August 11, 2003
The Bush Foreign Aid Package
The big bet on tax cuts has always been a question of timing.
The idea was that the cuts would kick in, and the growth would start, at the latest, in time for jobs to be plentiful come Election Day. The danger was government crowding-out private lending, but that was considered something for the second term. If the first part of the bet is lost, if there’s no growth, the second part is the Democrats’ problem.
So where is the growth? It’s in India, Singapore, and China. The big tax cut has been turned into foreign aid.
Had these cuts come along in the late 1980s the danger would have been obvious. The economic threat of Japan was on everyone's mind. Someone, probably a prominent Republican, would have pointed out that unless there were some control over where the tax cut was spent, it might just go East.
No one seems to have considered that question this time. Corporations are using the benefits of their tax cuts -- the renewed investment it causes -- to accelerate their export of jobs to China and India. Manufacturing jobs are going to China, white-collar jobs are going to India.
How could this happen? One reason is the maturity of the current technology cycle. When technology change is accelerating you need to be near the center in order to get the benefits. So Indian and Chinese engineers came to America.
But, thanks in part to patent and copyright lawyers, who have helped slow innovation, and thanks in part to where we are the current cycle (we're adapting to the Internet, not creating it) there is no longer that pressing need to be near the center. You can wait for Indian programmers to be trained. You can wait for the ship from China to come in. The savings are so great that this makes sense.
So whether directly (as in the case of Intel, which is moving more of its chip-making capacity to China) or indirectly (in the case of hundreds of big companies moving their software development to India), high-cost American labor is being replaced. The benefits of the tax cut only accelerate a trend that was there already.
Could this have been prevented? Yes. The easiest way to prevent it would have been to put the money into Big Science, say a race to Mars. The tax cuts could have gone directly to domestic investment funds -- put the money here and the benefits are tax-free.
Yes, that would have mean the government picking winners. But the government always picks winners, even when it's explicitly not picking winners.
When the government says, we won't pick winners, the government cedes the selection of winners to the open market. Right now the open market is saying that India and China (and Singapore and Malaysia) are winners.
American workers are losers. They won't like that come Election Day, assuming Democrats have the courage to point it out.
Posted by Danablankenhorn at August 11, 2003 11:54 AMCome election day, if the jobless trend continues, Democrats won’t need to point out anything. Bush is coming perilously close to beating Hoover’s jobless rate while enjoying the prominant title of a slash (services) and spend (your money) president.
The India, China, Singapore gambit is a loser of an issue, because Bush didn’t start that one (even though he has turned his back to it). Clinton tried to make America competitive by allowing immigrants more leniant visas, after 9/11 and the lock-down on immigration, the natural choice was to export the jobs, not import the workers.
What truly needs to happen in the US is more deflation, and an adjustment in prices that make out cost of living competitive with the rest of the world (housing, food, transportation). Then we may actually begin to catch up and become competitive again.
Posted by: Stephen VanDyke at August 11, 2003 01:02 PMI see this offshore trend as part of the demolition of the middle class. If everything is made offshore, then the US worker will be less and less empowered, until they are willing to work for any wage/benefit just to work.
This is how the wealthy ruling class in the US digs the moat.
Robbie
Posted by: Robbie D at August 11, 2003 03:59 PMThe only way to “win” is to stay ahead of the technology curve. We are not doing that. In fact, our over-protection of copyright and patent rights keeps many innovations from reaching the market.
We’re feeding lawyers and starving engineers. That’s a bipartisan effort.
Posted by: Dana Blankenhorn at August 11, 2003 04:56 PMThe argument here seems unclear. Are you suggesting that without tax cuts corporations would stay here? Or that the rate of fleeing jobs would increase?
Lowering corporate taxes to encourage MNC’s to move here is not a bad thing.
But using Richard Florida and Robert Reich’s argument, investing in great infrastructure and a superior education system would make more of a difference in keeping companies here. Can we have a superior education system and low taxes at the same time?
