that the politics are not supportive. A second

stimulus simply is not in the cards...

Or does he? I suspect that Barry agrees with me on what the appropriate fiscal policy for the U.S. is, he just believes that it is

politically unrealistic to argue for such a policy. I believe that Barry is committing a common fallacy what I call the

Samwickian fallacy, after Andrew Samwick's explanation of the failure of the Bush administration Council of Economic

Advisers to argue for the imposition of a carbon tax:

7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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Advisers to argue for the imposition of a carbon tax:

Republicans and Gas Taxes: [Politics] sets the framework for all policy outcomes--not the CEA--even on economic

issues. CEA... works to generate the best outcomes within that framework. And if the President is not interested in a gas

tax, then it becomes a very short conversation...

The Samwickian fallacy is the claim that economists should censor themselves and not argue for the best policies when those

policies are not politically attainable, but should instead argue for the best politically-attainable policies. That, I think,

mistakes the economist's role. First of all, economists are lousy at figuring out what is and what is not politically attainable.

Second, to make powerful and convincing arguments that policies that are not politically attainable are in fact best for the

country and the world is the best way to stretch the boundaries of the politically attainable.

It is Barack Obama's, Rahm Emmanuel's, Nancy Pelosi's, and Harry Reid's job to figure out what is politically attainable. It

is our job to figure out what it would be best to do. It's not at all clear to me that a combination of (a) more stimulus now,

(b) standby taxes later, and (c) health and climate-policy reforms that promise to improve the country's fiscal balance after

2012 will not be very politically possible come September--if those of us who know enough to know that such policies are

best for the country and the world spend the rest of the summer strenuously arguing for them.

Barry, however, despairs and seeks to persuade not the U.S. government but the government of China to do what is

economically good for the U.S and the world:

If there is going to be more aggregate demand, it can come from only... emerging markets like China. The problem is

that China has already done a lot to stimulate domestic demand, both through government spending and by directing

its banks to lend. As a result, its stock market is frothy, and it is experiencing an alarming property boom. Through

May, property prices were up 18% year on year. Understandably, Chinese officials worry about bubble trouble. The

obvious way to square this circle is [for China] to spend more on imports... purchase more industrial machinery,

transport equipment, and steelmaking material, which are among its leading imports from the US. Directing spending

toward imports of capital equipment would avoid overheating China’s own markets, boost the economy’s productive

capacity (and thus its ability to grow in the future), and support demand for US, European, and Japanese products just

when such support is needed most. This strategy is not without risks.... But these are risks worth taking if China is

serious about assuming a global leadership role.

The question is what China will get in return.... China is worried that its more than $1tn investment in US Treasury

securities will not hold its value.... It therefore wants to see a credible program for balancing the US budget once the

recession ends. And, tough talk notwithstanding, the Obama administration has yet to offer a credible roadmap for

fiscal consolidation. Doing so would reassure American taxpayers worried about current deficits. Just as importantly, it

would reassure Chinese policymakers.We live in a multipolar world where neither the US nor China is large enough to

exercise global economic leadership on its own. For China, leadership means assuming additional risks. But for this to

be tolerable, the US needs to relieve China of existing risks. Only by working together can the two countries lead the

world economy out of its current doldrums.

The problem is that China's economy is only one-quarter the size of America's. It is a generation too early for global

macroeconomic stabilization policy to be made in Beijing and Shanghai rather than Washington and New York. To call for

China to assume the role of the Hegemon in the world economy is even less realistic than to call for the government in

Washington to live up to its responsibility to boost demand in the short run and lay out a convincing roadmap for fiscal

consolidation in the medium run.

UPDATE: Andrew Samwick is unhappy:

In http://delong.typepad.com/sdj/2009/07/barry-eichengreen-the-samwickian-fallacy-the-role-of-the-economist-

and-chinese-economic-policy--opinion.html, that you would misquote one post from my blog and attribute such a

recommendation to me is contemptible.

7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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recommendation to me is contemptible.

The full paragraph you are quoting is:

The word "emerging" is in quotes, referencing a theme of the article, which is that it is much easier for people who have

worked inside a Presidential administration to advocate for politically unpopular ideas when they are on the outside.

That's true but only to a point. It's not that Greg Mankiw ever said anything other than what he now says about the gas

tax while on the inside. It's that the President sets the framework for all policy outcomes--not the CEA--even on

economic issues. CEA, like every other part of the administration, works to generate the best outcomes within that

framework. And if the President is not interested in a gas tax, then it becomes a very short conversation.

You make three errors:

1. You misquote me. You substitute the word "Politics" for the words "The President." You are correct that

economists may be lousy at determining what is politically attainable when considering all of the political

institutions in the argument you are making in your post. You are not correct that economist serving as CEA chair

is necessarily lousy in determining what is politically attainable when the President, after taking part in the

conversation, has decided that a particular policy is off the table.

