Don’t Let the Last Crisis Go to Waste

Democrats need a concrete plan for the next financial crisis; one that keeps in mind past mistakes and does not cow-tow to deficit hawks.

By Stuart Whatley

Tagged DemocratsEconomicsFinancial crisisInequalityRepublicansTrump Administration

Now that Democrats have reclaimed the U.S. House of Representatives, the jostling over policy and political priorities has begun. Obviously, oversight investigations into Trump Administration corruption are long overdue, as are measures to protect the integrity of the U.S. electoral system from threats foreign and domestic. But beyond these immediate imperatives, Democrats will also need to start preparing for the next economic downturn.

When that comes, it will occasion a larger debate about many of the fundamental values underpinning the twenty-first-century American political economy. After the last financial crisis, politics, not economics, ultimately determined the size and shape of the government’s response—a response that many now consider to have been inadequate given the depth of the recession. Rather than continuing to push for pro-growth structural reforms in the years after the crash, many Democrats allowed Republican demands for deficit reduction to push them rightward (remember “Simpson-Bowles”?).

If the Democrats do not land their arguments and pursue them next time around, then America’s continued descent into deeper inequality, deteriorating social conditions, and minority rule will be all but assured. For their part, Republicans already have a plan: slash earned benefits such as Social Security and Medicare, to say nothing of programs to alleviate poverty or offer education as a public good. That, after all, was the ancillary goal of last year’s tax cuts, which are projected to add an additional $1.9 trillion to the national debt. Having further undermined the U.S. government’s fiscal position, Republicans are eagerly waiting for a chance to “starve the beast” with renewed austerity in the event of a downturn.

There is no good reason to think they will be waiting long. Despite positive macroeconomic indicators such as low unemployment, manageable inflation, and strong GDP growth, many economists have begun to warn that the current expansion is not sustainable in light of tightening monetary conditions. Whenever the crash comes, it will be up to Democrats to make the case for countercyclical stimulus that is specifically directed at mitigating the damage for Main Street, laying the groundwork for sustainable growth in the real economy, and making it known that this stands in stark contrast to Republican plans.

The Democrats are not in position to enact policy, which means that their task—at least until January 2021, perhaps longer—will be to win the battle of ideas. As a starting point, they will have to set the record straight about the past decade. The Republicans’ line is that the Obama Administration bears responsibility for the historically weak recovery that followed the 2008 global financial crisis. In reality, the “Obama stagnation” was really the “McConnell/Boehner stagnation,” owing to the direct role that congressional Republicans played in smothering the post-crisis expansion in its crib.

A common critique of the Obama Administration’s response to the financial crisis is that it saved Wall Street but not Main Street. After all, out of the $700 billion allotted for bank bailouts under the 2008 Troubled Asset Relief Program—a law signed by George W. Bush but largely implemented by the Obama Administration—an infinitesimal fraction went toward rescuing underwater homeowners. Yet Obama’s stimulus program, the 2009 American Recovery and Reinvestment Act, did provide billions of dollars for unemployment insurance and nutrition assistance, created/saved an estimated 3.4 million jobs in its first two years, and lifted GDP by 2-3 percent between February 2009 and mid-2011.

More to the point, the Obama Administration’s initial stimulus and bailout policies were designed with the assumption that more far-reaching measures would follow. So what happened to Obama’s proposals for an American Jobs Act and a National Infrastructure Reinvestment Bank? They suffered death by threatened filibuster in 2010-2011 at the hands of Senate Republicans under the leadership of then-Minority Leader Mitch McConnell.

Around the same time, Republicans in the House under then-Speaker John Boehner, driven by the new Tea Party faction, threatened to block a routine lifting of the federal debt ceiling if the Obama Administration did not agree to deep spending cuts. So as not to risk a sovereign default, another recession, and significantly higher borrowing costs for years or even decades to come, the Administration folded, and the Budget Control Act (BCA) was signed into law in August 2011.

Thus began the era of Republican-imposed austerity, a multi-year process of fiscal tightening that would constrain aggregate demand and ensure the continuation of tepid growth throughout Obama’s second term. In 2013, the BCA’s “budget sequestration” provisions went into force, leading the nonpartisan Congressional Budget Office to conclude that GDP growth would be about 0.6 percentage points slower than it otherwise would have been that year. Worse still, in the absence of austerity, around 750,000 more full-time jobs would have been created or saved in 2013 alone.

