Demand Side knew this from the inside, but we did not think to try to prove it statistically. Correlation is not causation, we said. Heck, even Carmen Reinhart said it under her breath. Kimball and Wang, though, took off the statistical analysis gloves and showed that high sovereign debt does not affect growth going forward. Their primary tool was the scatter chart of long-run growth rates to debt levels. The central trend showed heavy influence of low growth in producing higher government debt, but again, and quoting Kimball and Wang:
"... the two of us could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth."The full text of the piece is on the transcript at demandsideeconomics.net, as well as a link to the original site.
We had Steve Keen in town, maybe I mentioned that. The guy is brilliant. We threw everything we had at him, paired him with a bond fund manager from Russell Investments, dropped him down cold in front of a conservative talk show host, then a liberal doubter, and finally a community radio guy who browsed around in left field. On point, straight talk, at the right level of understanding. He clicked with everyone. Fans clustered around the stage after the evening talk. The conservative talk show guy pencilled us in for a follow-up, but the truck hit the bridge, the bridge went in the water, and all the newscasters left town to look.
The bridge hit the water. That brings me to the problem with Steve Keen. It is a financial economy. Agreed. Growth and employment are determined by income and the change in debt, which comprise aggregate demand. Agreed. [Although apparently there will be vigorous discussion on that point later in June at the Harvard Law School.] But the economy is also real stuff. Growth and employment are all very well and good, but they are the buzzing around the hive, they are not necessarily the honey in the hive or the strength of the structure of the hive.
And for all Steve's insight about how to get things going again, there is still the question of direction. All the energy and organization and employment in the world is not so good if the locomotive is heading for the cliff. In fact, you might argue that that current stagnation has the benefit of slowing that locomotive a bit in its race toward the climate crisis.
I would love to be in Pula, Croatia, this week, where Steve Keen and James K.Galbraith are on the same bill. [Luxurious accommodations here.] "Economics in Crisis - the Crisis of Economics." Although the luxury of the context belies any crisis whatsoever. James -- I cannot bring myself to call him Jamie -- is the point man for planning. And direction is surely what we need. If we can get the audio, we will certainly relay it.
There's a chart online showing the collapse of infrastructure spending since 2008. Yes, there was a blip up with the Obama stimulus (ARRA), but not above the 2008 peak. It's not enough to waste breath on. Two-thirds of the ARRA money went to tax cuts.
In the middle of the last decade a blue ribbon commission -- public-private -- came up with a plan to put $250 billion PER YEAR for 20 years into surface transportation, to be financed by a 5 cent per year hike in the gas tax over that period. That is the scale we need. That was on rail, roads, waterways, harbors.
Plus we need a nation-wide DC transmission grid to bring renewable power to urban centers. Plus we need a re-design of transportation and retrofitting of commercial and residential structures. We cannot afford not to do it.
But here's the worst of it, our educational and social infrastructure is collapsing as well:
Now that's just medical research, thanks to On Point and Tom Ashbrook. Science across the board is being eviscerated. Just as huge challenges loom we are going to lose a generation of scientists. Why?
Here's Club for Growth's Barney Keller with the cogent answer: Government debt is the problem.
Leaving aside the waste of $300,000 in annual salary to spin doctor Keller, there are plenty of feces being thrown here. Social Security in balance for twenty years. Compare that to the Pentagon's budget. Of course, it's bull. I'll stop playing it. It is phenomenal that this is what passes for deliberation in our nation's capital.
Now let's go back to Keynes, and Leon Keyserling.
The level of investment has to be enough to absorb savings, or the non-consumption inherent in savings will eat away at incomes. Over time, a wealthy society invests more and more relative to consumption. They need to maintain the higher investment. If you start cutting, you cut incomes, you cut economic activity, you reduce savings in the aggregate.
Skipping now to the end. Do we have investment in real stuff that will return enough to pay it off? Not in the private sector. Overcapacity is a legacy of 30 years of economic policy aimed at business investment. Housing? Please. Eighty billion a month from the Fed to buy down interest rates and buy up mortgage-backed securities has begun to turn equity back up, so long as the federal agencies keep buying mortgages. But are we really going to find value there? Stocks, of course, are not investment at all, just trading.