2. The sentence before the one you misquote indicates that I do not claim that Greg censored himself in his internal

conversations about policy while CEA chair.

3. Even if you believe that sentence indicates that he did censor himself in his internal discussions about policy while

CEA chair, I have not in any way made the normative statement that this is what "should" happen.

I apologize. I do think that economists of both parties in and out of government censor themselves too much in the interest

of presenting positions that they think are palatable to their political masters. But I do not think the Bush administration

CEA was culpable of this mistake to a significantly greater extent than the CEA under other administrations. (The Bush

OMB, Treasury, and NEC, on the other hand...)

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Brad DeLong on July 24, 2009 at 09:56 AM in Economics, Economics: Economists, Economics: Fiscal Policy, Economics:

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The stimulus spending was contractionary spending on infrastructure. I am sure that with recent data Brad DeLong has figured out

the exact rise in unemployment and the contributing factors.

You loved this post ( ), you might also like:

Wonk Watch 7.24.09 (@The Sausage)

Economists Unclear on the Meaning of "Political" (@this site)

7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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You will never lower unemployment with infrastructure spending. Large spending relative to jobs created reduces money supply and

increases unemployment.

Posted by: Nancy Kirsch | July 24, 2009 at 10:53 AM

China cannot possibly rescue the US economy through bond purchases or through purchases of US good. They simply do not have the

scale yet to do so. Even if they had the scale, do they have the desire to do so? It appears not. Are they obligated to? Should we blame

them for not buying our high priced goods and over-priced bonds? Can we blackmail them into purchases beyond their capacity with

the threat of a general economic collapse in the US if they won't? Is this a resumption of MAD, except in the economic sphere?

Further, the amount of government debt being issued by all countries and all levels of government in the next year is simply too

much. Too much for the bond buyers to absorb. Too much for the remainder of the investment market to remain healthy.

It appears that our only path is the one we have started on- a path of self purchase of debt while denying it. And we better be hoping

that the next big thing is just around the corner.

Posted by: Neal | July 24, 2009 at 10:55 AM

"At a 3% per year average inflation rate, the trend growth rate of nominal GDP in America is somewhere between 6% and 7%. The

U.S. Treasury can currently borrow at 3 years for a nominal interest rate of 1.62%, for ten years at a nominal interest rate of 3.72%,

and for 30 years at a nominal interest rate of 4.58%. When the growth rate of your economy is greater than the interest rate you have

to pay, that is the definition of "grow[ing your way] out of [your] debt burden--as long as you can keep your budget in primary

balance: keep non-interest spending at or less than your revenues so that your net nominal debt issues are zero.

Is the U.S. in primary balance? Almost--if you take the CBO's "Alternative Fiscal Scenario" as your baseline, which you should, it

wouldn't take much in the way of tax increases to get us there by 2012. We should, I firmly believe, put those tax increases in place

now: pass legislation with standby triggers so that if we are not in primary surplus by 2012 the surtaxes kick in. And doing so does not

seem unrealistic to me at least."

Reading stuff like that, having leaders in charge who, at the very least are open to listening to the right ideas, and having people like

you, who write stuff like that, and others generating information for the public discourse keeps me confident. It doesn't strike me as

being particularly easy, but it does strike me as possible, as long as we are having an adult conversation about where we want to go.

The Republicans may not be willing to have it with us, but the Democrats--some of them, at least--are trying to do so.

Posted by: Brian J | July 24, 2009 at 11:06 AM

Both of those fine CBO graphs are rendered inaccurate to a significant degree via falling revenues.

US tax revenue, all sources, was reported down 34% YOY, 2008 to 2009, in April. Has it improved since then?

Posted by: Neal | July 24, 2009 at 11:52 AM

Of all the things the Obama administration could do to help the unemployed and get the economy back into shape they chose the two

worst things. Investing in infrastructure and bailing out bad companies because "they were too big to fail."

They were not too big to fail. Nothing is to big to fail. If it fails, other more efficient and better run companies will take their place.

The investors in those companies believed in the market until it looked like they were going to tank, and then it was the governments'

responsibility to maintain their asset prices. One characteristic of the market is when bad companies fail you must let them fail. That

money should have gone to help the unemployed workers.

In a well run economy, GDP/person is about $20,000. The maximum paid worker is about 5x what the lowest paid worker gets. That

should be a law. That way you avoid income stratification and deflation. Then you have your figure for money supply.

People should save about 10% a year for retirement. Private savings. Save about 1 years salary. Any more savings and that is not good

for the economy because it causes deflation. Deposit insurance at 100K. But if the economy is well run there are few failures. We have

a very poorly run economy and that's why we have all these problems.

Companies would be run by owner/manager and stock would be owned by the employees and so no stock market.