After years of austerity in the United States and other advanced economies, even the International Monetary Fund has concluded that fiscal tightening is inappropriate for a country that is falling short of its potential output, but not at risk of defaulting on its debts—that is, a country exactly like the United States. In a June 2016 report, three IMF economists point out that, “Austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand—and thus worsen employment and unemployment.” And this, in turn, translates into higher inequality, which undermines “both the level and the durability of growth.”

One perversity of the current political moment is that after tapping into the discontent of the McConnell/Boehner stagnation during the 2016 election campaign, Trump and congressional Republicans have since doubled down on fiscal stimulus in the form of increased spending and tax cuts, mostly for the rich, and achieved stronger growth. Their policies “may be ill-conceived,” Joseph Stiglitz recently observed, “but they show that with enough fiscal support, full employment can be attained, even as interest rates rise well above zero.”

Yet, unlike the Obama-era programs that Republicans blocked, today’s expansionary policy mix is not geared toward boosting productivity or long-term growth through funding for education, infrastructure, basic research, and so forth. The Trump tax package, according to the National Association for Business Economics, “has not broadly impacted hiring and investment plans.” And, meanwhile, Republican efforts to undermine the 2010 Affordable Care Act have left millions more people at risk of long-term or permanent unemployment due to catastrophic health events. Federal funding for education has been slashed. The country’s infrastructure remains in shambles. And nothing has been done to confront the specter of market consolidation, let alone the emerging problem of monopsony in labor markets and the broader accrual of total income away from labor.

All of this suggests that when the next recession comes, the U.S. economy’s growth capacity will have been more or less hollowed out. Not only that, the space for monetary-policy stimulus will be severely limited, given that the Federal Reserve’s benchmark interest rate is still at 2-2.25 percent (it was 5 percent in the fall of 2007). That means fiscal stimulus will be all the more important for making up lost demand. But in arguing the case for large-scale government spending in the event of a downturn, Democrats will have to give voice to the lessons of the last decade.

One lesson is that the size of the stimulus matters. Many economists now agree that the 2009 Recovery Act should have been bigger. Moreover, recent research by economists at the University of California, Berkeley, casts doubt on the notion that a country like ours might not have enough “fiscal space” to respond to a downturn with a sufficiently large stimulus. “Expansionary government spending shocks,” they conclude, “have not been followed by persistent increases in debt-to-GDP ratios or borrowing costs,” because well-constructed fiscal stimulus in a weak economy tends to pay for itself.

This points to a second lesson: The design of the stimulus matters, too. The Wall Street bailout and years of quantitative easing by the Fed have resulted in even greater income and wealth inequalities than in the era proceeding the crash. Come the next downturn, Democrats will need to marshal arguments on behalf of those most harmed, and disassociate themselves with moneyed interests. That might entail bailing out student-loan debtors and homeowners, introducing a federal jobs guarantee and infrastructure-oriented public works programs, or pursuing various other options. Either way, the focus would have to be on immediate relief for distressed households, and on public investments that actually contribute to long-run productivity growth.

A final lesson is to remember that the debate won’t really be about economics. Long-term fiscal deficits are not harmless or in any way desirable; but, as the IMF now believes, it is better for a country like the United States to grow out of debt “organically” than to force it through fiscal cuts at the expense of aggregate demand. Likewise, we now have three decades worth of evidence to show that tax cuts for the wealthy do not “trickle down.” In the case of last year’s corporate tax cuts, most of the money went toward share buybacks to line the pockets of the wealthy few who actually own stocks. Had it instead gone to low-income workers, it would have been far more effective and sustainable in stimulating the real economy.

The case to be made, then, is political. Crises are occasions for ideological reckoning. After the Great Depression, the New Dealers enacted a new social contract in America, whereas free-marketeers seized on the crisis of post-war Keynesianism in the 1970s to usher in a half-century of neoliberalism. The 2008 crisis was different in that it did not give rise to a new vision of political economy.

Still, this is not to say that it was unique. Often in history, Antonio Gramsci once observed, “The death of the old ideologies manifests itself as skepticism toward all theories and general formulas,” paving the way for a politics that is “cynical in its immediate manifestation.”

Cynicism has prevailed for a decade now. The task for Democrats is to articulate a new philosophy to replace it. In doing so, they should trust that the economics is on their side, and focus on the moral dimension. Republicans will say that earned benefits and social programs should be cut for the sake of future generations. They will say that debt relief introduces an unacceptable moral hazard. And they will depict the state as an engine of corruption and oppression.

What will the Democrats say?

Read more about DemocratsEconomicsFinancial crisisInequalityRepublicansTrump Administration

Stuart Whatley is Senior Editor at Project Syndicate. You can follow him on Twitter @StuartWhatley.

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