All the productive investment left -- and there is plenty of it -- is in public goods. Education, health care, infrastructure.
But we just got another Harvard guy as chief economist. It's Jason Furman the new chair of the Council of Economic Advisers. Just a week after we lampooned Harvard here for its Rogoff's and Reinhart's and Niall Ferguson's and Larry Summer's and Barack Obama's and W's and HW's and on down the line, we got A NOTHER Harvard guy. Don't know if he's Robert Rubin's choice, but he's been in DC for twenty-five years. The worst part, he has support from Harvard's Greg Mankiw.
Today's podcast brought to you by @kleinbattle. Yes, it's Twitter coming to Demand Side. Can you stand it? Follow us and next week we'll tell you the humiliating story of our first tweet. @ K L E I N B A T T L E. Maybe we'll even explain the derivation of the name. Hey, we didn't know it would be public.
Leaving aside monetary policy, the textbook Keynesian remedy for recession is to increase government spending or cut taxes. The obvious problem with that is that higher government spending and lower taxes tend to put the government deeper in debt. So the announcement on April 15, 2013 by University of Massachusetts at Amherst economists Thomas Herndon, Michael Ash and Robert Pollin that Carmen Reinhart and Ken Rogoff had made a mistake in their analysis claiming that debt leads to lower economic growth has been big news. Remarkably for a story so wonkish, the tale of Reinhart and Rogoff’s errors even made it onto the Colbert Report. Six weeks later, discussions of Herndon, Ash and Pollin’s challenge to Reinhart and Rogoff continue in earnest in the economics blogosphere, in the Wall Street Journal, and in the New York Times.
In defending the main conclusions of their work, while conceding some errors, Reinhart and Rogoff point out that even after the errors are corrected, there is a substantial negative correlation between debt levels and economic growth. That is a fair description of what Herndon, Ash and Pollin find, as discussed in an earlier Quartz column, “An Economist’s Mea Culpa: I relied on Reinhardt and Rogoff.” But, as mentioned there, and as Reinhart and Rogoff point out in their response to Herndon, Ash and Pollin, there is a key remaining issue of what causes what. It is well known among economists that low growth leads to extra debt because tax revenues go down and spending goes up in a recession. But does debt also cause low growth in a vicious cycle? That is the question.
We wanted to see for ourselves what Reinhart and Rogoff’s data could say about whether high national debt seems to cause low growth. In particular, we wanted to separate the effect of low growth in causing higher debt from any effect of higher debt in causing low growth. There is no way to do this perfectly. But we wanted to make the attempt. We had one key difference in our approach from many of the other analyses of Reinhart and Rogoff’s data: we decided to focus only on long-run effects. This is a way to avoid getting confused by the effects of business cycles such as the Great Recession that we are still recovering from. But one limitation of focusing on long-run effects is that it might leave out one of the more obvious problems with debt: the bond markets might at any time refuse to continue lending except at punitively high interest rates, causing debt crises like that have been faced by Greece, Ireland, and Cyprus, and to a lesser degree Spain and Italy. So far, debt crises like this have been rare for countries that have borrowed in their own currency, but are a serious danger for countries that borrow in a foreign currency or share a currency with many other countries in the euro zone.
Here is what we did to focus on long-run effects: to avoid being confused by business-cycle effects, we looked at the relationship between national debt and growth in the period of time from five to 10 years later. In their paper “Debt Overhangs, Past and Present,” Carmen Reinhart and Ken Rogoff, along with Vincent Reinhart, emphasize that most episodes of high national debt last a long time. That means that if high debt really causes low growth in a slow, corrosive way, we should be able to see high debt now associated with low growth far into the future for the simple reason that high debt now tends to be associated with high debt for quite some time into the future.
Here is the bottom line. Based on economic theory, it would be surprising indeed if high levels of national debt didn’t have at least some slow, corrosive negative effect on economic growth. And we still worry about the effects of debt. But the two of us could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth.
