Bidenomics – J. W. Mason

At Dissent: Industrial Policy without Nationalism

(This piece was published in the Fall 2024 issue of Dissent.)

In the first two years after Biden’s election, there was considerable enthusiasm on the left for the administration’s embrace of a larger, more active economic role for the federal government. I was among those who saw both the ambitions of the Build Back Better bill and the self-conscious embrace of industrial policy as an unexpectedly sharp break with the economic policy consensus of the past thirty years.

Biden squandered that early promise with his embrace of Israel’s campaign of mass murder in Gaza. His legacy will be the piles of shattered buildings and children’s corpses that he, with aides like Antony Blinken, did so much to create.

The administration has also struck a Trumpian note on immigration, promising to shut down the border to desperate asylum seekers. And internationally, it is committed to a Manichean view of the world where the United States is locked into a perpetual struggle for dominance with rivals like Russia and China.

Can industrial policy be salvaged from this wreckage? I am not sure.

There are really two questions here. First, is there an inherent connection between industrial policy and economic nationalism, because support for one country’s industries must comes at the cost of its trade partners? And second, is it possible in practice to pursue industrial policy without militarism? Or does it require the support of the national security establishment as the only sufficiently powerful constituency in favor of a bigger and more active government?

Much of the conversation around industrial policy assumes that one country’s gain must be another’s loss. U.S. officials insist on the need to outcompete China in key markets and constantly complain about how “unfair” Chinese support for its manufacturers disadvantages U.S. producers. European officials make similar complaints about the United States.

This zero-sum view of trade policy is shared by an influential strand of thought on the left, most notably Robert Brenner and his followers. In their view, the world economy faces a permanent condition of overcapacity, in which industrial investment in one country simply depresses production and profits elsewhere. In the uncompromising words of Dylan Riley, “the present period does not hold out even the hope of growth,” allowing only for “a politics of zero-sum redistribution.” Development, in this context, simply means the displacement of manufacturing in the rich countries by lower-cost competitors.

I don’t know if anyone in the Biden administration has read Brenner or been influenced by him. But there is certainly a similarity in language. The same complaints that Chinese investment is exacerbating global overcapacity in manufacturing could come almost verbatim from the State Department or from the pages of New Left Review. More broadly, there is a shared sense that China’s desire to industrialize is fundamentally illegitimate. The problem, Brenner complains, is that China and other developing countries have sought to “export goods that were already being produced” instead of respecting the current “world division of labor along Smithian lines” and focusing on exports complementary to existing industries in the North.

Fortunately, we can be fairly confident that this understanding of world trade is wrong.

The zero-sum vision sees trade flows as driven by relative prices, with lower-cost producers beating out higher-cost ones for a fixed pool of demand. But as Keynesian economists have long understood, the most important factor in trade flows is changes in incomes, not prices. Far from being fixed, demand is the most dynamic element in the system.

A country experiencing an economic boom – perhaps from a upsurge in investment – will see a rapid rise in both production and demand. Some of the additional spending will falls on imports; countries that grow faster therefore tend to develop trade deficits while countries that grow slowly tend to develop trade surpluses. (It is true that some countries manage to combine rapid growth with trade surpluses, while others must throttle back demand to avoid deficits. But as the great Keynesian economist A.P. Thirlwall argued, this is mainly a function of what kinds of goods they produce, rather than lower prices.)

We can see this dynamic clearly in the United States, where the trade deficit consistently falls in recessions and widens when growth resumes. It was even more important, though less immediately obvious, in Europe in the 2000s. During the first decade of the euro, Germany developed large surpluses with other European countries, which were widely attributed to superior competitiveness thanks to wage restraint and faster productivity growth. But this was wrong. While German surpluses with the rest of the European Union rose from 2 percent to 3 percent of German GDP during the 2000s, there was no change in the fraction of income being spent in the rest of the bloc on German exports. Meanwhile, the share of German income spent on EU imports actually rose.

If Germans were buying more from the rest of the European Union, and non-German Europeans were buying the same amount from Germany, how could it be that the German trade surplus with Europe increased? The answer is that total expenditure was rising much faster in the rest of Europe. Rising German surpluses were the result of austerity and stagnation within the country, not greater competitiveness. If Germany had adopted a program to boost green investment during the 2000s, its trade surpluses would have been smaller, not larger. The same thing happened in reverse after the crisis: the countries of Southern Europe rapidly closed their large trade deficits without any improvement in export performance, as deep falls in income and expenditure squeezed their imports.

