Anyone who has had even periodic exposure to the editorial pages of American newspapers or the expert panels of Sunday-morning news shows has probably heard Paul Krugman speak about the government’s proper role amid economic recessions, and particularly his trope about the mythical “confidence fairy” which in his mind has kept the government from exercising this role amid the current recession. His basic argument, which he repeats several times a week in different guises, is that the government should be spending more, not less, during recessions in order to stimulate commerce through the creation of public sector jobs. Thus for him, the policy of “austerity” which has been championed by the Republican party (most notably by Rep. Paul Ryan and Gov. Chris Christie) and effectively implemented throughout almost all of Europe is exactly the opposite of what should be done, and represents in his mind an abdication of the State’s responsibility for the common good. “For the past two years most policy makers in Europe and many politicians and pundits in America have been in thrall to a destructive economic doctrine,” he says in his most recent op-ed column appearing in the New York Times this past April 26th.
According to this doctrine, governments should respond to a severely depressed economy not the way the textbooks say they should — by spending more to offset falling private demand — but with fiscal austerity, slashing spending in an effort to balance their budgets. Critics warned from the beginning that austerity in the face of depression would only make that depression worse. But the ‘austerians’ insisted that the reverse would happen. Why? Confidence! ‘Confidence-inspiring policies will foster and not hamper economic recovery,’ declared Jean-Claude Trichet, the former president of the European Central Bank — a claim echoed by Republicans in Congress here. Or as I put it way back when, the idea was that the confidence fairy would come in and reward policy makers for their fiscal virtue.
“The good news,” he goes on to say, ” is that many influential people are finally admitting that the confidence fairy was a myth.” The austerity programs in Europe have made things worse, not better, and particularly when one compares them to the more moderate policies implemented by the US, it seems as if experience is validating Krugman’s oft-repeated argument.
I must admit that my usual response to Krugman’s consistent contribution to public discourse has been bewilderment, fatigue and disgust. I found it hard to believe that in the face of our nation’s skyrocketing debt, that someone would have the gall to propose that we should accrue even more debt. I mean, I’m no economist, but was it not our irresponsible profligate spending and the blithe acceptance of unsustainable levels of debt that brought about the economic collapse from which we are still recovering? Why then would we want to place our hopes for recovery on a doubling down on the same policy that got us in to this mess? Why should we view profligacy in the public sector as a cure to the pathology caused by profligacy in the private sector? One does not need to entertain the role of “confidence fairies” to be suspicious of that strategy.
In addition, I have always considered the “confidence fairy” to be the reddest of red herrings, since the rationale for austerity has always been primarily a negative rather a positive one. We need to control debt, say the “austerians,” in order to preserve the functionality of government as an economic actor. The consequences of not paying one’s debts are very real and dangerous; one need only look to the financial impotence of Greece to see what happens when governments spend more than they could ever realistically repay. As with every individual, a nation’s credit, along with the interest rates tied to that credit, serve as a check to unrestrained borrowing. It is not about any positive reward for virtue, as Krugman claims, but rather about the most basic conditions under which any economic agent can function. It is just a fact that we have reached our credit limit, the austerians would say, and so we have to find way forward other than more spending. Krugman’s only reply to that negative rationale, so far as I can tell, is to point to Japan, which continues to borrow at a very low interest rate despite years of heavy debt. Krugman thus never denies the dangers of debt in principle, but only downplays the probability of their coming to bear on developed economies in the present context. “It hasn’t happened to Japan yet,” he says in effect, “so why should we be scared that it will happen to us?”
Needless to say, I have found Krugman’s argumentation deeply unsatisfying from an intellectual point of view, but after reading his recent obituary for the confidence fairy something clicked in my mind that made me understand where he was coming from, and why his pleas for more governmental involvement were so persistent and heartfelt. The catalyst for this insight came with a rereading of Centesimus Annus in the wake of the government-led turnaround of the American automotive industry. First, let me spell out the contribution of Centesimus Annus. In section 40 of the 1991 encyclical, Bl. Pope John Paul II writes,
It is the task of the State to provide for the defense and preservation of common goods such as the natural and human environments, which cannot be safeguarded simply by market forces. Just as in the time of primitive capitalism the State had the duty of defending the basic rights of workers, so now, with the new capitalism, the State and all of society have the duty of defending those collective goods which, among others, constitute the essential framework for the legitimate pursuit of personal goals on the part of each individual. Here we find a new limit on the market: there are collective and qualitative needs which cannot be satisfied by market mechanisms. There are important human needs which escape its logic. There are goods which by their very nature cannot and must not be bought or sold.