The graphs at the top show show our first take at analyzing the Reinhardt and Rogoff data. This first take seemed to indicate a large effect of low economic growth in the past in raising debt combined with a smaller, but still very important effect of high debt in lowering later economic growth. On the right panel of the graph above, you can see the strong downward slope that indicates a strong correlation between low growth rates in the period from ten years ago to five years ago with more debt, suggesting that low growth in the past causes high debt. On the left panel of the graph above, you can see the mild downward slope that indicates a weaker correlation between debt and lower growth in the period from five years later to ten years later, suggesting that debt might have some negative effect on growth in the long run. In order to avoid overstating the amount of data available, these graphs have only one dot for each five-year period in the data set. If our further analysis had confirmed these results, we were prepared to argue that the evidence suggested a serious worry about the effects of debt on growth. But the story the graphs above seem to tell dissolves on closer examination.
Given the strong effect past low growth seemed to have on debt, we felt that we needed to take into account the effect of past economic growth rates on debt more carefully when trying to tease out the effects in the other direction, of debt on later growth. Economists often use a technique called multiple regression analysis (or “ordinary least squares”) to take into account the effect of one thing when looking at the effect of something else. Here we are doing something that is quite close both in spirit and the numbers it generates for our analysis, but allows us to use graphs to show what is going on a little better.
The effects of low economic growth in the past may not all come from business cycle effects. It is possible that there are political effects as well, in which a slowly growing pie to be divided makes it harder for different political factions to agree, resulting in deficits. Low growth in the past may also be a sign that a government is incompetent or dysfunctional in some other way that also causes high debt. So the way we took into account the effects of economic growth in the past on debt—and the effects on debt of the level of government competence that past growth may signify—was to look at what level of debt could be predicted by knowing the rates of economic growth from the past year, and in the three-year periods from 10 to 7 years ago, 7 to 4 years ago and 4 to 1 years ago. The graph below, labeled “Prediction of Debt Based on Past Growth” shows that knowing these various economic growth rates over the past 10 years helps a lot in predicting how high the ratio of national debt to GDP will be on a year by year basis. (Doing things on a year by year basis gives the best prediction, but means the graph has five times as many dots as the other scatter plots.) The “Prediction of Debt Based on Past Growth” graph shows that some countries, at some times, have debt above what one would expect based on past growth and some countries have debt below what one would expect based on past growth. If higher debt causes lower growth, then national debt beyond what could be predicted by past economic growth should be bad for future growth.
Our next graph below, labeled “Relationship Between Future Growth and Excess Debt to GDP” shows the relationship between a debt to GDP ratio beyond what would be predicted by past growth and economic growth 5 to 10 years later. Here there is no downward slope at all. In fact there is a small upward slope. This was surprising enough that we asked others we knew to see what they found when trying our basic approach. They bear no responsibility for our interpretation of the analysis here, but Owen Zidar, an economics graduate student at the University of California, Berkeley, and Daniel Weagley, graduate student in finance at the University of Michigan were generous enough to analyze the data from our angle to help alert us if they found we were dramatically off course and to suggest various ways to handle details. (In addition, Yu She, a student in the master’s of applied economics program at the University of Michigan proofread our computer code.) We have no doubt that someone could use a slightly different data set or tweak the analysis enough to make the small upward slope into a small downward slope. But the fact that we got a small upward slope so easily (on our first try with this approach of controlling for past growth more carefully) means that there is no robust evidence in the Reinhart and Rogoff data set for a negative long-run effect of debt on future growth once the effects of past growth on debt are taken into account. (We still get an upward slope when we do things on a year-by-year basis instead of looking at non-overlapping five-year growth periods.)
Daniel Weagley raised a very interesting issue that the very slight upward slope shown for the “Relationship Between Future Growth and Excess Debt to GDP” is composed of two different kinds of evidence. Times when countries in the data set, on average, have higher debt than would be predicted tend to be associated with higher growth in the period from five to 10 years later. But at any time, countries that have debt that is unexpectedly high not only compared to their own past growth, but also compared to the unexpected debt of other countries at that time, do indeed tend to have lower growth five to 10 years later. It is only speculating, but this is what one might expect if the main mechanism for long-run effects of debt on growth is more of the short-run effect we mentioned above: the danger that the “bond market vigilantes” will start demanding high interest rates. It is hard for the bond market vigilantes to take their money out of all government bonds everywhere in the world, so having debt that looks high compared to other countries at any given time might be what matters most.