Europe’s trade imbalances of a decade ago might seem far afield from current debates over industrial policy. But they illustrate a critical point. When a country adopts policies to boost investment spending, that creates new demand in its economy. And the additional imports drawn in by this demand are likely to outweigh whatever advantages it gains in the particular sector where investment is subsidized. Measures like the Inflation Reduction Act (IRA) or CHIPS and Science Act may eventually boost U.S. net exports in the specific sectors they target. But they also raise demand for everything else. This is why a zero-sum view of industrial policy is wrong. If the US successfully boosts investment in wind turbine production, say, it will probably boost net exports of turbines. But it will also raise imports of other things – not just inputs for turbines, but all the goods purchased by everyone whose income is raised by the new spending. For most US trade partners, the rise in overall demand will matter much more than greater US competitiveness in a few targeted sectors.

China might look like an exception to this pattern. It has combined an investment boom with persistent trade surpluses, thanks to the very rapid qualitative upgrading of its manufacturing base. For most lower- and middle-income countries, rapid income growth leads to a disproportionate rise in demand for more advanced manufactures they can’t make themselves. This has been much less true of China. As economists like Dani Rodrik have shown, what is exceptional about China is the range and sophistication of the goods it produces relative to its income level. This is why it’s been able to maintain trade surpluses while growing rapidly.

While Biden administration officials and their allies like to attribute China’s success to wage repression, the reality is close to the opposite. As scholars of inequality like Branko Milanovic and Thomas Piketty have documented, what stands out about China’s growth is how widely the gains have been shared. Twenty-first-century China, unlike the United States or Western Europe, has seen substantial income growth even for those at the bottom of the income distribution.

More important for the present argument, China has not just added an enormous amount of manufacturing capacity; it has also been an enormous source of demand. This is the critical point missed by those who see a zero-sum competition for markets. Consider automobiles. Already by 2010 China was the world’s largest manufacturer, producing nearly twice as many vehicles as the United States, a position it has held ever since. Yet this surge in auto production was accompanied by an even larger surge in auto consumption, so that China remained a net importer of automobiles until 2022. The tremendous growth of China’s auto industry did not come at the expense of production elsewhere; there were simply more cars being made and sold.

All this applies even more for the green industries that are the focus of today’s industrial policy debate. There has been a huge rise in production—especially but not only in China—but there has been an equally huge growth in expenditure. Globally, solar power generation increased by a factor of 100 over the past fifteen years, wind power by a factor of ten. And there is no sign of this growth slowing. To speak of excess capacity in this sector is bizarre. In a recent speech, Treasury Under Secretary Jay Shambaugh complained that China plans to produce more lithium-ion batteries and solar modules than are required to hit net-zero emissions targets. But if the necessary technologies come online fast enough, there’s no reason we can’t beat those targets. Is Shambaugh worried that the world will decarbonize too fast?

Even in narrow economic terms, there are positive spillovers from China’s big push into green technology. China may gain a larger share of the market for batteries or solar panels — though again, it’s important to stress that this market is anything but fixed in size — but the investment spending in that sector will create demand elsewhere, to the benefit of countries that export to China. Technological improvements are also likely to spread rapidly. One recent study of industrial policy in semiconductors found that when governments adopt policies to support their own industry, they are able to significantly raise productivity – but thanks to international character of chip production, productivity gains are almost as large for the countries they trade with. Ironically, as Tim Sahay and Kate Mackenzie observe, the United States stands to lose out on exactly these benefits thanks to the Biden administration’s hostility to investment by Chinese firms.

None of this is to say that other countries face no disruptions or challenges from China’s growth, or from policies to support particular industries in the United States or elsewhere. The point is that these disruptions can be managed. Lost demand in one sector can be offset by increased demand somewhere else. Subsidies in one country can be matched by subsidies in another. Indeed, in the absence of any global authority to coordinate green investment, a subsidy race may be the best way to hasten decarbonization.

As a matter of economics, then, there is no reason that industrial policy has to involve us-against-them economic nationalism or heightened conflict between the United States and China. As a matter of politics, unfortunately, the link may be tighter.

