March 26, 2012
Simon Johnson and James Kwak on Learning -- or Not -- from the Past
I’ve been reading some history, from Simon Johnson and James Kwak's new book, White House Burning. And it strikes me how ahistorical (or just plain ignorant of history) so many of the prescriptions for fixing up the economy are. For instance, the tax cutting ideology of today is merely a recapitulation of what has caused America to come to grief at the Nation’s birth.
From White House Burning, on the lead-up to the War of 1812:
... the War Hawks were ideologically and politically opposed to taxes—particularly the excise (internal trade) taxes that Gallatin wanted to impose. As the party of small government, the Democratic-Republicans believed that higher tax revenues constituted a threat to individuals’ and states’ rights. Perhaps more importantly, they feared that raising taxes to fight a war could hurt them at the ballot box. ...
Hampered by Congress’s reluctance to raise taxes, the Treasury Department struggled to pay for soldiers in the field and ships at sea. ... Congress finally agreed to impose excise taxes in 1813, but it was too late to build up a world-class military. ... In August 1814, British forces sailed into Patuxent. ... The soldiers marched overland ... and eventually reached Washington, where they encountered little resistance. On the night of August 24, they burned the Capitol, the Treasury Building, and the White House ...” (pages 3-4)
So when I see the Ryan Plan promising a balanced budget with all Federal spending (excluding Medicare, Medicaid and Social Security) equaling 3.75 percentage points of GDP in 2050, all I can say is we deserve what we get if we go down that path. (As an aside, here’s a cautionary tale of military disaster avoided by deferring tax cuts, from the Classical Age.)
White House Burning is an excellent explication of how sheer ignorance of history (not to mention economics) can lead to policy prescriptions sure to lead to disaster. At the same time, Johnson and Kwak do not engage in indiscriminate fear mongering. In particular, they understand that the US is not in currently running headlong into an instant replay of Greece. In particular:
... As a matter of logic, the United States is not immune to fiscal crises at some point, if the debt is big enough, the deficit is high enough, and the chances of reducing the deficit appear slim enough, we could go the way of Greece. It probably isn’t anytime soon. But no one knows when it could happen.
No one knows because there is no other country in the world quite like the United States – and there never has been one, either, for several reasons. Two centuries of fiscal responsibility count for something. So do a generally healthy economy and the ability to borrow money in our own currency ... But what really matter are our unique status as the world’s safe haven in a financial storm and the dollar’s unique status as the world’s reserve currency. (pages 153-54)
Difficulties in arranging debt limit increases and the refusal by certain policymakers to raise taxes are of course fast eroding the reputation for fiscal responsibility, but for now we retain reserve currency status and the ability to borrow in our own currency. (For more on the dollar as an international currency, see here and here).
One thing I have learned about writing books (as opposed to articles) is that the enterprise is fraught with hazards, since the last word is written long before the book comes out -- but in this case, one of the last sentences sticks in my mind as incredibly timely, as certain individuals call for immediate military action against Iran. 
In 1812, the Democratic-Republican majority in congress pushed for war with Great Britain yet was unwilling to raise taxes enough to pay for it. ...
We just started a war nine years ago, and then cut taxes. Will we do it again?
Figure 1: Cumulative direct costs, in current dollars by fiscal year, in the Iraq theater of operations ("Operation Iraqi Freedom"). Does not include resulting debt service. Source: Amy Belasco, "The Cost of Iraq, Afghanistan, and Other Global War on Terror Operations Since 9/11," RL33110, Congressional Research Service, March 29, 2011, Table 3. Data for FY2011 is for continuing resolution, for 2012 is Administration FY2012 request.
As Jeffry Frieden and I stated in Lost Decades:
[T]rue fiscal responsibility involves a willingness to raise sufficient tax revenue, over the longer term, to pay for the programs the government implements. Fiscal responsibility should not be equated with a small government, but rather with a commitment to pay for the government services provided. ...
... If the nation affirms that enhancing national defense and improving health care for the poor are legitimate goals, fiscal responsibility entails raising the revenue to fund these programs, rather than borrowing for them. (Chinn and Frieden, 2011, pp. 202-03.)
Much more from Johnson and Kwak at Baseline Scenario.
Posted by Menzie Chinn at March 26, 2012 09:28 PMdigg this | reddit
I reading and re-reading this post to find the point, or any kind of reasonable take-away and its proving very difficult. The title suggest some lesson from history, followed by the line "the tax cutting ideology of today is merely a recapitulation of what has caused America to come to grief at the Nation’s birth." Then you lead into a story about how the failure to properly fund an army led to the the burning of the White House. Is this somehow an argument against the reluctance to raise taxes in general? How simplistic! This story is immediately followed by a reference to the Ryan Plan, which does not call for defense spending cut. Ironically, Obama's budget does. Menzie, I suggest you get your facts in order.
