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Socialism in Washington?

June 14th, 2009 · No Comments

Politics is about getting votes, especially when you’re in opposition…

Hence it’s understandable the opposition in the US brands the government as socialist. It’s a nice, catch-all, scary term (at least in the US), so it’s no surprise it’s used. We would probably do the same, given the chance. But is it right? Not really, although there are certain aspects which we have pointed out before (Socialism for the rich!), the government has been way to nice to the financial sector.

But here are a few stylized facts from economics on these matters:

  • The crisis originated in asset markets (housing, credit, and derivatives), if anything, there was to little government meddling (like sound regulation)
  • The result of all this has been a collapse in demand for goods and services. Since the private sector is either repairing damaged balance sheets (households, financial institutions) or credit constrained (business), and export led growth is not an option because the whole world is in deep recession. So governments (and central banks) really had to step in to keep economies sinking off a cliff.
  • Is all this government spending seriously mortgaging the future? The deficits are scary, and the absolute numbers are staggering just because the American economy is so large, but put as a percentage of GDP, things look quite a bit less frightening. The US public debt/GDP ratio is probably going to end up at something like 70% by the end of next year. Large, but still quite manageable. You don’t want to know what Japan’s figure is, it’s more than twice this. It’s only 10% points above the famous European EMU norms, an entry requirement for the European Monetary Union. Several other big advanced economies have triple digit debt/GDP ratios, like Italy and Belgium. Or look in the US past; at the end of WOII, America’s public debt/GDP ratio stood at 120%, that’s still a far cry now.
  • What will get the ratio lower? Well GDP growth will help, and here is where the stimulus helps in two ways. Not only does it create demand for goods and services, it also rebuilds necessary public infrastructure, a much neglected item in tax shy USA (ask people New Orleans, if you’re not sure..), which will help future growth.
  • A little inflation might also help. The UK, for instance, had a public debt/GDP ratio of almost 300% after WOII. Mild inflation eats at the real value of the debt and inflates the GDP growth. This can work quite fast, especially if most of the outstanding bonds bear a low nominal interest rate. The problem here is, of course, that market sense this, and have started asking higher interest rates to compensate for the expected rise in inflation.
  • The US differs in two respects from most other countries. Unlike many other countries, it can issue all its debt in its own currency. That’s an advantage. Root problem of many financial crisis is a weak currency combined with a lot of outstanding debt denominated in a foreign currency, which any devaluation will immediately increase in value.
  • More problematic is the size of the US, it’s the largest economy in the world by quite some margin, so even if it’s debt/GDP ratio is really not terribly frightening, it’s absolute size is, as it needs to be financed, to a considerable part from abroad. But luckily, one side-effect of the crisis is that the American savings rate in the private sector has gone up, more domestic funds are available to finance the public debt.
  • One other matter is that of public ownership of companies (like GM and some financial institutions). The overwhelming amount of economic research concludes that this in itself doesn’t have to be a problem. What matters much more is not whether a company is privately or publicly owned, but whether there is competition, unless politics saddles the publicly owned company with extra-market goals or detailed instructions.

Lawrence Summers, Obama’s economic heavyweight argues much better than us, of course. Here is his take.

Tags: Public Policy · The World according to Economics