They are certainly linked in the rhetoric of the Biden administration. Virtually every initiative, it now seems, is justified by the need to meet the threat of foreign rivals. A central goal of the CHIPS Act is to not only reduce U.S. reliance on Chinese imports but to cut China off from technologies where the United States still has the lead. Meanwhile arms deliveries to Ukraine are sold as a form of stimulus. This bellicose posture is deeply written in the DNA of Bidenomics: before becoming Biden’s national security advisor, Jake Sullivan ran a think tank whose vision of “foreign policy for the middle class” was “Russia, Russia, Russia and China, China, China.”

Thea Riofrancos calls this mindset the “security-sustainability nexus.” Is its current dominance in U.S. politics a contingent outcome—the result, perhaps, of the particular people who ended up in top positions in the Biden administration? And if so, can we imagine a U.S. industrial policy where the China hawks are not in the driver’s seat? Or is the political economy of the United States one in which only a Cold War enemy can motivate a public project to reorient the economy?

In a recent paper, Benjamin Braun and Daniela Gabor argue for the second alternative. It is only “the salience of geopolitical competition” with China that has allowed the United States to go as far with industrial policy as it has. In the absence of much more popular pressure and a broader political realignment, they suggest, the only way that “green planners” can overcome the deep-seated resistance to bigger government is through an alliance with the “geopolitical hawks.”

Many of us have pointed to the economic mobilization of the Second World War as a model for a quick decarbonization of the U.S. economy through public investment. Wartime mobilization — the “greatest thing that man has ever done,” in the words of a contemporary Woody Guthrie song — offers an appealing model for decarbonization. It combines both the most rapid expansion and redirection of economic activity in U.S. history, and the closest the country has ever come to a planned economy. But given the already dangerous entanglement of industrial policy with war and empire, it’s a model we may not want to invoke.

On the other hand, the climate crisis is urgent. And the arguments that it calls for a more direct public role in steering investment are as strong as ever. It’s safe to say that neither the historic boom in new factory construction nor the rapid growth in solar energy (which accounts for the majority of new electrical generating capacity added in 2024) would have happened without the IRA. It’s easy to see how climate advocates could be tempted to strike a Faustian bargain with the national security state, if that’s the only way to get these measures passed.

Personally, I would prefer to avoid this particular deal with the devil. I believe we should oppose any policy aimed at strengthening the United States vis-à-vis China and flatly reject the idea that U.S. military supremacy is in the interest of humanity. An all-out war between the United States and China (or Russia) would be perhaps the one outcome worse for humanity than uncontrolled climate change. Even if the new Cold War can be kept to a simmer—and that’s not something to take for granted—the green side of industrial policy is likely to lose ground whenever it conflicts with national security goals, as we’ve recently seen with Biden’s tariffs on Chinese solar cells, batteries, and electric vehicles. The Democratic pollster David Shor recently tweeted that he “would much rather live in a world where we see a 4 degree rise in temperature than live in a world where China is a global hegemon.” Administration officials would not, presumably, spell it out so baldly, but it’s a safe bet that many of them feel the same way.

Adam Tooze observes somewhere that historically socialists often favored strictly balanced budgets — because they expected, not without reason, that the main beneficiary of lax fiscal rules would be the military. The big question about industrial policy today is whether that logic still applies, or whether an expansion of the state’s role in the economic realm can be combined with a diminution of its capacity for war.

Climate Policy from a Keynesian Perspective

(This is the extended abstract for a piece I am writing for “The Great Turnaround,” a collection of essays on the economics of decarbonization from ZOE-Institute for Future-fit Economies and the Heinrich Böll Foundation.)

In the world in which we live, large-scale cooperation is largely organized through payments of money. Orthodox economics conflates these money flows, on the one hand with quantities of real social and physical things, and on the other hand with a quantity of wellbeing or happiness. One way of looking at Keynes’ work is as an attempt to escape this double conflation and see money as something distinct. Eighty years later, it can still be a challenge to imagine our collective productive activity except in terms of the quantities of money that organize it. But this effort of imagination is critical to address the challenges facing us, not least that of climate change.

The economic problems of climate change are often discussed, explicitly or implicitly, in terms of the orthodox real-exchange vision of the economy, in which problems are conceived of in terms of the allocation of scarce means among alternative ends.

In the real-exchange framework, decarbonization is a good which must be traded off against other goods. From this point of view, the central question is what is the appropriate tradeoff between current consumption and decarbonization. The problem is that since climate is an externality, this tradeoff cannot be reached by markets alone; the public sector must set the appropriate price via a carbon tax or equivalent. In general, more rapid decarbonization will be disproportionately more costly than slower decarbonization. A further problem is that since the climate externality is global, higher costs will be borne by the countries that move more aggressively toward decarbonization while others may free-ride.

