the Biden Administration is a terrain of struggle

At The International Economy: Low Interest Rates Were OK

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s roundtable was on concerns that ultra-low interest rates after the 2007-2009 financial crisis contributed to rising inequality and asset bubbles, and asked contributors to grade post-2007 monetary policy on a scale of A to F.)

Overall, I give the negative interest rate experiment a grade of B. The costs of negative rates have been greatly exaggerated. But so have the benefits. The main lesson is that conventional monetary policy is surprisingly weak in a depressed economy, even when carried to extremes. The next time we need stimulus, greater weight should be put on fiscal policy.

The case against ultra-low rates on distribution grounds is not very strong, in my view. Yes, low rates do tend to raise asset values, and it’s the rich who own most of the assets. But we should not make the mistake so many people do, and confuse a change in the present value of future income streams with a change in those streams themselves. Low rates, for example, imply a greater present value of the same future dividend payments, and thus higher stock prices. But that has no effect on income distribution — the owners of the stock are receiving the same payments as they were before.

The bigger criticism of ultra-low rates is that they didn’t have much effect one way or another. Did 20 years of zero nominal rates in Japan significantly boost demand and growth? It doesn’t seem like it.

At the same time, we should be careful of language like “distortion,” which suggests that there is some true, natural level of interest rates and investment. Whether high or low, interest rates are always set by policy. And this always involves tradeoffs between competing social goals.

Whether ultra-low rates contribute to bubbles is debatable. Many of the world’s great bubbles — from the 1920s in the US to the 1990s in Sweden — have occurred in environments of high interest rates. But let’s say for the sake of argument that cryptocurrency is socially useless, and that it would never have taken off if rates were higher. Is this a problem with negative rates? Or is it a problem with the financial system? The reason we have so many well-educated, well-compensated people working in finance is that they are supposed to direct credit to the best opportunities. If cheap money leads them to invest in projects that are worthless, or worse, rather than ones with moderate returns, they’re not doing their jobs.

If jet fuel were free, we would all probably fly more. But if planes kept crashing into the ocean, we’d blame the airlines, not the cheap fuel.

Speaking of airlines, it’s easy in retrospect to see the subsidized loans to them and other pandemic-hit industries as excessive. But we don’t know what the counterfactual is — it’s possible that without public support, they would have collapsed into bankruptcy, leading to a much slower recovery. Certainly we couldn’t be sure at the time. Under the extraordinary circumstances of the pandemic, there was no safe course, only a balance of risks. The high inflation of 2021-2022 was unfortunate; a prolonged depression would have been much worse. Perhaps next time — and climate change ensures that there will be a next time — we will strike a better balance. But it seems to me that under the circumstances, policymakers did pretty well.

That’s what I wrote for the symposium. Let me add a couple of things here.

First, this is not a new debate. Many of the same arguments were being made immediately after the global financial crisis, and even before it in the mid-2000s, in the context of the supposed global savings glut. At that time, the idea was that the volume of excess savings in Asia were too great to be absorbed by productive investment in the US and elsewhere, leading to downward pressure on interest rates and an excess of speculative investment, in housing especially.

It’s progress, I suppose, that the more recent period of low interest rates is attributed straightforwardly to central banks, as opposed to an imagined excess of “saving.” (For a critique of the savings-glut story, you can’t do better than Jörg Bibow’s excellent work.) But the more fundamental problem remains that the savings-glut/too-low-for-too-long stories never explain how they coexist with all the other economic stories in which more abundant financing is unambigously a good thing. As I wrote a dozen years ago¹:

the savings glut hypothesis fails to answer two central, related questions: Why was there a lack of productive investments available to be financed, and why did the financial system fail to channel the inflow of savings in a sustainable way? From a Keynesian perspective, there is nothing strange about the idea of a world where savings rates are chronically too high, so that output is demand-constrained; but this is not the perspective from which the savings-glut hypothesisers are arguing. In other contexts, they take it for granted that an increase in the savings rate will result in greater investment and faster growth.