The record is mixed about big science projects. (South Korea and Japan haven’t been exactly successes). Unfortunately, defense research and spending tends to crowd out even Big Science projects.
Speaking of foreign aid, it’s worth noting that (wars notwithstanding), the US foreign aid budget has never been larger. And that’s good, isn’t it? That’s something GW did right.
Robert Nagle offers no solution.
My argument is quite clear. Tax cuts must be targeted at increasing domestic investment.
It’s increasingly clear that the only beneficiaries of the second Bush’s tax cuts were a few of the very rich (and a very few of them). The 2001 tax cut was 2 years ago — certainly we would see a positive impact by now if one were available.
I would argue that, even for these millionaires and billionaires, the benefits have been mixed. Yes, they got back a lot of money. But they didn’t get any good domestic investments. And profits are far more important to the rich than welfare.
Whose fault is that? At some point policy makers must take responsibility.
The “let’s throw out hands up in the air, economic growth is totally disconnected from political decisions” argument is a cop-out. The fact is that government represents a significant portion of the real economy (especially when state and local expenses are added). The idea that decisions on that magnitude have zero economic impact is absurd.
We have two examples of what might be done. We have the first Bush-Clinton example. GHWB froze domestic spending, Clinton adjusted tax rates down for the poor and up for the rich. We have that economy.
Then we have the second Bush era tax cuts, and their ignorance of the deficit’s dangers. And we have the current record.
Voters need to have this pointed out repeatedly. And voters will make a choice.
I hope they’ll choose prosperity. But there is no guarantee. Democracy is like that. (It has that in common with business.)
Posted by: Dana Blankenhorn at August 11, 2003 08:33 PMQuote:
“What truly needs to happen in the US is more deflation …”
Deflation? I’ve never before heard anyone say that’s a good idea.
Money consists of bank balances, cash, and Federal Reserve balances. The Federal Reserve controls the amount of cash and Fed balances, and it controls the fraction of their balances that banks have to keep as cash and Fed balances. So it controls the amount of money — as long as banks keep as much of their money lent out as they can.
If there is deflation, to the point where nominal interest rates are negative on safe assets, banks are better off holding money than lending it. If banks decide not to lend, that means that the amount of money collapses to the amount of cash plus Fed balances. As money gets scarcer, deflation accelerates. As deflation accelerates, it’s more advantageous to hold onto cash rather than spending it. The economy freezes. Unemployment skyrockets. Real capital gets liquidated as people scrabble for money. A deflationary crash is bad.
There can be deflation without a deflationary crash, if deflationary shocks push the inflation rate negative. It’s only when there’s expected deflation that a deflationary crash happens. But intentional deflation would almost have to be expected deflation. To have a reasonable prescription for deflation, you would have to say how to have deflation intentionally without having a deflationary crash.
Posted by: Dan Wylie-Sears at August 11, 2003 11:36 PMDana wrote “Tax cuts must be targeted at increasing domestic investment.”
I fully disagree. Tax cuts are not stimulating in the least. We need to raise taxes, re-invest that money in America’s infrastructure and re-build the nation.
Just another point of view. I have no problem paying personal or business taxes as long as the money is used wisely and at home.
Robbie
Posted by: Robbie D at August 12, 2003 09:37 AMI fully agree with Robbie D. A great amount of money has been wrongfully distributed in the current economy. Raising taxes for a moderately short period of time would regurgitate America and hit the refresh button on the economy.
I as well have no “beef” with raising the economy as long as I am certain that my contribution will be well invested.
Posted by: Adam at August 12, 2003 11:15 AMDan Wylie-Sears: I see your point, but I think you are being a bit extremist in your example. I was not suggesting rampant, run-away deflation, but a gradual trend (we have experienced gradual inflation and more recently in the 1980s to 1990s, more severe inflation). Admittedly, they are both painful processes, however long-term inflation is far more harmful to the economy than deflation (unless you enjoy buying a loaf of bread with a wheelbarrel full of money).