Posted by: Nancy Kirsch | July 24, 2009 at 02:23 PM

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Doesn't the fact that China is insanely mercantilist bode ill for their contribution to global demand for American stuff anytime in the

near future?

Posted by: Noah | July 24, 2009 at 02:24 PM

Brad makes the key assumption that something like the longterm growth rate pre-crash is achievable post crash. But what if that isn't

the case?

One argument that it won't be, is that not only government, but also households and businesses are going to be trying to reduce their

debt levels for quite a few years to come. What does this mean for the rate of growth post recession?

IMO a much stronger concern is that we have reached the limits to growth in our consumption of a number of important industrial

and agricultural commodities. Oil, coal, iron ore, fertilizer, water, the ability of the atmosphere to absorb our wastes, are now at or

near their limits. In a supply constrained world, are pre supply constraint growth rates likely? We better hope the next big thing is

stuff that makes living within those constraints easy.

Posted by: bigTom | July 24, 2009 at 03:02 PM

That you would misquote one post from my blog and attribute such a recommendation to me is contemptible.

The full paragraph you are quoting is:

The word "emerging" is in quotes, referencing a theme of the article, which is that it is much easier for people who have worked

inside a Presidential administration to advocate for politically unpopular ideas when they are on the outside. That's true but only to a

point. It's not that Greg Mankiw ever said anything other than what he now says about the gas tax while on the inside. It's that the

President sets the framework for all policy outcomes--not the CEA--even on economic issues. CEA, like every other part of the

administration, works to generate the best outcomes within that framework. And if the President is not interested in a gas tax, then it

becomes a very short conversation.

You make three errors:

1) You misquote me. You substitute the word "Politics" for the words "The President." You are correct that economists may be lousy at

determining what is politically attainable when considering all of the political institutions in the argument you are making in your

post. You are not correct that economist serving as CEA chair is necessarily lousy in determining what is politically attainable when

the President, after taking part in the conversation, has decided that a particular policy is off the table.

2) The sentence before the one you misquote indicates that I do not claim that Greg censored himself in his internal conversations

about policy while CEA chair.

3) Even if you believe that sentence indicates that he did censor himself in his internal discussions about policy while CEA chair, I

have not in any way made the normative statement that this is what "should" happen.

Posted by: Andrew Samwick | July 24, 2009 at 03:02 PM

I agree with Rithholtz. I think the nominal growth rate in GDP will be significantly less than your 6-7%. The link below, for example,

shows something that averages out to a little under 3% over the next couple years.

http://forecasts.org/gdpgrowth.htm

Posted by: mark | July 24, 2009 at 03:28 PM

Revenue is highly dependent on GDP growth. Fixing the economy and a return to economic growth will do wonders for closing the

budget gap. OTOH, high unemployment and slow economic growth do too little to close the gap and create problems that make it

larger. The best course is to get out in front with a JOBS program (not a non-targeted stimulus).

Posted by: bakho | July 24, 2009 at 07:10 PM

"I do think that economists of both parties in and out of government censor themselves too much in the interest of presenting

positions that they think are palatable to their political masters."

Agreed. The business of an economist is to tell the truth - this is often the exact opposite of the business of a politician.

Posted by: Lucas M. Engelhardt | July 25, 2009 at 04:54 AM

7/26/09 3:19 PMBarry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

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Me: Economists:

Paul Krugman

Mark Thoma

Cowen and

Tabarrok

Chinn and

Hamilton

Brad Setser

Juicebox Mafia:

Ezra Klein

Matthew Yglesias

Spencer

Ackerman

Dana Goldstein

Dan Froomkin

Moral

Philosophers:

Hilzoy and

Friends

Crooked Timber

of Humanity

Mark Kleiman and

Friends

Eric Rauchway

and Friends

John Holbo and

Friends

The pending energy legislation actually is a second stimulus round, and therefore for this reason (not to mention its other virtues,

such as abating climate catastrophe), it should be passed as soon as possible. First, with the "cornerstone" (Senator Bingaman's word)

of the Green Bank the legislation would create an additional $200 billion of investment in clean energy replacement of existing

carbon energy plant, property and equipment. Due to the nature of this investment, when fully deployed it would create about two

million permanent jobs, adding more than one percent to the total size of the workforce. Second, the legislation's alleged cost burden

on the economy arising from cap permits is delayed in time so that it would have no impact for 5 to 10 years and in any case would

have minimal impact even in later years due to the method of allocation of the permits chosen by the House.

Posted by: rod | July 25, 2009 at 05:59 AM

To my post from yesterday, I just want to add that the 6-7% nominal growth rate earlier in this decade reflected easier money, easier

credit and lower tax rates than lie ahead. It's very hard to construct an environment in which you reverse all that and strong real

growth results.

Posted by: Mark | July 25, 2009 at 02:00 PM

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