Posted by: Jeff at March 26, 2012 11:05 PM
"dollar’s unique status as the world’s reserve currency"
I really do not like this phrasing. It seems to imply that the dollar's unique status is a result of the "dollar" somehow, when in actuality it is a consequence of the faith of the world in the United States government over any other sovereign in the world (because the USD only derives value from the full backing of the US govt).
The difference is that the second (IMO correct) phrasing clarifies how important good, sensible governance really is, and how dangerous the Republican shenanigans with stuff like the debt ceiling actually is.
Posted by: addicted at March 27, 2012 12:54 AM
Jeff: Get my facts right? You were the one who commented on 3/2/2012 10:09AM:
Nonsense. How did the country manage to survive its first two centuries without bailing anyone out?
That tells me you would do well to read the book and learn some history. Geez.
Posted by: Menzie Chinn at March 27, 2012 07:44 AM
With regard to defense, we don't remember that we have mobilized productive capacity when needed. 1812 was an exception: if not for John Adams, we wouldn't even have had ships. We were unwilling to recognize the British were willing to fight for trade dominance, particularly for Caribbean routes. And we stupidly believed a private system - chartered pirates - would be useful against the British Navy. Despite the romanticizing of the privateer story, we were wholly non-competitive militarily with the British. Our landmass and their unwillingness to engage in protracted land war saved us.
But for the rest of our history, we have mobilized for war. Usually late. WWI saw our troops without working rifles for months. WWII saw us with torpedoes that were more dangerous to our ships than to the Japanese. But we did mobilize and that is what's lacking in the current defense debate - except for a note below. Mobilization has a different effect on the economy: it is stimulus that continued levels of spending aren't.
The odd thing that shows the twisted nature of the debate is that Obama was recently accused by Gingrich of having a plan to take over private enterprise. That's true: if we mobilize for war, then we need plans to enlist and encourage and even to coerce private companies into war production. Think we'd have won WWII without that? So planning has become an evil while spending much more than is necessary - because we can mobilize if needed - has become a necessity. Truly bizarre.
Posted by: jonathan at March 27, 2012 08:21 AM
Of course, government spending was much lower then. I seem to recall is was 7% of GDP prior to FDR, 14% under FDR, 22% under Truman, and 32% under Johnson. And now, as much as 42% under Obama (albeit with a significant cyclical component). It is, of course, higher in many European countries, a number of which are in fiscal crisis.
But let's not quibble. Let's make it 20% of GDP (also Romney's number), and let's get spending and taxes to that level, and all will be well.
Posted by: Steven Kopits at March 27, 2012 09:22 AM
Lesson from history: The US has never paid for its wars through current taxation.
In 1774 the vast majority of colonialists did not want war with England. It was a tax rebellion. The taxes were principally on luxury items. The elites won that argument by enticing Britain to act more aggressively. The colonies were in serious debt at the end of the war. Partly prompting the federation.
The first use of the US standing army was to put down a tax revolt. The tax was an excise tax on whiskey. The largest distiller in the country was the president of the US. The tax and its enforcement eliminated a large amount of his competition.
In 1812 the people did not want war with England. However, the shipping interests and the industrialists who exported did. Again the elites got the government to go to war, but they did not want the internal strife associated with raising taxes.
In 1850 the people did not want to war with Mexico. Pres. Tyler and other elitists dreaming of manifest destiny did. The gov't raised taxes to pay for the war. There was internal strife. Thoreau went to prison rather than pay taxes to support an unjust war and became a hero to most of the US.
The Civil War tax was also not popular. Lincoln's unconstitutional levy of an income tax spurred rioting in the streets. The Union could not raise the taxes to pay for the war. It borrowed heavily. At the outbreak of WWI, the US had still not paid its debt from the Civil War.
I have not studied the economics of the Spanish-American war. Pulitzer made it popular. It was a very short war: 6 months of active hostilities--less than one year from start to finish.
From 1914 t0 1916 the vast majority of Americans wanted nothing to do with the European War. The elites who wanted greater US influence in World affairs did. Even after the sinking of the Lusitania in 1915 Americans did not want war. Germany promised not to use U-Boats to sink our ships anymore. We restrained. In 1917 Germany declared unrestricted U-Boat war to stop US war materials from reaching Europe. The mercantists got the US to declare war over a breach of promise. The US levied a war tax of one cent per item mailed to pay for the war. It also war taxed phone calls at 3%. It was a very short war. I can find no tax revolt.