As I read this passage, I came to the realization- which many have come to much more naturally than myself- that the State should not itself be thought of as just another actor in the market. One of the State’s principal tasks in defending the common good is to regulate the market, and in carrying out that task it should not presume to act according to all the orthodoxies of the market. Its job, after all, is to determine the limits of market orthodoxy, especially when that orthodoxy adversely impacts the well-being of the citizenry.
In other words, market mechanisms are not ultimate, according to Catholic Social Teaching, and while the government should understand and respect the ways that markets work, it should not view itself as wholly subject to market forces. The point sounds extremely elementary, I know, but it helped me to see the blindspot in the analogy between private and public profligacy upon which I had hitherto relied. While no one would argue that the kind of profligacy displayed by the banks and by individual citizens before the mortgage crisis is ultimately sustainable, one should not be so quick to turn first and foremost to market mechanisms in order to figure out how to address that problem from a legislative standpoint.
It is the State’s job not only to preserve the conditions under which the market can function, but also to make substantive judgments about the social ends which the market is meant to serve. What are the limits of the market? What can and cannot be bought and sold? When should we disregard calculations of maximal efficiency for the sake of irreducible human goods? These are moral questions which the government must make, and it cannot make them based upon economic theory alone.
So that insight opened me to the idea that the State should not consider itself beholden to the normal prudence of the marketplace. I then considered how that insight might apply to the bailout and subsequent resurrection of Chrysler and General Motors, which as many pointed out at the time of the bailout, went directly contrary to the free market notion of “creative destruction.” Let me say that I have been incredibly impressed and heartened by the turnaround of the American auto industry; so much so that I feel I can point to it as a model for how the State may successfully act upon the market in order to preserve those social goods for which the market provides the means. Here the government acted against the consensus of purely economic prudence, and succeeded beyond all expectations. So how did the State pull it off?
Let me postulate the existence of another quite different “confidence fairy:” the confidence which binds together the civil authority and the people entrusted to its care. Granted the options were very limited at the time of the automotive bailout, and the unions were likely motivated by necessity above all else, but the fact remains that they compromised with the government-appointed ownership. They found a way to move forward, to make things work, and that required trust. Nothing inspires trust more than a lack of any other alternative, but trust was necessary nonetheless. Likewise, there is implicit in the possibility of this kind of governmental action a measure of trust between the State and the citizenry. Citizens in a democratic society must place some measure of trust in the government in order for it to take steps like this one.
If citizens do not trust the government- if this confidence fairy is incapacitated- then resentment within civil society will grow and fester and eventually tear the fabric of democracy apart. I for one am generally distrustful and suspicious of government (which is merely to say that I share a perennial American sentiment). Yet the auto bailout has inspired a flicker of confidence in me, and has moreover led me to the realization that if the State is to be more than simply another actor within an all-pervading economic reality, then the trust which the citizenry places in the State is absolutely vital. If market theory is no longer the common language spoken between government and citizens, then what is? If our polity is going to avoid descending (further) into pure unmediated conflict, then some common language must replace the “market fundamentalism” which has come to dominate the political arena these last three decades. If Krugman has truly buried the confidence fairy as a mechanism of the free market, then another confidence must rise in its place in order to support the kind of role Krugman wants the State to play in relation to the market.
Government stimulus and aid cannot be another market mechanism; it must be a genuine expression of subsidiarity, ennacted on behalf of the social ends at the heart of the common good- ends which are incommensurable with market schematics. Yet there is no getting around the hard truth: this model of governmental intervention requires that the government must be trustworthy. Any vision of the human good that might replace the prevailing “market universalism” and inform a different conception of the State’s role has to presume a level competency and integrity sufficient to earn the trust of the citizenry. A gross lack of such competency and integrity is what makes me continue to be pessimistic in this regard (in contrast to Krugman’s curiously blithe optimism), but the resurgence of the American auto industry presents us with one authentic reason for hope.