Posted by: Stephen VanDyke at August 12, 2003 11:48 AMRe: Dana’s remark about my comment not offering a solution.
First, to say that a person does not offer a solution is not to indict an
argument. In fact, not to offer a solution or to say that an easy
solution does not exist (HL Menken’s remark about “answers that are easy,
obvious and WRONG” comes to mind) may be the most intellectually honest
position to take.
Second, in my original post I did hint at solutions. I mentioned Robert
Reich and Richard Florida’s call for regions to work on public
infrastructure and education as a way to attract regional investment.
(I”m a big fan of Robert Reich’s Work of Nations book by the way). Also,
I hinted at my deep opposition to defense spending.
I support general laissez faire and free trade stuff (it comes from
teaching at East European colleges where the government mucked around
with everything). But I’m uncomfortable with the WTO’s failure to adopt
side agreements setting minimal environmental and labor standards. Also,
I think that America’s current educational system does a poor job of
retraining workers (or of providing opportunities for retraining).
Reich’s call for retraining tax breaks or corporate tax breaks for
retraining does not strike me as intrinsically bad. Also, health
insurance is still not very portable, which makes it more difficult for
the “free agent economy” to work as well as it should.
Corporate welfare programs (incentives to keep a company in a particular
region for example) have not been shown to be particularly effective. But
if they worked, I wouldn’t have a problem with our government using them.
Part of the problems is that tax cuts and public investment are seen as
mutually exclusive. Part of the problem is the government’s myopia at
how much spending on defense really drags the economy down.
Two personal thoughts.
1)When I was laid off by Dell in 2001, about half of the job postings in
my field (technical writer) were for defense contractors. Defense
spending crowds out other finite public spending. That is bad.
2)My current company (TI) and my former one (Dell) both used workers from
India and a number of B-1 visas. I am not blind to this phenomenon, and
I’m sure it has cost me a job opportunity or two. A lot of this is just
countries catching up with our standard of living. When railing about
this trend, we should not lose sights of opportunities created; a country
of richer Indians with credit cards might be more likely to be customers
for US-made products.
Dan writes in criticism of Stephen’s point about deflation with a solid explanation of the Federal Reserve’s role in the process. But he’s forgetting external factors. We have been exporting deflation through China, and creating deflation for years through Moore’s Law.
In a deflationary spiral, like Japan is experiencing right now, wages fall faster than prices. It’s a very, very bad thing. It’s what we had during the Great Depression.
Robbie writes, “Tax cuts are not stimulating in the least.” That’s not true. The government is the 800 pound gorilla of the economy and everything it does has an impact. Pretending that’s not so doesn’t do us any good.
In fact, the Bush people probably believe it’s not so. You may remember that in 2001 tax cuts were sold as a cure to the SURPLUS. Now the claim is made that they’re domestic fiscal stimulus. In fact, as I have said, they are acting as foreign aid.
If you want a policy to have a specific effect then you have to write the policy with that effect in mind. You may get unintended side effects, or even effects that contradict your intent, but that doesn’t mean you didn’t have an effect.
Posted by: Dana Blankenhorn at August 13, 2003 12:47 PM>I was not suggesting rampant, run-away deflation, but a gradual trend (we have experienced gradual inflation and more recently in the 1980s to 1990s, more severe inflation)
My point is that you can’t have foreseeable gradual deflation. Because of the way the banking system works, if there’s deflation, that makes the amount of money (as bank balances) collapse. If there’s less money, that makes more deflation. It’s a positive feedback. As long as there’s some inflation, banks are better off lending money — even if in real terms it’s a losing investment — and making some nominal interest on it than holding onto the money and having it lose value to inflation.
Quote:
“We have been exporting deflation through China, and creating deflation for years through Moore’s Law.”
As far as I know, Moore’s law says nothing about the size of dollars. It says computing power for a given cost will double in some way (speed, memory, drive capacity, some combination) every year (or was it six months?). But that cost is real, not nominal: labor, factory usage, and materials, not dollars.