In particular, as I pointed out there, many of the same people arguing for these stories also think that it is very desirable to reduce government budget deficits. But if you ask any economist what is the economic benefit of moving the government balance toward surplus, their answer will be that it frees up saving for the private sector; that is, lower interest rates.²

Second. Returning to the International Economy roundtable, it’s striking how many of the contributors shared my basic analysis³ — ultra-low rates didn’t achieve very much, but they were better than nothing given the failure of the budget authorities to undertake adequate stimulus. It’s interesting is that people with this same analysis — and who also reject the idea that the low rates of the 2010s are to blame for the inflation of the early 2020s — give such different responses on the grading component. I agree with everything that Jamie Galbraith writes, and especially appreciate his points that hardly any private borrowers ever faced zero (let alone negative) rates, and that higher rates do not seem to have done much to curb speculative excess. (Just look at “AI”.) I also agree with everything Heiner Flassbeck says (especially the underappreciated point that we’ve also had a decisive test of the benefits of wage flexibility, with negative results) and with almost everything Brigitte Granville says. Yet two of us give As and Bs, and two give Ds and Fs. It’s the difference between comparing monetary policy’s actual performance to what it reasonably could have accomplished, and to what it promised, perhaps.

Finally. It might seem strange to see me speaking so positively about macroeconomic policy over the past decade. Aren’t I supposed to be a radical of some sort?⁴ It was even a bit disconcerting to me to see I typed those words a few months ago (there’s a bit of turnaround time with these things), given that my main feelings about Western governments these days tend toward rage and disgust.

But the point here is important. It’s important to remember that the central macroeconomic problem in recent years has been insufficient demand.⁵ It’s important to remind people of the overwhelming evidence, and the quite broad consensus, that the economic problem over the past 15 years has not been a lack of real resources, but a lack of spending — of demand. (A world in which over-low interest rates could even be a concern, is not a world where the central economic problem is scarcity.) And I think that it’s true, and important, that the institutions — at least in the US and Western Europe — that were consistently trying to address this problem, were the central banks.

Even today, while we can certainly argue that central banks raised rates too aggressively, the main contractionary pressure is coming from elected governments. This is most obvious in Europe, but in the US, it seems to me, the withdrawal of pandemic unemployment benefits and the child tax credit have done more harm than anything the Fed has done. There’s an old idea that elected governments are structurally biased toward deficits and generous social benefits.⁶ But it’s clear this is no longer true, if it ever was.

Against this background, I think both the broader recognition of hysteresis and chronic demand shortfalls in the 2010s, and the aggressive response to the pandemic in this decade, are positive lessons that need to be preserved and defended and built upon. It’s very challenging to separate this positive record on domestic economic policy from the increasingly horrifying treatment of the rest of the world that we have seen from the same governments. (I make this argument in the context of industrial policy in a forthcoming piece in Dissent.) But I think it’s vitally important, both politically and analytically, that we continue to try to do so.

China’s Economic Growth Is Good, Actually

(I write a monthlyish opinion piece for Barron’s. This one was published there in June. My previous pieces are here.)

Once upon a time, the promise of globalization seemed clear. In an economically integrated world, poor countries could follow the same path of development that the rich countries had in the past, leading to an equalization of global living standards. For mid-20th century liberals, restoring trade meant bringing the New Deal’s egalitarian model of economic development to a global stage. As Nebraska Senator Kenneth Wherry memorably put it, “With God’s help, we will lift Shanghai up and up, ever up, until it is just like Kansas City.”⁷

For better and for worse, globalization has failed in its promise to deliver a planet of Kansas Cities. But Shanghai specifically is one place that it’s come through, and then some. As we debate the Biden administration’s new tariffs, let’s not lose sight of the fact that China’s industrialization is a very good thing for humanity. Indeed, it is the outstanding case of globalization’s promises being fulfilled.

For most of modern history, the gap between the global rich and global poor has only gotten wider. Though there are many tricky issues of measurement, most economic historians would agree with Branko Milanovic — perhaps the world’s foremost authority on the global distribution of income — that global inequality rose steadily for perhaps 200 years until 1980 or so. Since then, and particularly since 2000, there has been a sharp reversal of this trend; according to Milanovic, global income is probably more equally distributed today than at any time since the 19th century.

The reason for this remarkable turn toward equality? China.

According to Milanovic, the rise of China was almost singlehandedly responsible for the reduction in global inequality over the past 30 years. Thanks to its meteoric growth, the gap between the world’s rich and poor has closed substantially for the first time since the beginning of the Industrial Revolution.

Almost all the fall in global inequality in recent decades is attributable to China. Source.