The US stayed out of WWII because it was another European war and the yeoman farmer was still the norm. No one knows why FDR tried to strangle Japan's access to oil. But, that is why they attacked us. First War for oil I can find. The US raised its income tax for the first time. Instead of a tax on the rich it became a tax on everyone. People making as little as $500 per year were taxed at marginal rate of 23%; millionaires at 93%. The average tax was 20.3%. The biggest change was collection by wage witholding. The treasury did this because they did not want the people to have a chance to refuse to pay their taxes. Even so in 1945 tax revenues were $45B and war expenditures (all by themselves) exceeded $83B. More than half the cost of the war was paid for by borrowing (war bonds).
Truman raised taxes on everyone and everything to pay for the Korean War. The US still had to borrow money to support it. Many veterans were bitter that they were taxed for surviving the war to pay for the war they fought.
Johnson adamantly opposed raising taxes to support the Vietnam war. It was unpopular and raising taxes would make it more so. From 65 to 68 Johnson tried to "pay for both guns and butter without raising taxes" (quote from Johnson). He did not ask Congress for a tax hike until 1968. The best estimate I can find is that we spent $423B on the war without raising taxes.
Bush went to two wars, both fairly popular at the time. He cut taxes. (Perhaps to keep them popular?)
Perhaps if we had to pay for military adventures in real time we would stop having military adventures?
Posted by: JLR at March 27, 2012 10:27 AM
Then you lead into a story about how the failure to properly fund an army led to the burning of the White House.
I never expected to read here an argument to increase taxes to fund increased military spending. :-)
Posted by: Jim Glass at March 27, 2012 12:56 PM
JLR In 1850 the people did not want to war with Mexico. Pres. Tyler and other elitists dreaming of manifest destiny did.
Actually, the Mexican War was in 1846-1848 and it was President James K. Polk who prosecuted the war. I would recommend the Polk biography "A Country of Vast Designs." I don't know whether "the people" opposed the Mexican War, but the Whigs certainly did, including one famous then-Whig named Abraham Lincoln.
Posted by: 2slugbaits at March 27, 2012 01:42 PM
Jim Glass: Then you haven't been reading my posts closely enough. I've always been in favor of sufficient funding for defense, and have not ever to my recollection ever advocated for cuts to VA.
In fact, I was in favor of increased and accelerated investment in body armor. I *was not* in favor of spending billions for wars to look for non-existent WMDs.
Posted by: Menzie Chinn at March 27, 2012 01:43 PM
Steve Kopits Government's share of consumption expenditures and investment was 20.1% of GDP in 2011. Of that, the federal government was responsible for 8.2 percentage points, with state & local governments accounting for 11.9 percentage points. Of the federal government's share, 5.5 percentage points were for national defense, with only 2.7 percentage points for everything else. So in order to get all of federal consumption expenditures and investment savings down to 3.75% of GDP, as targeted in Ryan's plan, that means (
5.5% - 3.75%) / 5.5% = 32% of DoD spending will have to be cut along with 100% of all other non-defense spending. Do you really think the US Navy can maintain the Fifth Fleet's mission of keeping the oil lanes open in the face of budget cuts that severe? The war production function back in 1812 was labor intensive and capital thin, with most of the capital (i.e., guns) being provided by the soldiers themselves because George Washington and the first Congress passed a law mandating that people had to personally buy guns (so much for the anti-Obamacare argument about never having to buy a commodity before!!!). Anyway, today we put a very high value on human life, which drives the war production function towards capital deepening. And you can bet that DoD will become even more capital intensive as time goes by. That's what happens when countries become richer...the labor input costs for war increase, so you have to shift towards more capital. Ryan's numbers are laughable on their face.
Posted by: 2slugbaits at March 27, 2012 03:22 PM
After Menzie got schooled about how climate change is a figment of lefty imagination (and the preparatory work for their subsequent genocide fantasies), I hope he took the opportunity for some introspection.
I mean, I actually cringed at the sheer shellacking he took from the avalanche of facts and logic being presented to him.
I continue to be amazed at the existence of the macroeconomics niche. It is the only niche where a leftist can reside, because the very basics of economics are wholly incompatible with leftism.
A left-wing economist is sort of like a vegan butcher. I think the profession is dominated by people who covet money, but lack the means to earn it via their own merit.