However, I did acknowledge the existence of deflationary shocks. If something becomes cheaper in real terms and people didn’t expect it to, that can take a while to work its way through the economy, and it can cause a temporary decrease in the price level. In the long run, though, inflation/deflation is a purely monetary phenomenon.
Quote:
“Robbie writes, “Tax cuts are not stimulating in the least.” That’s not true.”
That depends on the rest of the model. Tax cuts without spending cuts are phony. They’re tax delays, and actually tax increases; the spending still has to be paid for, and now the interest has to be paid too. If your model assumes that people understand this and prepare perfectly, then they have a bill to save for, and the the effect may be nothing at all. But one thing it definitely does in the real world is create uncertainty: people know that tax bill is going to come due, with interest, but they don’t know who it’s going to hit.
Risk-bearing is a factor of production, and causing unnecessary uncertainty is equivalent to consuming it. In ideal markets, at the margin, all factors of production are fungible with each other. In this sense, phony tax cuts impose a real cost.
Posted by: Dan Wylie-Sears at August 13, 2003 09:39 PMDan: Moore’s Law is deflationary. Period. The same computer power you bought for $1 two years ago costs less than 50 cents now. That’s deflation in action.
China also creates deflation. Low wages and high productivity means lower unit costs, and intense competition guarantees the savings are passed on to you.
This is also deflation.
Neither China nor Moore’s Law, however, creates a “deflationary spiral,” which Japan has experienced for years, and which America experienced in the 1930s.
In the 1930s, the value of commodities that farmers produced, and that factories produced, went down. Wages and jobs were cut, and they went down further.
The right answer to this spiral was inflation. The Roosevelt Administration, however, didn’t fully trust the theories of John Maynard Keynes. Roosevelt tried to balance budgets, although he did create a whole lot of agencies with lots of initials in them.
The result was modest fiscal stimulus, and a second recession in 1937-38, which caused the country to shift more to the Republicans.
Keynsianism didn’t become the policy until WWII became imminent. Then, with programs like Lend-Lease, and increases in military spending, the Roosevelt Administration began spending a lot more than it was taking in. Defense bonds to pay for this were sold on the back of patriotism, not coupon rates.
As the war ended there was great fear of another recession, even another Great Depression. But the huge demands of the rest of the world, combined with the fact that the U.S. had not lost productive capacity during the war, resulted in the longest boom in American history, which lasted (with short interruptions to adjust inventories) through the 1960s.
Posted by: Dana Blankenhorn at August 14, 2003 08:09 PMQuote:
“China also creates deflation. Low wages and high productivity means lower unit costs, and intense competition guarantees the savings are passed on to you.”
It does in real terms: it guarantees that your made-in-USA widget will buy you more made-in-China gewgaws than it did when the gewgaws were made here by high-wage Americans. But it doesn’t guarantee anything about the value of the dollar either in terms of widgets or in terms of gewgaws.
It can be a disinflationary (deflationary) shock, depending on expectations and price stickiness.
Also, there’s a quibble with your statement that “[l]ow wages and high productivity means lower unit costs”. If high productivity (output per hour of labor) is achieved at high cost in capital and/or resources, unit costs can still be high. But that’s only a quibble.
Quote:
“Neither China nor Moore’s Law, however, creates a “deflationary spiral,” “
If we accept your position that China and Moore’s law do foreseeably cause prices to be lower than they otherwise would be, then the reason they don’t create a deflationary crash is that they’re disinflationary rather than deflationary. I hadn’t been making that distinction either up until now. It’s the same effect: nominal prices are lower than they would be without the effect. But if prices are still going up, it’s a decrease in inflation, i.e. disinflation, whereas if prices go down, it’s deflation. Foreseeable deflation leads to a deflationary crash, regardless of the source, unless real interest rates are high enough to keep nominal rates positive, even risk-hedging ones and even short-term ones that include transaction costs.
Posted by: Dan Wylie-Sears at August 14, 2003 09:42 PM