This perspective does leave space for more direct public action to address climate change. Public investment, however, faces the same tradeoff between decarbonization and current living standards that price-mediated private action does. It is also limited by the state’s fiscal capacity. Governments have a finite capacity to generate money flows through taxation and bond-issuance (or equivalently to mobilize real resources) and use of this capacity for decarbonization will limit public spending in other areas.

The claims in the preceding two paragraphs may sound reasonable at first glance. But from a Keynesian standpoint, none are correct; they range from misleading to flatly false. In the Keynesian vision, the economy is imagined as aa system of monetary production rather than real exchange, with the binding constraints being not scarce resources, but demand and, more broadly, coordination. From this perspective, the problem of climate change looks very different. And these differences are not just about terminology or emphasis, but a fundamentally different view of where the real tradeoffs and obstacles to decarbonization lie.

In this paper, I will sketch out the central elements that distinguish a Keynesian vision of the economics of climate change. For this purpose, the Keynesian monetary-production framework can be seen as involving three fundamental premises.

1. Economic activity is coordination- and demand-constrained, not real resource-constrained.

2. Production is an active, transformative process, not just a combining of existing resources or factors.

3. Money is a distinct object, not just a representative of some material quantity; the interest rate is the price of liquidity, not of saving.

These premises have a number of implications for climate policy.

1. Decarbonization will be experienced as an economic boom. Decarbonization will require major changes in our patterns of production and consumption, which in turn will require substantial changes to our means of production and built environment. In capitalist economies, these changes are brought about by spending money. Renovating buildings, investing in new structures and equipment, building infrastructure, etc. add to demand. The decommissioning of existing means of production does not, however subtract from demand. Similarly, high expected returns in growing sectors can call forth very high investment there; investment can’t fall below zero in declining sectors. So even if aggregate profitability is unchanged, big shift in its distribution across industries will lead to higher investment.

2. There is no international coordination problem — the countries that move fastest on climate will reap direct benefits. While coordination problems are ubiquitous, the real-exchange paradigm creates one where none actually exists. If the benefits of climate change mitigation are global, but it requires a costly diversion of real resources away from other needs, it follows that countries that do not engage in decarbonization can free-ride on the efforts of those that do. The first premise is correct but the second is not. Countries that take an early lead in decarbonization will enjoy both stronger domestic demand and a lead in strategic industries. This is not to suggest that international agreements on climate policy are not desirable; but it is wrong and counterproductive to suggest that the case for decarbonization efforts at a national level is in any way contingent on first reaching such agreements.

3. There is no tradeoff between decarbonization and current living standards. Real economies always operate far from potential. Indeed, it is doubtful whether a level of potential output is even a meaningful concept. Decarbonization is not mainly a matter of diverting productive activity away from other needs, but mobilizing new production, with positive spillovers toward production for other purposes. The workers engaged in, say, expanding renewable energy capacity are not being taken away from equal-value activity in some other sector. They are, in the aggregate, un- or underemployed workers, whose capacities would otherwise be wasted; and the incomes they receive in their new activity will generate more output in demand-constrained consumption goods sectors.

4. Price based measures cannot be the main tools for decarbonization. There is a widely held view that the central tool for addressing climate should be an increase in the relative price of carbon-intensive commodities, through a carbon tax or equivalent. This make sense in a vision of the economy as essentially an allocation problem where existing resources need to be directed to their highest value use. But from a Keynesian perspective there are several reasons to think that prices are a weak tool for decarbonization, and the main policies need to be more direct. First, in a world of increasing returns, there will be multiple equilibria, so we can not think only in terms of adjustment at the margin. In the orthodox framework, increasing the share of, say, a renewable energy source will be associated with a higher marginal cost, requiring a higher tax or subsidy; but in an increasing-returns world, increasing share will be associated with lower marginal costs, so that while even a very large tax may not be enough to support an emerging technology once it is established no tax or subsidy may be needed at all. Second, production as a social process involves enormous coordination challenges, especially when it is a question of large, rapid changes. Third, fundamental uncertainty about the future creates risks which the private sector is often unwilling or unable to bear.