Convergence to rich-country living standards is extremely rare historically. Prior to China, the only major examples in modern times were Taiwan and South Korea. Much more typical are countries like the Philippines or Brazil. Sixty years ago, according to the World Bank, their per-capita incomes were 6 and 14 percent that of the USA, respectively. Today, they are … 6 and 14 percent of the USA. There were ups and downs along the way, but overall no convergence at all. Other poor countries have actually lost ground.

Or as Paul Johnson summarizes the empirical growth literature: “Poor countries, unless something changes, are destined to remain poor.”

China is not just an outlier for how rapidly it has grown, but for how widely the benefits of growth have been shared. One recent study of Chinese income distribution over 1988-2018 found that while growth was fastest for the top, even the bottom 5 percent of wage earners saw real income grow by almost 5 percent annually. This is faster than any group in the US over that period. Milanovic comes to an even stronger conclusion: The bottom half of the Chinese income distribution saw faster growth than those at the top.

Even studies that find rising inequality in China, find that even the lowest income groups there had faster income growth than any group in the US.

Thomas Piketty finds a similar pattern. “The key difference between China and the United States,” he writes, “is that in China the bottom 50 percent also benefited enormously from growth: the average income of the bottom 50 percent [increased] by more than five times in real terms between 1978 and 2015… In contrast, bottom 50 percent income growth in the US has been negative.”⁸

It’s clear, too, that Chinese growth has translated into rising living standards in more tangible ways. In 1970, Chinese life expectancy was lower than Brazil or the Philippines; today it is almost ten years longer. As the sociologist Wang Feng observes in his new book China’s Age of Abundance, Chinese children entering school in 2002 were 5-6 centimeters taller than they had been just a decade earlier – testimony to vast improvements in diet and living conditions. These improvements were greatest in poor rural areas.

How has China delivered on the promises of globalization, where so many other countries have failed? One possible answer is that it has simply followed the path blazed by earlier industrializers, starting with the United States. Alexander Hamilton’s Report on Manufacturers laid out the playbook: protection for infant industries, public investment in infrastructure, adoption of foreign technology, cheap but strategically directed credit. The Hamiltonian formula was largely forgotten in the United States once it had done its work, but it was picked up in turn by Germany, Japan, Korea and now by China. As the Korean development economist Ha-Joon Chang puts it, insistence that developing countries immediately embrace free trade and financial openness amounts to “kicking away the ladder” that the rich countries previously climbed.

Today, of course, the US is rediscovering these old ideas about industrial policy. There’s nothing wrong with that. But there is something odd and unseemly about describing the same policies as devious manipulation when China uses them.

When John Podesta announced the formation of the administration’s White House Climate and Trade Task Force last month, he tried to draw a sharp line between industrial policy in the United States and industrial policy in China. We use “transparent, well-structured, targeted incentives,” he said, while they have “non-market policies … that have distorted the market.” Unlike us, they are trying to “dominate the global market,” and “creating an oversupply of green energy products.” Yet at the same time, the administration boasts that the incentives in the Inflation Reduction Act will double the growth of clean energy investment so that “US manufacturers can lead the global market in clean energy.”

No doubt if you squint hard enough, you can make out a distinction between changing market outcomes and distorting them, or between leading the global market and dominating it. But it certainly seems like the difference is when we do it versus when they do.

The claim that China is creating a global “overcapacity” in green energy markets — often trotted out by tariff supporters — is particularly puzzling. Obviously, to the extent that there is global overcapacity in these markets, US investment contributes exactly as much as Chinese does — that is what the word “global” means.

More importantly, as many critics have pointed out, the world needs vastly more investment in all kinds of green technologies. It’s hard to imagine any context outside of the US-China trade war where Biden supporters would argue that the world is building too many solar panels and wind turbines, or converting too quickly to electric vehicles.

Not so long ago, the dominant view on the economics of climate change was that the problem was the “free rider” dynamic — the whole world benefits from reduced emissions, while the costs are borne only by the countries that reduce them. In the absence of a global government that can impose decarbonization on the whole world, the pursuit of national advantage through green investment may be the only way the free rider problem gets solved.

As development economist Dani Rodrik puts it: “Green industrial policies are doubly beneficial – both to stimulate the necessary technological learning and to substitute for carbon pricing. Western commentators who trot out scare words like ‘excess capacity,’ ‘subsidy wars,’ and ‘China trade shock 2.0’ have gotten things exactly backwards. A glut in renewables and green products is precisely what the climate doctor ordered.”⁹

The Biden administration is not wrong to want to support US manufacturers. The best answer to subsidies for green industries in China is subsidies for green industries in the US (and in Europe and elsewhere). In a world that is desperately struggling to head off catastrophic climate change, a subsidy race could harness international rivalry as a part of the solution. But that requires that competition be channeled in a positive-sum way.