Our view is that evidence from trends in the average level of debt around the world over time are just as instructive as evidence from the cross-national evidence from debt in one country being higher than in other countries at a given time. Our last graph (just above) shows what the evidence from trends in average levels over time looks like. High debt levels in the late 1940s and the 1950s were followed five to 10 years later with relatively high growth. Low debt levels in the 1960s and 1970s were followed five to 10 years later by relatively low growth. High debt levels in the 1980s and 1990s were followed five to 10 years later by relatively high growth. If anyone can come up with a good argument for why this evidence from trends in the average levels over time should be dismissed, then only the cross-national evidence about debt in one country compared to another would remain, which by itself makes debt look bad for growth. But we argue that there is not enough justification to say that special occurrences each year make the evidence from trends in the average levels over time worthless. (Technically, we don’t think it is appropriate to use “year fixed effects” to soak up and throw away evidence from those trends over time in the average level of debt around the world.)
We don’t want anyone to take away the message that high levels of national debt are a matter of no concern. As discussed in “Why Austerity Budgets Won’t Save Your Economy,” the big problem with debt is that the only ways to avoid paying it back or paying interest on it forever are national bankruptcy or hyper-inflation. And unless the borrowed money is spent in ways that foster economic growth in a big way, paying it back or paying interest on it forever will mean future pain in the form of higher taxes or lower spending.
There is very little evidence that spending borrowed money on conventional Keynesian stimulus—spent in the ways dictated by what has become normal politics in the US, Europe and Japan—(or the kinds of tax cuts typically proposed) can stimulate the economy enough to avoid having to raise taxes or cut spending in the future to pay the debt back. There are three main ways to use debt to increase growth enough to avoid having to raise taxes or cut spending later:
1. Spending on national investments that have a very high return, such as in scientific research, fixing roads or bridges that have been sorely neglected.But even if debt is used in ways that do require higher taxes or lower spending in the future, it may sometimes be worth it. If a country has its own currency, and borrows using appropriate long-term debt (so it only has to refinance a small fraction of the debt each year) the danger from bond market vigilantes can be kept to a minimum. And other than the danger from bond market vigilantes, we find no persuasive evidence from Reinhart and Rogoff’s data set to worry about anything but the higher future taxes or lower future spending needed to pay for that long-term debt. We look forward to further evidence and further thinking on the effects of debt. But our bottom line from this analysis, and the thinking we have been able to articulate above, is this: Done carefully, debt is not damning. Debt is just debt.
2. Using government support to catalyze private borrowing by firms and households, such as government support for student loans, and temporary investment tax credits or Federal Lines of Credit to households used as a stimulus measure.
3. Issuing debt to create a sovereign wealth fund—that is, putting the money into the corporate stock and bond markets instead of spending it, as discussed in “Why the US needs its own sovereign wealth fund.” For anyone who thinks government debt is important as a form of collateral for private firms (see “How a US Sovereign Wealth Fund Can Alleviate a Scarcity of Safe Assets”), this is the way to get those benefits of debt, while earning more interest and dividends for tax payers than the extra debt costs. And a sovereign wealth fund (like breaking through the zero lower bound with electronic money) makes the tilt of governments toward short-term financing caused by current quantitative easing policies unnecessary.
Follow Miles on Twitter at @mileskimball. His blog is supplysideliberal.com. Follow Yichuan on Twitter at @yichuanw. His blog is Synthenomics. We welcome your comments at firstname.lastname@example.org.
Business Insider: "[P]ublic Construction Spending Is Lower Than Its Been In Over 20 Years." Joe Weisenthal at Business Insider reported on May 24:
The big news today is that a bridge in Washington collapsed, throwing cars into the water. Amazingly, nobody died. This may revive debate about the need to spend more on infrastructure, which would have multiple positive effects. Nothing is likely to happen, however. That being said, here's a chart of public construction spending (TLPBLCONS) as percentage of GDP. You can see, public construction spending is lower than its [sic] been in over 20 years.
