“The baseline scenario is bleak, but the problem is political, not economic”: that was the core of the message delivered last week by nationally acclaimed economist Dr. Dean Baker at an NC Policy Watch Crucial Conversation luncheon. (To watch video from Baker’s talk, click here).
Baker, Co-Director of the Washington, DC-based Center for Economic and Policy Research (and author of the new book, False Profits: Recovering from the Bubble Economy), rose to national prominence during 2007 and 2008 as one of a tiny number of economists who had accurately diagnosed the nation’s economic problems as having been rooted in a “housing bubble” – that is, the phenomenon in which home and commercial real estate prices were wildly inflated in comparison to historical patterns. Last week, Baker reiterated that message and offered his predictions for what lies ahead, as well as some prescriptions for what policymakers can do to speed recovery.
The bubble
Despite the widespread attention Baker has garnered for pinpointing the housing bubble back in the early part of the decade – a time in which former Federal Reserve Chairman and supposed economist extraordinaire Alan Greenspan was casually dismissing such talk – it clearly and understandably rankles him that the subject continues to escape many policymakers, pundits and other paragons of mainstream thought. So Baker began his talk in Raleigh by providing the audience with a brief refresher course on the bubble – its history, size and scope, where it’s headed and what we might have done differently.
First of all, Baker noted, it’s wrong to have described the economic downturn as having been the result of a “financial crisis.” Yes, the U.S. did have a financial crisis in late 2008 and early 2009 in which many large banks and investment houses suffered partial or complete meltdowns, but that problem did not happen spontaneously. Nor was it necessarily the disaster in and of itself that has been portrayed in the mainstream media.
In fact, both the Wall Street mess and the general economic downturn were symptoms of the collapse of the housing bubble. According to Baker, the growth of the bubble was the main fuel of the rapid economic growth that spread across the nation during the middle years of the Bush presidency. And make no mistake, it was a bubble. This can be seen in the fact that throughout the 20th Century, U.S. housing prices adhered quite closely to the general inflation rate. Then, all of a sudden during the early years of the 2000′s, these prices spiked to 70% above the long-term trend.
Not surprisingly, this gave rise to building boom, a modest stock market boom and, ultimately, a spending boom as Americans moved to cash in some of their new found equity. This was abetted by then-Fed Chair Greenspan’s refusals spoil the fun by questioning the staying power of the boom. Add to this mix the explosive growth in risky lending practices and complex financial instruments and the bubble was quickly stretched to the breaking point. By 2006 and 2007 things had begun to head south.
The result of this collapse was an amazing loss in economic demand. By Baker’s reckoning, the bubble collapse caused the U.S. economy to lose more than $1.2-plus trillion annually in private sector demand — $450 billion as a result of residential construction declines, $200 billion from lost non-residential construction losses and $600 billion as a result lost consumption to lost household equity (the “reverse wealth effect”). This was the cause of the recession.
The stimulus
What about the federal stimulus package – the American Recovery and Reinvestment Act? What has it done to alleviate the effects of the collapse? According to Baker, the answer is “some – more than critics give it credit for – but not enough.”
To prove his point, Baker showed that once one pulls out from the stimulus package the ordinary tax cuts that Congress approves every year as part of the regular annual adjustments to the Alternative Minimum Tax and the spending that did nothing other than help state governments stay afloat, the size of genuine stimulus spending was really quite modest. According to Baker, the federal stimulus/recovery spending was less than $160 billion in 2009 – half of that in the form of tax cuts. In 2010, the number is even smaller – about $120 billion.
When viewed in the context of an economy that has suffered more than $1.2 trillion in lost demand, it quickly becomes apparent why stimulus spending has had only a modest impact. Baker says this shows why the Obama administration has made “a horrible mistake in overselling its stimulus.” While important and welcome (and a main reason national unemployment is at 10% rather than 11 or 12%), ultimately, the stimulus had no chance to really return the nation to anything approaching full employment. To get truly serious about promoting rapid recovery, the federal government would have to pump a lot more money into the economy.
Recovery outlook
According to Baker, the combination of the remaining housing bubble (as much as a third still remains) and the government’s mostly tepid response to the downturn assure that the prospects for quick recovery are distressingly dim. He noted that even according to the official federal projections, unemployment rates are likely to remain at levels that would have been considered unacceptable a couple of years ago throughout most of the decade.
This is not, Baker pointed out, the result of an “attitude problem” – i.e., that Americans are simply refusing to spend enough. Things aren’t going to “turn around” because of a new optimistic spirit. Rather, he argued, Americans are not spending for “the same reason homeless people aren’t spending – they don’t have any money!” Add this fact to the scheduled expiration of the new homebuyer program and stimulus spending, says Baker, and the case for pessimism becomes even stronger.
So, what to do?
According to Baker, the problem is actually not that complicated. The problem is a basic matter of Keynesian economics – the U.S. needs to increase demand by spending a lot more money. Likely candidates for spending: public infrastructure, green energy projects and state fiscal relief. In addition, Baker would also work to raise inflation rates slightly and allow the dollar to weaken somewhat in order to boost demand for American exports.
Given the political hurdles associated with each of his first three recommendations, Baker would also work to promote a program that’s worked very successfully in some European countries – job sharing. With this latter concept, instead of paying people unemployment benefits, government pays private employers to reduce work time. Workers work 20% less time, but only realize a wage cut of around 4%. As Baker put it (only semi-facetiously), “In the U.S. we’re experiencing the downturn in the form of double-digit unemployment. In Germany and the Netherlands, they’re experiencing it in longer vacations and shorter work weeks.”
But what about the deficit? Are concerns in this area legitimate or overblown? Baker answers it in three ways: 1) The markets disagree with those who are worried. Investors are still more than happy to buy U.S. bonds. If there were reason to be terribly concerned, this would not be the case. 2) As a percentage of our economy, U.S. deficits are still not even close to the levels of many other countries or where they were here during and after World War II. 3) The President is right. Health care spending is main deficit driver – not stimulus spending.
Baker’s bottom line: Right now, we’re telling people that they have to suffer through massive unemployment and deprivation because of our fears – fears that are unjustified when examined closely – that we will raise deficits to unusually high levels by aggressively tackling the current problem. This, he says, is an absurd result. We may be in a crisis, but it doesn’t have to be experienced in the form of widespread human suffering. With better policies, America’s economy can be placed on much sounder footing.
Let’s hope Washington starts listening more carefully to Dr. Baker’s prescriptions.