5. Central bank support for decarbonization must take the form active credit policy. As applied to central banks, carbon pricing suggests a policy to treat “green” assets more favorably and other assets less favorably. This is often framed as an extension of normal central bank policies toward financial risk, since the “dirty” asset suppose greater risks to their holders or systematically than the “green” ones. But there is no reason, in general, to think that the economic units that are at greatest risk from climate change are the same as the ones that are contributing to it. A deeper and more specifically Keynesian objection is that credit constraints do not bind uniformly across the economy. The central bank, and financial system in general, do not set a single economy wide “interest rate”, but allocate liquidity to specific borrowers on specific terms. Most investment, conversely, is not especially sensitive to interest rates; for larger firms, credit conditions are not normally a major factor in investment, while for smaller borrowers constraints on the amount borrowed are often more important. Effective use of monetary policy to support decarbonization or other social goals requires first identifying those sites in the economy where credit constraints bind and acting to directly to loosen or tighten them.

6. Sustained low interest rates will ease the climate transition. A central divide between Keynesian and orthodox macroeconomic theory is the view of the interest rate. Mainstream textbooks teach that the interest rate is the price of saving, balancing consumption today against consumption in the future — a tradeoff that would exist even in a nonmonetary economy. Keynes’ great insight was that the interest rate in a monetary economy has nothing to do with saving but is the price of liquidity, and is fundamentally under the control of the central bank. He looked forward to a day when this rate fall to zero, eliminating the income of the “functionless rentier”. As applied to climate policy, this view has several implications. First, market interest rates tell us nothing about any tradeoff between current living standards and action to protect the future climate. Second, there is no reason to think that interest rates must, should or will rise in the future; debt-financed climate investment need not be limited on that basis. Third, while investment in general is not very sensitive to interest rates, an environment of low rates does favor longer-term investment. Fourth, low interest rates are the most reliable way to reduce the debt burdens of the public (and private) sector, which is important to the extent that high debt ratios constrain current spending.

7. There is no link between the climate crisis and financial crisis. It is sometimes suggested that climate change and/or decarbonization could result in a financial crisis comparable to the worldwide financial crisis of 2007-2009. From a Keynesian perspective, this view is mistaken; there is no particular link between the real economic changes associated with climate change and climate policy, on the one hand, and the sudden fall in asset values and cascading defaults of a financial crisis, on the other. While climate change and decarbonization will certainly devalue certain assets — coastal property in low-lying cities; coal producers — they imply large gains for other assets. The history of capitalism offers many examples of rapid shifts in activity geographically or between sectors, with corresponding private gains and losses, without generalized financial crises. The notion that financial crises are in some sense a judgement on “unsound” or “unsustainable” real economic developments is an ideological myth we must reject. This is the converse of the error discussed under point 6 above, that measures to protect against the financial risks from climate change and decarbonization will also advance substantive policy goals.

8. There is no problem of getting private investors to finance decarbonization. Many proposals for climate investment include special measures to encourage participation by private finance; it is sometimes suggested that national governments or publicly-sponsored investment authorities should issue special green bonds or equity-like instruments to help “mobilize private capital” for decarbonization. Such proposals confuse the meaning of “capital” as concrete means of production with “capital” as a quantity of money. Mobilizing the first is a genuine challenge for which private businesses do offer critical resources and expertise not present in the public sector; but mobilizing these means paying for them, not raising money from them. On the financing side, on the other hand, the private sector offers nothing; in rich countries, at least, the public sector already borrows on more favorable terms than any private entity, and has a much greater capacity to bear risk. If public-sector borrowing costs are higher than desired, this can be directly addressed by the central bank; offering new assets for the private sector to hold does nothing to help with any public sector financing problem, especially given that such proposal invariably envision assets with higher yields than existing public debt.

These eight claims mostly argue that what are widely conceived as economic constraints or tradeoffs in climate policy are, from a Keynesian perspective, either not real or not very important. Approaches to the climate crisis that frame the problem as one of reallocating real resources from current consumption to climate needs, or of raising funds from the private sector, both suffer from the same conflation of money flows with real productive activity.

I will conclude by suggesting two other economic challenges for climate change that are in my opinion underemphasized.