Posted by: Orson at March 27, 2012 04:09 PM
Here's a little fact for you Menzie; there are more than one Jeffs in the world. Better recheck your IP log. In any case, I'll interpret the attempted jab and lack of material response to the fact that there really isn't any coherent point in this post.
Posted by: Jeff at March 27, 2012 06:19 PM
Our military seems more prone to misuse than good use, but it may come in handy if we have catastrophic changes in global climate over a short period - something like what happened to the Greek city states before Homer.
Posted by: don at March 27, 2012 07:31 PM
Jeff: My apologies for mixing up your comment with those of someone equally confused.
So let me deal with your first assertion -- no cuts in defense. Well, you should read the Klein article to see how the assumptions in Ryan plan imply 3.75% for all Federal expenditures except Medicare, Medicaid,Social Security. Current defense expenditures are 4.7% of GDP. Hmm. Think about that. I guess you expect to default on debt, so we won't pay interest. Get rid of all government officials (who needs judges, etc.). And get rid of weather service, USGS, CDC, NSF, NIH, FBI, etc.
But you are right, Rep. Ryan never *says* in the document he will cut defense. He also never mentions how big a supply side response is necessary...Wonder why.
Posted by: Menzie Chinn at March 27, 2012 07:40 PM
That was hilarious Orson. You might not be Onion or Colbert material but truly a gifted amateur.
Posted by: Dennis at March 28, 2012 12:19 AM
I was not defending Ryan's plan. As you can see, I suggested we go to a 20/20 Fed fiscal structure, which would be on the highish side for taxes, within historical norms for spending. I could live with a little less, say 18.5/18.5, as spending was under Clinton, but given our aging population, I wonder whether we could realistically achieve that.
The critical issue, however, is the incentives for politicians, and that, here as elsewhere, is a virtually taboo topic.
Posted by: Steven Kopits at March 28, 2012 02:48 AM
From my experience with those who believe that spending to increase consumption is the path to recovery, and its corollary taxing to balance the spending, Menzie definitely manafests the most powerful religious faith I have ever seen. The efficacy of taxing the daylights out of the economy is unquestionable, totally a matter of blind faith. Reasonable taxation is absolutely anathema.
Posted by: Ricardo at March 28, 2012 08:38 AM
Ricardo: In my experience, those who comment without any regard to data and real world phenomena are most clearly driven by delusion. What do you mean by "taxing the daylights out of the economy" when total tax revenues to GDP are at record lows, and effective tax rates on top incomes are also at record lows. I know you know these statistics since you comment on the associated posts. And yet you completely dismiss facts in favor of, dare I say it, ideology of the most sophomoric kind.
Posted by: Menzie Chinn at March 28, 2012 11:20 AM
Slugs: Thank you for correcting me. You are right. And, more importantly, I was wrong. Also, thanks for the reference, I will get it right away.
Posted by: JLR at March 28, 2012 11:39 AM
Gosh, I'm with Menzie rather than ideologues like Jeff and Ricardo . Unfortunately, the idea of democracy requires that most people are open-minded about what strategies have been successful in the past. America seems to be plumbing new lows in open-mindedness and historical sophistication.
Posted by: Doctor Bob at March 28, 2012 12:59 PM
What I meant by "taxing the daylights out of the economy" is you go back and blame those who wanted to reduce taxation in the early 1800s for British victories in the War of 1812, and then you equate that to those who want to reduce taxes today. Anyone but a total religious tax and spend Keynesian would quickly understand that this is apples and oranges (see Stephen Kopits comment March 27).
I am sure that going back you also would condemn the early Americans for separating from England because of what they considered high tax policy. Compared to today things like the Stamp tax would be considered relief.
The Keynesian base of your economic theory causes you to see taxation as salvation. A case in point is your response to Jim Glass: "I've always been in favor of sufficient funding for defense..." is totally consistent. Jim assumed that you were first a "leftist liberal" and secondly a radical Keynesian and so should be against military spending. He should realized that it is natural for Keynesians to support wars for the same reason they support digging holes for no reason or building infrastructure that no one will use. Modern Keynesians see consumption as salvation and stimulating "demand" as the road to recovery, so a nonsense war, spending on the military for the sake of spending, makes perfect economic sense. After all didn't spending on WWII pull us out of the Great Depression? NOT!
So as a committed radical Keynesian "taxing the daylights out of the economy" comes second nature.
