Brad DeLong thinks that, under present circumstances, the crowding out of private expenditure by fiscal stimulus is not a live issue. The basic argument is that since neither average wages nor interest rates have risen in response to stimulus, no resources are being diverted from private to public uses.
I am unsure what the standards of good analysis are among Keynesian macroeconomists, so I proceed with some trepidation. However, as readers of this blog will know, I am unhappy with the level of macro-aggregation usually practiced by both Keynesian and new-classical macroeconomists. So I want to disaggregate the analysis a bit.
In the first place, expenditure is not simply expenditure in general. It is expenditure on specific things and in specific sectors of the economy. These lines of expenditure use resources appropriate to producing the output in question. They involve input combinations from many areas of the economy – not only labor, but other resource complexes including those that will have other uses. To the extent that these resources are non-specific to a specific line of production they may come from areas in which they were not formerly unemployed.
Second, unemployment of resources, including labor, is not always pure idleness. We are living in conditions of real uncertainty. A bubble has burst, the domestic auto industry faces uncertain prospects, tax rates are on the way up – how far and in what respects in anyone’s guess – we have just faced a possible healthcare transformation with its unique costs and taxes, European debt problems are becoming manifest, and more.
Now this is clearly not merely a problem of aggregate-demand confidence. The private spending the government hopes to stimulate must have a direction. Firms must worry about the sustainability of demands in specific areas and about costs in specific areas. Unemployment is a quite rational response to real sectoral uncertainty. To bring resources out of “unemployment” prematurely is a form of crowding out – crowding out of the economically-valuable activity of recalculation, recalibration or search.
To anticipate a Keynesian response: Some will say that there is a difference between the rationality of the individual agent and the collective irrationality of agents, each of whom is waiting for the others to move (spend) first. This is by no means an inconceivable phenomenon. So let’s think about it.
The phenomenon is not unlike situations that entrepreneurs face all of the time. Factors of production may be underpriced and undercapitalized relative to longer-run predicted demand. Markets may be underprovided with goods relative to longer-run demand. These provide profit opportunities to alert entrepreneurs. Those who move first can earn greater profits than others (and, of course, they open themselves up to losses).
Third, it is difficult to believe that once recovery does occur that the new equilibrium rate of interest will not be considerably higher because of the new large amount of government debt that has been, and will be, accumulated. These higher than otherwise rates will ensure that investment projects in the future will, in effect, be crowded out by today’s stimulus.
I have no doubt that economists can, in sufficient time, generate quantitative estimates to varying degrees of approximation on these forms of crowding out. But consider today’s political problem.
The crowding-out consequences are indirect, complex, and hard to see without theoretical lenses. If stimulus creates jobs in construction, retains various state and local government jobs and so forth, these are more easily seen by voters. (However, there are still many theoretical and methodological issues involved in the counting. It is not a simple matter.) Therefore, as with most government programs there is a political bias toward the direct and immediate consequences, even where the indirect may be far more important. This is Frederic Bastiat’s story of the seen and the unseen. (It may well turn out that even with the political bias working in its favor, the voters still sense that the stimulus crowd has gone too far. So much the better.)
But now dear readers: Do you think Steve Horwitz is a “clueless idiot”?
Update: A Clarification
“What it [the total of stimulus-created or saved jobs — MR] doesn’t consider are the jobs lost due to the very policies that are “saving” jobs. Government can only spend what it takes from the private sector one way or another, either through taxation, borrowing, or the redistribution effects of inflation. For every dollar that government spends, there is one less dollar being spent somewhere else in the economy. The jobs that weren’t created because the private sector lacked access to capital due to increases in government borrowing should be offset against whatever jobs the stimulus supposedly is creating.” Steve Horwitz.
Brad DeLong says (in the comments below my previous post) that I got Steve Horwitz’s point about crowding out wrong and therefore my defense of Horwitz is inappropriate. Furthermore, then, I miss the importance of DeLong’s evaluation that Horwitz is incompetent.
First, and most important, I did not intend my post to be primarily a defense of Horwitz and therefore an implicit criticism of DeLong in his criticism of Horwitz. (Got that, readers?)
I intended to say simply that (1) DeLong is wrong for not worrying about crowding out in its various dimensions; and (2) that someone who worries about crowding out, like Steve Horwitz, is therefore not clueless or worse.
I did not realize that DeLong considered Horwitz’s particular version or presentation of the crowding out idea as the evidence of his incompetence. I should have seen that.
Second, please keep in mind that Horwitz’s argument does not appear in a journal article but on the Nightly Business Report (NBR) blog of the PBS Network. This is journalism directed to non-specialists.
Third, let’s look at what Horwitz said. The “offending” sentences are quoted above. It is true that he simplifies the process. But you will note that, as a statement about the long run, it is not bad. Deficits now that ensure higher interest rates later are going to result in an intertemporal crowding out. Raising marginal tax rates (or allowing the Bush tax reductions to expire) will result in jobs lost, especially as they impact small businesses. If the Fed is unsuccessful in contracting the high-powered money it has created, there will be inflation.
But, quite honestly, I am not that interested in correcting Horwitz’s NBR blog posts. And I don’t really care whom Brad DeLong considers incompetent or engaging in economic malpractice.
My central purpose is to say: If you believe in crowding out – even if you simplify the argument for the general public – you are not thereby clueless.
Incidentally, I think that Bastiat’s general point about the seen and unseen is a very valuable lesson for the public to learn. When some consequences are hard to measure or hard to see, it doesn’t mean they are not there doing their mischief. I think Brad DeLong must agree with this.