Tuesday, April 28, 2009

Posner's A Failure of Capitalism -- VI

In chapter five -- by far the longest chapter in the book -- Judge Posner examines the efforts the federal government has made so far to combat the current depression.

I will blog this chapter in two parts, this being part one.

By this point, his arguments will already have alienated libertarian and conservative readers. This chapter will now alienate readers on the left. Judge Posner has no illusions about the political nature of what the Obama administration is undertaking. At one point he suggests that the stimulus program perhaps "should be called the 'half stimulus-half New Deal' program," and notes that "[t]here is a legitimate concern that Keynesian depression-fighting theory is being used as a fig leaf to disguise a program of massive government expenditures based on a liberal ideology that a majority of Americans may not subscribe to -- at least not yet." (That closing "at least not yet" is apparently a reference to an argument earlier in the chapter that wealth-transferring programs are very hard to remove once they have been put in place, because they create their own constituencies of supporters/dependents.)

He identifies five phases that the government's response has so far moved through or into, not necessarily in sequence. The first three phases together form the "bailout": (1) the attempt to use TARP funds to buy "sick" mortgage-related assets from banks, (2) direct government investment in large banks in exchange for preferred stock, and (3) loans to GM and Chrysler in December '08 "to head off the bankruptcy of these companies or at least defer it." The fourth phase Judge Posner calls "easy money" -- the Fed's purchase of $800 billion of private debt (as opposed to buying back debt issued by the federal government). The fifth phase is the stimulus program, which had not become law at the time Judge Posner completed the book, in February '09, though he correctly assumed that it would be enacted.

Judge Posner explains the economic rationale behind each of the above phases, the political complications associated with them, and their likelihood of being effective on balance. The first phase, as he discussed in a previous chapter, failed because it was based on the faulty premise that the illiquidity of the "sick" assets resulted from uncertainty as to their value. (It turns out that they're just not worth much.) The second phase did help stabilize banks, but it did not have much immediate effect on the depression because banks needed funds so badly that they added much of the invested money to their reserves rather than loaning it out and thereby boosting economic activity.

The third phase (the second shoe of which is dropping now) was, in Judge Posner's view, more successful than is generally allowed. There was never any chance that the government could remake those companies or the auto industry as a whole. But, he argues, the main benefit of the loans to GM and Chrysler was simply to help them survive until the depression is over. In "normal" times, their bankruptcies would not be a problem. But the failure of such large firms "just as the nation was sliding into a depression" would have dangerously accelerated the cycle of lowered spending / lowered production / increased unemployment / lowered spending / etc.

After discussing the above, Judge Posner turns his attention to the stimulus program. The stimulus was planned (at the time he was writing) to consist of three elements: tax cuts, transfer payments and "other social-welfare expenditures," and public works. Conservatives prefer the tax-cut solution because, of the three, it's the only one that promises to make government smaller instead of larger. Tax cuts alone, however, are unlikely to increase economic activity much, because most people view tax cuts as temporary and therefore tend to save, not spend, the additional money they get to withhold from Uncle Sam. (And people who are so poor that they must spend all the money they have are also so poor that they pay little, if any, income tax in the first place.)

As for transfer payments and social programs, that "component of the proposed stimulus is also questionable, though politically irresistible." On the plus side, this component puts money directly into the hands of the poor, who are the ones most likely to spend it soon -- what we want a stimulus program to accomplish. On the negative side, this component is most likely to create permanent new "drains" on the federal government.

In that regard, the public-works component of the stimulus is superior, because public-works projects are, by their nature, more likely to be temporary. They are also more likely to result in real benefits to society aside from the benefit of helping to end the depression. To an extent, they also accomplish the same thing as the second component, since some of the money spent on public works finds its way to individuals who also spend it. (Relatedly, Judge Posner mentions the Keynesian "multiplier" that is supposed to capture the extent to which government spending results in additional spending down the road. He acknowledges that some estimates put the multiplier at 1.4, but "this is one of the roughest of rough estimates and some economists think the multiplier is less than [1.0].")

The problem with public-works spending is that public-works projects need a long lead time. Judge Posner's solution is to focus the spending on infrastructure repairs, and on projects (whether state or federal) that have already been started but have stalled for lack of funds.

At this point, Judge Posner ask if the stimulus program is "an $800 billion mistake, as the economist Martin Feldstein has called it?"

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