First, I suggest that we face a political conflict involving climate and growth, this will come not because decarbonization requires accepting a lower level of growth, but because it will entail faster economic growth than existing institutions can handle. Today’s neoliberal macroeconomic model depends on limiting economic growth as a way of managing distributional conflicts. Rapid growth under decarbonization will be accompanied by disproportionate rise in wages and the power of workers. There are certainly reasons to see this as a desirable outcome, but it will inevitably create sharp conflicts and resistance from wealth owners that has to be planned for and managed. Complaints about current “labor shortages” should be a warning call on this front.

Second, rapid decarbonization will require considerably more centralized coordination than is usual in today’s advanced economies. If there is a fundamental conflict between capitalism and sustainability, I suggest, it is not because the drive for endless accumulation in money terms implies or requires an endless increase in material throughputs. Rather, it is because capitalism treats the collective processes of social production as the private property of individuals. (Even the language of “externalities” implicitly assumes that the normal case is one where production process involves no one but those linked by contractual money payments.) Treatment of our collective activity to transform the world as if it belonged exclusively to whoever holds the relevant property rights, is a fundamental obstacle to redirecting that activity in a rational way. Resistance on these grounds to a coordinated response to the climate crisis will be partly political and ideologically, but also concrete and organizational.

The Politics of Pay-Fors: A Simple Framework

One of the central economic debates among progressives is over the necessity or desirability of accompanying new public spending with similar-sized tax increases. In recent years perhaps the most visible, or at least the most heated, instances of this debate have been around Modern Mone(tar)y Theory. But the debate itself is broader and older.

These debates are in part about economic questions — both what the constraints on issuing new public-sector liabilities (“borrowing”) are in principle, and of how close we are to those constraints in practice. But a second and arguably more important dimension of the debate is political: In a public or legislative debate, what are the advantages and disadvantages of linking proposals for public spending with proposals for increased taxes?

I think it’s useful to think of this second question in terms of the grid of possibilities below. Some of this may seem obvious, but I find it’s sometimes helpful to spell out even obvious points.

On the horizontal axis we have spending relative to the baseline, from less to more. This axis also describes the political priority of the new spending — if there is to be only a small increase in spending, it will presumably go to items that are deemed highest value by the budget authorities, while greater overall spending allows for lower value items. Assuming that we think the priorities of the political process at least somewhat reflect social value, points at the far right can be thought of as socially useless or “waste”.

The vertical axis shows tax increases relative to the baseline, from less to more. Again, this also has a qualitative dimension. Modest tax increases can be targeted, for instance on higher incomes or on socially undesirable products or activities (Pigouvian taxes). But in order to raise large amounts of revenue, broad-based taxes are needed.¹ The upper left corner, then, represents the status quo; the diagonal line coming down from it represents proposals that are fully paid for, that leave the expected fiscal balanced unchanged. Points below the line represent shifts toward fiscal surpluses, while points above it represent shifts toward deficit. If you think that spending to some degree pays for itself through Keynesian and/or supply side effects, you can imagine the slope of the diagonal line being flatter.

Remember: This is just a conceptual diagram, useful for organizing the debate. It doesn’t imply any substantive claims about what particular forms of spending will be prioritized by the political process, or what particular taxes should be seen as desirable for their own sake. And “status quo” here just means the null, what will happen if nothing happens, which might or might not be a continuation of current spending and tax policies.

Since I want to focus on the political question here, let’s stipulate that the budget balance itself isn’t economically important. So we can assess our preferred spending and tax proposals independently. We will want whatever progressive and Pigouvian taxes are desirable for their own sake, indicated by the blue bar on the left of the figure. And we will want whatever level of spending is required to meet urgent social needs, indicated by the blue bar at the top of the figure. Both of these will be modified based on current macroeconomic conditions — unemployment calls for more spending and/or lower taxes, while sustained inflation calls for less spending and/or higher taxes. (That’s why they are ranges rathe than points.) Thus the social optimal mix of spending and taxes will fall in the region marked with blue dotted lines.²

The question is now, what is the effect of linking spending changes with revenue changes — of requiring that new spending be “paid for”?

In general, it is to shift the policy debate away from the upper right and toward the lower left. This is shown by the various red arrows in the the figure, all of which represent trajectories from budget deficit toward surplus. The different arrows reflect the extent to which the pay-for requirement is felt more strongly on the expenditure side (the flatter arrow) or the tax side (the steeper arrow), and what kinds of proposals you think are likely to be put forward in the absence of such a requirement.