Patrick: If the “confidence fairy” is merely another phrase for “trust,” then both the federal govt debt levels and the pre-packaged bankruptcy of GM and Chrysler may be doing more harm than good, though that harm may not yet be apparent.
In the case of the federal debt level, there are two points to consider.
One; the case of Japan with a debt to GDP above 200%. Japan’s economic growth is anemic and slower than that of the U.S, despite (or in spite of?) its spending. It’s GDP is forecasted to grow 1.7% this yr vs 2.3% for the U.S., based on surveys of economists. And for the last 7 yrs, Japanese GDP growth has averaged 0.3% per year vs 1.2% per year for the U.S. While the two countries do not have identical economic models, they are similar enough for us to conclude that Japan’s growth is lagging far behind. The mounting debt levels, 0% central bank interest rates are not having the effect Krugman might argue they should be having. Worse, is that Japan continue to follow the same well-worn path of low rates, higher debts – living proof of Einstein’s definition of insanity of repeating the same actions over and over again and yet expecting a different result. For America to follow the same path as Japan, we would be squandering the trust this nation still enjoys in the debt markets where, for all our political warts, are seen as capable managers of our nation’s finances and we adhere to the promise to pay our bills on time.
The second point is that debt markets are inherently unpredictable, and what they are giving today (low interest rates, robust bid-to-cover ratios at auctions) can not only be taken away tomorrow but we’ll get a severe lashing on top of it. Why? For U.S. Treasury bond investors, a loss of confidence would result in much higher yields across the Treasury yield curve resulting in much higher interest payments on the national debt — precious tax dollars will bediverted to bond holders and away from the government’s normal functions. As for the lashing, a lost of trust will result in a premium on top of whatever the normal rate is deemed to be; when risks go up, so do interest rates. Do not be fooled by today’s low rates, in part engineered by the Federal Reserve’s bond purchases. Just because we are the U.S. we should not delude ourselves that we are immune to the laws of finance and trust.
Ignoring the possibility of a bond market calamity is also immoral, is it not? For if the government’s role is to take on the tasks that cannot be effectively run by private actors, how can it continue in that role when more and more of its tax revenue is spent on interest on the debt? And if rising taxes deprive private citizens of income, they are also denied the ability to step into the vacuum left by the government.
Your initial feelings are, in my opinion, correct. The government has a unique role in any society in that its financial recklessness can destroy all of us – rich, poor, healthy, disabled, talented and ho-hum alike.
Greece is an extreme example, yet at the least it is a cautionary tale as to what can happen when the government finds itself in dire straits and must retreat from the wealth-distribution or the security promises it made. Imagine a U.S. that is no longer able to afford patrolling the Strait of Hormuz, the China Sea etc. Would we as a nation, and the wider world for that matter, be better off? The cascading dominoes of a much poorer U.S. government would endanger the health, safety and well-being of billions of people who rely on America’s wealth, defense and generosity worldwide.
We must keep the unique role our country has in the world in the front ot ouf minds when entertaining thoughts that we can borrow and spend with impugnity. America’s economy is several times LARGER than China, the #2 economy on the planet. Our defense budget DWARFS those of Europe and China combined. Our consumers are the engine of global commerce. And foreigners still flock to our shores for political and economic freedom, for the best health care money can buy, and for the liberation that comes from the rule of law rather than the rule of man.
For me, the dangers inherent in a much higher cost of U.S. debt more than offset Krugman’s argument that the government should borrow more because it can. It can today thanks to Europe’s troubles and the puny size of other govt bond markets. Absent that demand, U.S. Treasury yields would be higher. How much higher is hard to know. And if the bond market loses confidence in the U.S.’s ability to pay its debt, the consequences would be swift and brutal. Thankfully, the chances of that happening anytime soon are slim, at least based on what we currently know. But why take that chance?
You referenced Gov. Christie (my governor). He has made modest spending changes and undertaken other initiatives thereby putting the state’s finances on a stroner footing. There was no radical elimination of government services. No bread lines. What it took was switching the path the government is on. If we stay on this new path, NJ will appear much stronger than California, which has yet to reign in spending.
