James K. Galbraith

Incurable Optimists


In the status hierarchy of my profession, the Wall Street economist holds a strangely prominent role. Typically, though not always, he lacks academic standing, analytical achievement, significant publication. Research is foreign to him; independent thought unknown. His job is mainly to get his name in the papers. At this he works exceptionally hard. And the financial pages, which in their turn exist mainly to celebrate the great financial houses, oblige. Hence the Wall Street economist has the luxury of seeing his thoughts in print, without the burden of actually thinking.

This tribe, a year ago, was predicting three percent growth or better for 2001. Last spring, as things began to turn sour, forecasters were still optimistic. We were told that the economy might recover in a “V”—or a “U”—or in the worst possible case, an “L”. But there is no letter, in the Roman alphabet anyway, to describe the pattern we are actually observing (though Hebrew has ” ” which is pretty good). By late summer, we were grasping at straws. Perhaps interest rate cuts would save us. Or the rebates. Or lower oil prices. Or a consumer rebound. It didn’t happen.

Now, the jobless surge has cut sharply against these illusions. Forecasters now concede that, yes, sorry to say, they were wrong. However, one reads, “No one saw this recession coming.” And so, of course, none can blame the Wall Street economist for failing to warn of the trouble we are in. Moreover, in joyful chorus these roosters once again crow in the dawn: Recovery, everyone agrees, is on the horizon for early next year. And so, while a few more tax cuts for business would be nice, thank you very much—nothing very serious need be done.

Notice the fine logic. We cannot fault the last forecast if everyone made the same mistake. Yet, curiously, the fact that we have achieved consensus once again validates the present forecast. If recovery fails to develop, in part because of failure to act effectively now, the defense will be ready-made: Since no one foresaw that a recovery would not occur, again they will say that no one can be blamed.

But the claim that nobody foresaw the current recession is actually false. It was possible to predict the present disaster, if not its timing, on simple grounds. Let me quote my review of the Economic Report of the President for 1999, which is prepared annually by the White House’s Council of Economic Advisors (CEA):

[B]udget analysts now project vast excesses of tax revenue over public spending, sufficient if sustained nearly to eliminate the public debt within twenty years.

How likely is this actually to happen? The [CEA] provides evidence, inadvertently, in a chart showing… fiscal surpluses since 1945. In every single case, excepting once during the Korean War, the achievement of budget surplus was followed by a slump, with falling real GDP, rising unemployment, and a return to deficit spending (emphasis added). As a matter of history, the actual achievement of sustained budget surpluses is unheard-of.

Why is this so? The old Keynesian answer is fiscal drag, the fact that excess taxation and inadequate public spending deplete private incomes and slow down private consumption and investment. This simple phenomenon of yesterday’s textbooks has not disappeared. It has, merely, been forgotten, over-ruled by the mass amnesia concerning basic Keynesian principles that seems to afflict the economics profession.

Like most Democrats, I’m tempted by a simple tale: Things were wonderful, and then the Republicans screwed up. But in truth this slump should be blamed in part on the Robert Rubin-Larry Summers Democratic policy of debt reduction at all costs, the cause of the fiscal drag that I and others warned of in 1999. When taxes go above public spending, public saving is high. But households are crunched, and growth can continue only if private Americans stop saving. They did so, completely, and household debts soon mounted to record levels. This kept the expansion going for a time, but it could not last forever. And when the Federal Reserve raised interest rates in 1999-2000, that hit the consumer at her vulnerable point. Moreover, given that household debts do not disappear overnight, the recession could prove long and deep, and it could be followed by years of stagnation and high unemployment. Recovery early next year is not only uncertain. It is unlikely.

The issue now becomes, what to do? Democrats should focus on their traditional goal: full employment without inflation. This is what Americans rightly care about: They want jobs. And if the private sector will not provide jobs or the spending that creates them, then government will have to. Only Democrats, God help us, can make this point.

We need a short list of immediate actions. Extend and expand the individual tax rebates. Expand unemployment insurance and the Earned Income Tax Credit. Enact a prescription drug benefit for seniors—cutting the expense by opening our borders to, ahem, free trade in foreign pharmaceuticals. And raise the minimum wage. None of these actions will likely get through the House or past the White House, but they should be proposed, under a banner reading: Save The Economy First.

And here’s one idea that might attract bipartisan support—a slim hedge against disaster. States and localities now buy almost twice as many goods and services as the federal government does. They will cut back massively as their revenues fall. So, why not re-enact general revenue sharing—for Democratic and Republican states alike—and let Washington pay the bills for the teachers, clinics, roads, and renovations that states and cities need? If the states have more money than they want to spend, let them rebate their sales and property taxes for the next few years.

James K. Galbraith teaches at the LBJ School of Public Affairs.