Independently of where you think the socially optimal region is located, your judgement about the desirability of pay-for requirements will depend on what mix of spending cuts and revenue increases you think will result from it; what outcome you expect in its absence; and how you prioritize getting close to the optimum on the expenditure side versus on the revenue side. The argument of this post is that where people fall on paying for public spending depends more on these political judgments than on disagreements about economics.

Here are some cases, corresponding to the arrows in the picture:

Arrow a reflects a view that the main effect of pay-for requirements is to impose priorities on spending. In this view, the normal outcome of the legislative process when large spending increases are proposed is to increase them even further, with items of limited or negative social value. So the main effect of fiscal constraints, in this view, is to force the budget authorities to focus on higher-priority items.³ This is reflected in an arrow that moves mainly to the left out of the “waste” region, toward the social optimum. This, I think, captures the view of the Obama team in 2009 and of prominent Obamanauts still in public life.

Arrow b is even flatter, and starts further to the left. This reflects a similar judgement that the main effect of pay-for requirements is to limit spending, but also that the bias of the political system is toward too little spending and that tax increases are politically very difficult. In this view, the main effect of a pay-for requirement is to make it likely that socially valuable spending will not take place. This is the view of most people in the progressive macro space today, as far as I can tell. Here is a version of this argument from some of my colleagues at the Roosevelt Institute.

Arrow c is steeper, moving directly toward the balanced-budget line. This reflects a judgement that a pay-for requirement will result in a mix of spending cuts and tax increases. Unlike the first two lines, which clearly move toward and away from the social optimum, respectively, this one is ambiguous on that point. This arrow, I think, captures where a lot of people around the Biden administration are right now. There is a range of views about what kind of fiscal position is appropriate in current conditions, and no significant commitment to balanced budgets as such. But there is, or has been, a strong view that it’s not possible to pass further large deficit-financed spending increases through Congress, in which case it’s important to preemptively move the debate (in the terms of the diagram) towards the diagonal. There’s also a view — reflected in the position of the arrow — that even if a pay-for requirement means the loss of some useful spending, the revenue raisers it encourages may be socially desirable for their own sake.

Finally, arrow d is even steeper, and starts higher up. This reflects a judgement that the main effect of pay-for requirements is to create pressure for higher taxes, and that this is a good thing. In this view, the main effect of “Keynesian” deficit financing is to allow the rich to escape the burden of paying for public spending, spending which will take place one way or the other. This is a minority but not fringe position on the left. It’s especially pronounced among MMT critics who attribute the school’s prominence to the fact that rich people welcome an excuse not to be taxed.

Broadly then, we have views that pay-for requirements are: politically helpful, because they reduce wasteful spending; politically harmful, because they reduce valuable spending; an unfortunate necessity, because deficit increases are politically harder than raising revenue; and politically helpful, because they motivate taxes on the rich.

Again, all of this may seem a bit obvious. But I think it’s worth spelling out, because there’s some avoidable confusion that comes from treating as economic disagreements what are actually differing judgements about the contours of political possibility.

Between the two “left” positions (b and d), for example, you could put it this way: If we’re looking at a big expansion of public spending, what’s the effect of adding a requirement that it be paid for? Relative to the case without the requirement, it is more likely that we will get both the spending and a progressive tax increase. But it is also more likely that we won’t get the spending at all, or get less of it. How you trade these off against each other depends not just on your assessment of the relative likelihood, but also the relative importance you assign to the two goals. If you think that income inequality and the political power of the rich is the existential problem of our times, and progressive taxes are the only tool to rein it in, it’s not unreasonable to, in effect, hold public spending hostage in order to win them. If you think that other problems or more important, or there are other tools, you’ll feel differently.

My purpose here is not to say that any of these views is right or wrong. I’m just trying to clarify what’s being argued about.

That said, here is the news story that prompted me to finally sit down and write this post. It’s a Financial Times article with the eye-catching headline “‘A Humiliating Climbdown’”:

This week Richard Neal, a Massachusetts Democrat and the leading tax writer in the House of Representatives, released his plan for $2.9tn in tax increases to fund Biden’s $3.5tn package… Neal’s proposal includes an increase in the top individual income tax rate from 37 per cent to 39.6 per cent, yet shies away from more aggressively targeting taxes on capital gains, the source of a huge share of wealth for millionaires and billionaires.

… The changes to Biden’s tax plan proposed in the House highlight the extent of the backlash among Democratic donors, lobbyists and constituents who have balked at the president’s efforts to tax wealth — especially capital gains.