As for GM and Chrysler, the federal government showed little trust in working with corporate bondholders which the President himself demonized in several speeches (remember the bond holders are often the pension funds, retirement accounts of average Americans and yet the President bashed them as greedy and shameless. Are those the adjectives one associates with trust?). The bailout was brute force. And the anger in the bond market was palpable, but ignored by the mainstream press. Rather than protecting property rights of bondholders, those rights were trampled. The federal govt made a singular offer to them: take it or leave it. The bailouts done in the name of the public good may results one day in the absolute rejection of any systemically important company’s debt should they encounter financial trouble. Why would any bondholder buy GM paper if it is losing money such that its cosolvency is in question? The precedent has now been set for the government to dictate the terms of a rescue, forcing bondholders to take losses without reciprocal compensation in the form of equity in the new company. The result of that action in the future? Let’s assume GM encounters losses again, management seems adrift and the company skates near the financial cliff. Rating agencies may downgrade the debt faster than normal given the new risk of a government-induced haircut; that in turn forces interest rates up on GM paper. Those developments in turn make bondholders may shun any new debt GM may try to sell; a “failed” debt sale may accelerate the company’s demise — not because GM is a bad credit risk, but because the risk of the goverment stepping in is too much for bonholders to bear (they do have shareholders to answer to, you know). The hypthetical future GM may be forced into bankruptcy that much faster because a loss of trust may come to the fore given the government’s actions.
The President side-stepped a well worn system of bankruptcy, negotiation, a meeting of the minds of all interested parties to arrive at a new company with a robust business plan that will compensate fairly all those involved, all done under the oversight of an impartial judge. The President overrode that system and the effects of it may yet haunt us.
In both cases, trust is the critical element companies and the government are dealing in, not merely dollars and cents.
Being blase about that trust is a foolish game of chicken we would do well to avoid.
-Andy
Very good post! I especially like how you point out that the role of the government should go beyond the market. This is a great quote:
“Government stimulus and aid cannot be another market mechanism; it must be a genuine expression of subsidiarity, ennacted on behalf of the social ends at the heart of the common good- ends which are incommensurable with market schematics.”
Also, I am an economist, with a special interest in Catholic Social Teaching. You can learn more about me at my blog by clicking on my username.
Krugman has only half-truths concerning the debt which throws people off and confuses the issue. What I am about to say is absolute fact, not an opinion.
The U.S. cannot go bankrupt on its debt. It is the issuer of its own currency. It has the power to control the interest rates it pays on that debt. In fact, it doesn’t even have to issue debt to pay its obligations, nor does it have to tax to raise revenues in order to spend. All it does is change numbers in bank accounts.
Greece is not the issuer of its own currency, so you cannot compare the two. They cannot pay back their obligations without either taxing or selling bonds. They are like the state of California, or Kansas.
Japan does issue its own currency and is in a similar situation as the U.S. It too has misunderstood its own situation and though spending what seems to be an incredible amount, has in fact, not spent enough to grow the economy.
Debt was a big part of this past crisis, but not federal debt, private debt was the culprit. Private businesses, banks, and households accrued enormous debts that they eventually couldn’t make payments on, defaults ensued, and subsequently the crisis.
I know this seems to go against common sense and everything you probably learned or hear on TV. I was very skeptical as well, but I dug deeper, and am thoroughly convinced of these truths. It all has to do with the nature of money which my profession has thoroughly misunderstood for centuries.
Anyway, I don’t want to make this too long. I really enjoyed your post and felt an obligation to point out a few things. If you’re curious about these things, I can give you many, many resources to read.
For quick sources you can read some of my blog posts:
http://csteconomics.blogspot.com/2011/11/understanding-fiat-money.html
http://csteconomics.blogspot.com/2012/02/functional-finance-govt-household.html
http://csteconomics.blogspot.com/2012/05/sectoral-balances.html
And here is my ‘solution’ to ‘fixing’ the economy grounded in the principles of Catholic Social Teaching:
http://csteconomics.blogspot.com/2011/09/employment-for-all.html