Posted by: Ricardo at March 29, 2012 07:25 AM
I don't know who you are, but I appreciate your commentary. I've been over at Kwak's website telling them that they should have stuck to arguing against the big banks, because on this topic they simply do not know what they are talking about. An added argument you should make is that we currency issuers as opposed to currency users like greece, and as you say our debts are denominated in our own currency and are non-convertible to anything else. This is a simple point many idiots don't seem to comprehend, much like some of your commentators above. this has nothing to do about economics, it has to do with reality. Kwak and Johnson are two of the most dangerous people on the left today, because they are actually looked up to by many people who read 13 bankers, but little do they know that they are simply doing the bidding of Pete Peterson. Also, if Paul Ryan gets his way and destroys the economy, you're right, we'll have deserved it.
Posted by: DeusDJ at March 29, 2012 09:57 AM
Ricardo WTF are you ranting about? Unlike real business cycle types, Keynesians (of pretty much any stripe) believe in two curves...an aggregate demand curve and an aggregate supply curve. Sometimes things get out of equilibrium. If the reason for disequilibrium is some aggregate demand shock, then demand stimulus is appropriate to restore equilibrium. If the reason for disequilibrium is a supply shock, then stimulating aggregate demand may or may not be helpful.
As best I can make out, you seem to believe that there is only one curve (the aggregate supply curve), in which case I guess I can see why you wouldn't think the economy would never get out of equilibrium.
As to your prejudice that leftists must also be anti-military, that's just some fantasy left over from your 1960s time warp. By almost any measure I consider myself pretty far to the left. I also believe in a vigorous defense policy. News flash: countries without armies and navies tend to get run over and aren't long for this world. That's been true for thousands of years and I'm not aware of any recent visits from space aliens warning us to mend our ways or else: Klatu Barada Nikto. But favoring a strong defense establishment is not at all the same thing as favoring every stupid war that we happen to stumble into.
Posted by: 2slugbaits at March 29, 2012 03:13 PM
You are trapped in Keynesian circular flow models. Do you know anything about Hayekian triangles?
Posted by: Ricardo at March 30, 2012 08:07 AM
Ricardo Yes, I know all about Hayek's triangles. He confuses investment and capital stock. And it simply isn't true that investment only comes at he expense of consumption. For example, increasing the consumption of learning and knowledge also increases the efficiency of any given capital stock. Hayek was trapped in an economic world that we would not recognize today. Even Hayek eventually gave up on his own economic theories and more or less conceded that Kaldor was right. In his later years he quit writing about economics and moved to political philosophy...eventually even finding himself in agreement with John Rawls and his cousin Wittgenstein. [Note: one of my old profs was the last living member of Wittgenstein's original Vienna Circle. So that's my six degrees to Kevin Bacon connection to Hayek!] I didn't think there were any adults who actually took all of the Hayekian "concertina effect" stuff seriously. I never bought Austrian arguments, but my experience has been that people who do buy into it are usually over it once they get past their sophomore year. Sort of like Ayn Rand. And most people who admire Hayek today only know his libertarian political philosophy and not his economics.
Posted by: 2slugbaits at March 30, 2012 03:23 PM
He confuses investment and capital stock. And it simply isn't true that investment only comes at he(sic) expense of consumption.
Now the question becomes not do you know Hayekian triangles but do you understand them? Investment and consumption may be additive as an identity but not as an indicator of real economic growth.
Try this, Keynesian investment (malinvestment) can come from monetary expansion even as it drives over-consumption.
Consider real life. Housing was stimulated by both monetary and fiscal policies since the Great Depression. Overcomsumption of housing became the American way of life resulting in malinvestment in homes, always larger and more elaborate housing fewer people (compare US housing with the world average). At each point where a correction appeared monetary and fiscal stimulus was increased masking the crisis pushing it into the future at the expense of a higher level of error. In 2008 the house of cards came crashing down.
A huge malinvestment in homes - partial and fully built - suddenly sat idle. The Keynesians saw this malinvestment in the aggregate as useful idle resources and begged for more "investment," but this proved useless. Stimulus became excess bank reserves. The over-consumption suddenly became manifest abs prices fell as homes went into foreclosure. Families saw life savings destroyed. Even those prudent enough to defy the government stimulus and put 20% down found that the problem had grown to a size that even this prudence was overwhelmed.
Today we still face remanents of over-consumption and malinvestment, but Keynesians and monetarists unintentionally institute policies that perpetuate the problem and hinder recovery. Each small hint of recovery is met with more monetary expansion and renewed fiscal actions that increase malinvestment. Hayek's presence screams at us through the Great Recession, boom-bust is alive but certainly not so well.
Posted by: Ricardo at March 31, 2012 07:27 AM