Unfortunately, the Biden Administration seems to be choosing the path of confrontation instead. In the 1980s, the Reagan administration dealt with the wave of imported cars that threatened US automakers through a voluntary agreement with Japan to moderately reduce auto exports to the US, while encouraging investment here by Japanese automakers. Unlike the pragmatists around Reagan, the Biden team seems more inclined to belligerence. There’s no sign they even tried to negotiate an agreement, instead choosing unilateral action and framing China as an enemy rather than a potential partner.

Tellingly, National Security Advisor Jake Sullivan is described (in Alexander Ward’s new book The Internationalists) as arguing that the US can make serious climate deals with other countries while “boxing China out,” a view that seems to have won out over the more conciliatory position of advisors like John Kerry. If Sullivan’s position is being described accurately, it’s hard to exaggerate how unrealistic and irresponsible it is. The US and China are by far the world’s two largest economies, not to mention its preeminent military powers. If their governments cannot find a way to cooperate, there is no hope of a serious solution to climate change, or to other urgent global problems.

To be clear, there’s nothing wrong with an American administration putting the needs of the United States first. And if it’s a mistake to treat China as an enemy, it would also be wrong to set them up as an ideal. One could make a long list of ways in which the current government of China falls short of liberal and democratic ideals. Still, it’s clear that China is being punished for its economic success rather than its political failures. Tellingly, the same month that the tariffs on China were announced, the Biden administration indicated that it would resume sales of offensive weapons to Saudi Arabia, whose government has nothing to learn from China about political repression or violence against dissidents.

The policy issues around tariffs are complicated. But let’s not lose sight of the big picture. The fundamental premises of globalization remain compelling today, even if attempts to realize them have often failed. First, no country is an island – today, especially, our most urgent problems can only be solved with cooperation across borders. Second, economic growth is not a zero sum game – there is not some fixed quantity of resources, or markets, available, so that one country’s gain must be another’s loss. And third, democracy spreads best via example and the free movement of ideas and people, not through conquest or coercion. We don’t have to endorse the whole classical case for free trade to agree that its proponents were right in some important ways.

China’s growth has been the clearest case yet of globalization’s promise that international trade can speed the convergence of poor countries with rich ones. The opportunity is still there for its broader promises to be fulfilled as well. But for that to happen, we in the United States must first accept that if the rest of the world catches up with us, that is something to be welcomed rather than feared.

At Barron’s: With the Debt Ceiling Deal, the Administration Takes a Step Backward

(I write a monthly-ish opinion piece for Barron’s. This is my most recent one. You can find earlier ones here.)

Since the onset of the pandemic, policy makers in the U.S. and elsewhere have embraced a more active role for government in the economy. The extraordinary scale and success of pandemic relief, the administration’s embrace of the expansive Build Back Better program, and the revived industrial policy of the Inflation Reduction Act and the Chips and Science Act all stand in sharp contrast with the limited-government orthodoxy of the past generation.

The debt ceiling deal announced this weekend looks like a step back from this new path – albeit a smaller one than many had feared. Supporters of industrial policy and more robust social insurance have reason to be disappointed – especially since the administration, arguably, had more room for maneuver than it was willing to use.

To be fair, the agreement in part merely anticipates the likely outcome of budget negotiations. Regardless of the debt ceiling, the administration was always going to have to compromise with the House leadership to pass a budget. The difference is that in a normal negotiation, most government spending continues as usual until a deal is reached. Raising the stakes of failure to reach a deal shifts the balance in favor of the side more willing to court disaster. Allowing budget negotiations to get wrapped up with the debt ceiling may have forced the administration to give up more ground than it otherwise would.

The Biden team’s major nonbudget concession was to accept additional work requirements for some federal benefits. The primary effect of work requirements, with their often onerous administrative burdens, will be to push people off these programs. This might be welcome, if you would prefer that they not exist in their current form at all. But it’s a surprising concession from an administration that, not long ago, was pushing in the other direction.