\The point is, in this case at least, the link to tax increases seems to be making House Dems less likely to vote for something that includes them, not more likely. And this is especially true for the progressive income and wealth taxes that are central to the progressive case for pay-fors.

Even more than to the intra-left debate I just mentioned, the article speaks to the pragmatic mainstream case for pay-fors. One sometimes hears people say, ok, you’re right, there isn’t any real economic argument for matching spending and revenue. With interest rates on public debt still well below anything seen in US history before 2020, it’s hard to argue with a straight face that financial markets limit the US government’s ability to borrow. But, they say, there are still political constraints — at some point Congress is not going to pass more spending financed with debt.

In the view in which pay-fors are politically helpful, the space of political possibility slopes downward from upper right to lower left. The less borrowing you ask people to vote for, the easier it is. By committing to fully paying for all new spending, you are more likely to end up with a package that can make it past all the various veto points. But things like the FT article suggests that this isn’t the case — that the gradient of political feasibility instead slopes from bottom to top. The less revenue you need, the easier.

In Arjun Jayadev’s and my piece on MMT and mainstream economics, we argued that differences between the two schools mostly “involve practical judgement about policy execution rather than any fundamental difference about how policy works in principle.” We continued:

We suspect that most in the mainstream macroeconomic policy world reject a functional finance rule not because they believe that it would not work if followed, but because they believe it would not in fact be followed. There is a widely shared though not always explicitly theorized presumption in mainstream policy discussions that macroeconomic policy in democratic polities suffers from a systematic bias toward deficits and inflation… Conversely, many MMT advocates believe that policymakers operating under a conventional assignment consistently err in the direction of accepting unemployment higher than required to maintain stable prices. … These judgements about the most likely direction of policy error are quite important for evaluating alternative policy rules, but they do not depend on any difference in strictly economic analysis.

That still seems right to me.

So which, then, seems more plausible? “Congress can’t pass something that will raise the deficit, so we need to find revenues to offset our spending,” versus “Congress hates raising taxes, so we need to be ready to accept higher deficits if we want higher spending.”

Or again, which seems more plausible? “In the absence of some kind of financial constraint — even an artificial or imaginary one — we’ll see a wave of wasteful or even socially harmful spending,” versus, “Even in the absence of financial constraints, any expansion of the public sector has to overcome all kinds of hurdles and resistance.”

I am arguing against my own interest as an economist here. But I suspect that clarifying what we believe — and why — on these kinds of questions would at this point advance the conversation around paying for public spending more than more narrowly economic analysis would.

A Few Followup Links

The previous post got quite a bit of attention — more, I think, than anything I’ve written on this blog in the dozen years I’ve been doing it.

I would like to do a followup post replying to some of the comments and criticisms, but I haven’t had time and realistically may not any time soon, or ever. In the meantime, though, here is some existing content that might be relevant to people who would like to see the arguments in that post drawn out more fully.

Here is a podcast interview I did with some folks from Current Affairs a month or so ago. The ostensible topic is Modern Mone(tar)y Theory, but the conversation gave me space to talk more broadly about how to think about macroeconomic questions.

A pair of Roosevelt reports (cowritten with Andrew Bossie) on economic policy during World War II are an effort to find relevant lessons for the present moment: The Public Role in Economic Transformation: Lessons from World War II, Public Spending as an Engine of Growth and Equality: Lessons from World War II

Here is a piece I wrote a couple years ago on Macroeconomic Lessons from the Past Decade. Bidenomics could be seen as a sort of deferred learning of the lessons from the Great Recession. So even though this was written before the pandemic and the election, there’s a lot of overlap here.

This report from Roosevelt, What Recovery? is an earlier stab at learning those lessons. I hope to be revisiting a lot of the topics here (and doing a better job with them, hopefully) in a new Roosevelt report that should be out in a couple of months.

If you like podcast interviews, here’s one I did with David Beckworth of Macro Musings following the What Recovery report, where we talked quite a bit about hysteresis and the limits of monetary policy, among other topics.

And here are some relevant previous past posts on this blog:

In The American Prospect: The Collapse of Austerity Economics

A Baker’s Dozen of Reasons Not to Worry about Government Debt

Good News on the Economy, Bad News on Economic Policy

A Demystifying Decade for Economics

A Harrodian Perspective on Secular Stagnation

Secular Stagnation, Progress in Economics