Washington Post: "U.S. Infrastructure Spending Has Plummeted Since 2008." According to Brad Plummer of the Washington Post, "Not surprisingly, the collapse of a bridge along Interstate 5 in Washington state yesterday has revived the long-standing debate over whether Congress should spend more to repair the nation's aging roads and bridges." After discussing the chart from Business Insider, Plummer continued:
[Business Insider, 5/24/13]
In 2012, the Federal Highway Administration said 67,000 -- 11% -- of the nation's 607,000 bridges were structurally deficient. That means the bridges are not unsafe but must be closely monitored and inspected or repaired. That percentage is little changed since 2007 when 12% of the nation's bridges were listed as structurally deficient and the I-35 bridge collapsed in Minneapolis. [USA Today, 5/24/13]USA Today: The American Society Of Civil Engineers Called For An Increase In Spending On Bridge Investment. From USA Today on May 24:
[F]unding repairs and replacements continues to be a problem, especially because bridges are getting older, says Andrew Herrmann, an engineer and past president of the American Society of Civil Engineers. The average bridge in the USA is 42 years old, Herrmann says.
The group gave the nation a C+ in its report card for maintaining bridges, saying federal, state and local governments need to increase bridge investment by $8 billion annually to meet the needs of deficient bridges. [USA Today, 5/24/13]
U.S. infrastructure spending has plummeted since 2008
By Brad Plumer, Published: May 24, 2013 at 11:37 amE-mail the writer
Not surprisingly, the collapse of a bridge along Interstate 5 in Washington state yesterday has revived the long-standing debate over whether Congress should spend more to repair the nation’s aging roads and bridges.
I-5 bridge collapse. (AP)
It’s worth being very clear upfront that the I-5 bridge in question wasn’t considered “structurally deficient” in any way — the bridge collapse is being blamed on a truck bumping an overhead girder. All we do know is that the bridge was sort of old. (Fortunately, no one died or was seriously injured.)
Here’s the AP: “The bridge was built in 1955 and has a sufficiency rating of 57.4 out of 100. That is well below the statewide average rating of 80 … but 759 bridges in the state have a lower sufficiency score.” The bridge was also classified as “functionally obsolete,” but that doesn’t mean it was unsafe, just that it was built according to earlier standards.
That said, infrastructure spending is in the news again, so here are a few ways to think about the topic. Joe Wiesenthal created this chart to show that U.S. public construction spending as a percentage of GDP has dropped to its lowest point in 20 years, after a big uptick before the recession:
Now, that’s a chart of all public construction spending, from highways to water projects to public hospitals to schools. So what if we just look at highways and roads? We get this chart:
There’s still been a big drop-off in recent years, although that also came after a big build-up in the late 2000s. (Sadly, the data series doesn’t extend back before 2002, so it’s tough to see what this looks like historically.)
How did this happen? States and local governments are the biggest part of the story here. They’ve historically provided the vast majority of spending for roads, highways and bridges, and they’ve been pulling back on spending since 2008 as a result of the economic downturn and requirements to balance their budgets. California’s transportation spending declined by 31 percent from 2007 to 2009, for instance. Texas’s fell by 8 percent.
At the same time, Congress hasn’t filled in the gap. There was a one-time $46 billion infusion of transportation spending in the stimulus bill. But that wasn’t enough to offset the drop at the state and local level. Meanwhile, the most recent highway bill out of Congress kept federal spending at current levels rather than increasing it.
The big question is whether Congress should be spending more — and if so, how much? We’ve seen various reports arguing that America’s infrastructure is in dire need of an upgrade. The American Society of Civil Engineers gave the nation’s bridges a C+ in its 2013 report card, and said that full repairs would cost $20 billion per year over the next decade, a 60 percent boost in spending. These estimates don’t always take a full account of costs and benefits, but the I-5 collapse will no doubt give these groups more ammo.
Another consideration, meanwhile, is that Congress can borrow money for remarkably low rates right now. And experts say it’s typically cheaper to fix roads and bridges early on rather than wait until they get truly decrepit. That suggests now could be an apt time to invest in repairs, rather than putting them off until later.