In a bigger sense this change directly repudiates one of the main social-policy lessons of recent years. Pandemic income-support programs were an extraordinary demonstration of the value of simple, universal social insurance programs, compared with narrowly targeted ones. The expiration of pandemic unemployment benefits gave us the cleanest test we are ever likely to see of the effect of social insurance and employment. States that ended pandemic benefits early did not see any faster job growth than ones that kept it longer – despite the fact that these programs gave their recipients far stronger incentives against work than those targeted in the budget deal.

These compromises are all the more disappointing since there were routes around the debt ceiling that the administration, for whatever reason, chose not to explore. The platinum coin got a healthy share of attention. But there were plenty of others.

The Treasury Department, for example, could have looked into selling debt at a premium. The debt ceiling binds the face value, or principal, of federal debt. There is no reason that this has to be equal to the amount the debt sells for – this is simply how auctions are currently structured. For much of U.S. history, government debt was sold at a discount or premium to its face value. Fixing an above-market interest rate and selling debt at more than face value would allow more funds to be raised without exceeding the debt ceiling.

The administration might also have asked the Federal Reserve to prepay future remittances. In most years, the Fed makes a profit, which it remits to the Treasury. But it can also report a loss, as it has since September. When that happens, the Fed simply creates new reserves to make up the shortfall, offsetting these with a “deferred asset” representing future remittances. (Currently, the Fed is carrying a deferred asset of $62 billion.) The same device could be used to finance public spending without issuing debt. In a report a decade ago, Fed staff suggested that deferred assets could be used in this way to give the Treasury department “more breathing room under the debt ceiling.” (To be clear, they were not saying that this was a good idea, just noting the possibility.)

Another route around the debt ceiling might come from the fact that about one-fifth of the federal debt – some $6 trillion – is held by federal trust funds like Social Security, rather than by the public. (Another $5 trillion is held by the Federal Reserve.) This debt has no economic function. It is a bookkeeping device reflecting the fact that trust fund contributions to date have been higher than payments. Retiring these bonds, or replacing them with other instruments that wouldn’t count against the ceiling, would have no effect on either the government’s commitment to pay scheduled benefits or its ability to do so. But it would reduce the notional value of debt outstanding.

None of these options would be costless, risk-free, or even guaranteed to work. But there is little evidence they were seriously considered. This is a bit disheartening for supporters of the administration’s program. It’s hard to understand why you would go into negotiations with one hand tied behind your backs, and not have a plan B in case negotiations break down.

Tellingly, the one alternative the Biden team did consider was invoking the 14th Amendment to justify issuing new debt in defiance of the ceiling. The amendment refers specifically to the federal government’s debt obligations. But of course, hitting the debt ceiling would not only endanger the government’s debt service. It would threaten all kinds of payments that are legally mandated and economically vital. The openness to the 14th Amendment route, consistent with other public statements, suggests that decision-makers in the administration saw the overriding goal as protecting the financial system from the consequences of a debt default – as opposed to protecting the whole range of public payments.

What looks like a myopic focus on the dangers to banks recalls one of the worst failures of the Obama administration.

In the wake of the collapse of the housing market, Congress in 2009 authorized $46 billion in assistance for homeowners facing foreclosure through the Home Affordable Modification Program. But the Obama administration spent just a small fraction of this money (less than 3%) in the program’s first two years, helping only a small fraction of the number of homeowners originally promised.

The failure to help homeowners was not due to callousness or incompetence. Rather, it was due to the overriding priority put on the stability of the banking system. As Obama’s Treasury Secretary Timothy Geithner later explained, they saw the primary purpose of HAMP not as assisting homeowners, but as a way to “foam the runway” for a financial system facing ongoing mortgage losses.

Geithner and company weren’t wrong to see shoring up the banks as important. The problem was that this was allowed to take absolute priority over all other goals — with the result that millions of families lost their homes, an important factor in the slow growth of much of the 2010s.

One wouldn’t want to push this analogy too far. The debt ceiling deal is not nearly as consequential – or as clear a reflection of administration priorities – as the abandonment of underwater homeowners was. But it does suggest similar blinders: too much attention to the danger of financial crisis on one side, not enough to equally grave threats from other directions.

It’s clear that Treasury Secretary Janet Yellen and the rest of the Biden administration are very attuned to the dangers of a default. But have they given enough thought to the other dangers of failing to reach a debt-ceiling deal — or of reaching a bad one? Financial crises are not the only crises. There are many ways that an economy can break down.