Despite the crisis of unprecedented magnitude, it’s politics as usual in the US..

At it’s most simple, this crisis has two dimisions, shrinking balance sheets and (largely as a result), shrinking spending. The recipe is to get bad assets off balance sheets as fast as possible (and don’t let that turn into a vicious cycle), hence the Fed and Government bail-out plans (we don’t agree with all the details, but broadly it’s what should be done).

Since spending has fallen off a cliff, only the Government can (temporary) remedy that, hence the stimulus package. Again, we don’t agree with every item on that, but there is a simple rule for its effectiveness. The more recipients are inclined to spend, and the faster they do that, the more effective the stimulus becomes.

This is the simple economics that argues tax cuts are less efficient than government spending. Tax cuts will at least in part be saved. Giving money to the unemployed is also very efficient (apart from the fact that they might need it), as they are least likely to save, and most likely to spend directly.

What we’ve just argued is really quite uncontroversial in macro-economics (look under marginal propensity to consume in your textbook). Apparently not in politics though..

From the NYT:

• Some other Republican governors have also announced reservations about accepting the federal money, particularly when it comes to expanding jobless benefits.
• Texas Gov. Rick Perry last week announced that he turned down $555 million of federal stimulus funding that would expand the state’s unemployment benefits. Louisiana Gov. Bobby Jindal has said he would not accept nearly $100 million to expand unemployment benefits.
• And South Carolina Gov. Mark Sanford has said he only wants to use the federal money to pay down debt.

We find this curious, to be honest. What’s the reason? We’re hard-pressed to come up with any, even one we would disagree with. We understand that there might be some kind of long-term commitment to higher unemployment benefits, but surely there are other ways to deal with that than to reject what is not only the most efficient way to increase spending, but also to relieve some real hardship where it’s needed most.

Compared to almost anywhere in Europe, US unemployment benefits are a pittance. We understand that many in the US do not want to become like Europe, but now is perhaps not the best of times to let these considerations overrule fighting the recession.

And there are some solid economic arguments in having relatively generous unemployment benefits:

• These act as automatic stabilizers in a downturn, maintaining a considerable amount of spending
• They reduce the fear of losing one’s job, this can help in increasing the pace of structural change in the economy by reducing the fight in old industries as people there have less to lose

The argument against it is that they decrease the incentives to work, and that paying for the insurance adds to labour cost.

The first might have been the case in some European countries like 25 years ago, but:

• Unemployment benefit is almost nowhere an eternal right (sooner or later people move into welfare), the best structured programs are rather generous the first couple of months, to taper off after that, increasing the incentives to look for a job
• Even better is it to combine that with ‘active’ labour market policies, like retraining. In today’s fast changing economies, embracing structural change is better than fighting it, and emphasizing employability, rather than the right to employment, works better.
• The cost can be high, but it should be an insurance scheme, so people are paying to reduce risk for themselves