Dispelling Common Folktales of Government Spending, Taxation and Deficits How Modern Money Works by ALAN NASSER

http://www.alannasser.org/articles/howmodernmoneyworks.htm

The tasks facing colonizers were formidable. The colonized must be made into wage laborers, they must accept their wages in the colonizer’s currency and they must acquire what they want by spending that currency. Prior to colonization, the indigenes produced and distributed what came to be called “goods and services” by all sorts of customary means which may have required little or no buying and selling, virtually never required wage labor and never involved the use of the colonizer’s currency. European colonizers needed to replace native subsistence production and internal forms of exchange with modern money and the correlative capitalist practices and institutions. They accomplished this by imposing on the local population a tax obligation denominated in the colonizer’s currency. The effects of this single strategy were economically transformative.

The function of taxation is in this case apparent. It has nothing to do with financing government spending. The levying of a tax obligation effects the transformation of traditional economies into modern money economies by forcing colonized populations to need and use the colonizer’s currency in order to meet their tax liabilities. Taxation establishes the colonial government’s currency as the standard unit of exchange for all goods and services, making it the basis of the country’s monetary system. The establishment of a national monetary system requires not merely that citizens want money, but that they need money as well. There must be an arrangement that guarantees that citizens possess and use the one and only national currency. The same process created a growing population of wage laborers. The locals would get the newly required money by growing cash crops and/or by becoming wage laborers. That state currencies are tax-driven was understood by Adam Smith, John Stuart Mill and J.M. Keynes, among others.

April 13, 2011
CounterPunch and other venues
The Kind of Stimulus We Need
Putting People to Work
By ALAN NASSER

"Our greatest primary task is to put people to work."

-- Franklin Delano Roosevelt's 1933 inauguration address

No reasonable economist denies that the economy's problems are grave and that some kind of remedial stimulus is required. Stimuli are of two kinds, fiscal and monetary. Fiscal stimuli subdivide into two types, one aiming to boost aggregate demand, the other to stimulate effective demand. Both types require, in a sustained recession, large-scale government deficit spending, which is presently ridiculed in Washington and Wall Street and given no serious consideration. On the contrary, policy makers' priority is to give deficit reduction the highest priority. This leaves but one alternative, to stimulate hiring and spending by monetary means, which has meant purchases by the Federal Reserve of Treasury bonds, now termed Quantitive Easing (QE).

Ben Bernanke's second round of bond buying, QE2, has been a grand flop. Housing sales and prices are falling at an unhealthy clip, foreclosures and bankruptcies continue to mount and QE2 has had no measurable impact on the dismal employment picture. Nor should we expect it to. A study by the highly reliable Macroeconomic Advisors indicates that even an additional $1.5 trillion bond purchase by the Fed would reduce unemployment by a mere two tenths of one percent. (J. Hilsenrath, "Fed Fires $660 Billion Stimulus Shot", Wall Street Journal, November 4, 2010)

Progressives and all Leftists feel vindicated in their insistence that fiscal stimulus is the order of the day. Obama's February 2009 stimulus, it is argued, was on the right track. It saved the economy from a major collapse and created as many as 2 million jobs. But it was not enough to bring the economy to anything close to full employment or to reverse the housing decline and restore homeowners' equity.

The deficit doves conclude from this that a far bigger stimulus was required. The only problem with the administration's stimulus was its size. The notion that the principal Keynesian agenda is to stimulate aggregate demand is taken to be axiomatic. But it isn't.

Two Kinds of Fiscal Stimulus: Keynesian and Conventional/Neoliberal

The problem is not merely the size of the stimulus. The kind of stimulus adopted can make all the difference. Indeed, the kind of fiscal stimulus is what is at issue. This is overlooked by those who see that the impotence of monetary policy justifies the promotion of a fiscal alternative. But it's not enough to know that. For there are two kinds of fiscal stimulus corresponding to two possible policy goals. One has been demonstrated to work. The other has not fared so well.

Policy goals have to be precisely stated. Government might aim to close the "output gap", the difference between what the economy could be producing given existing resources, including of course the employable labor force, and what the economy is producing. This aim would require stimulating the production of total output. Government would take measures to stimulate the growth of Gross Domestic Product (GDP). But there is an alternative goal. Government might seek to close the employment gap, the different between the number of employable workers and the number of workers actually employed. The difference between these two aims of stimulus policy is not merely semantic.

Closing the output gap is a general and somewhat vague objective. It aims to stimulate "aggregate demand" or "growth". Closing the employment gap requires a specifically targeted stimulus, intended to stimulate not merely aggregate demand, but "effective demand". This was the kind of stimulus Keynes had in mind as his remedy for chronic unemployment. Aggregate demand stimulation is not authentically Keynesian. Keynes was explicit that the goal of macroeconomic stabilization policy is "a closer approximation of full employment as nearly as is practicable." (The General Theory, p. 378-379) He was unambiguous as to the principal effective means of accomplishing this goal: direct government job creation through public works projects.

The fiscal stimulus agenda of the Obama administration has been to stimulate aggregate demand. This is what some of the most prominent "Keynesian" economists urge. Paul Krugman writes that "we need policies to sustain aggregate demand." (New York Times Blog, January 19, 2011) And Joseph Stiglitz tells us that "the deficit increase has been caused by the enormous shortfall between the economy's potential and actual output." (Politico, March 28, 2011) Framing the problem this way reinforces the notion that the desireable goal is to increase the magnitude of the GDP. This policy has been ineffective in its stated purpose, to reduce unemployment. But the problem is not merely that the stimulus was not large enough.

The Achilles heel of aggregate demand policy is its implicit reliance on the market, and hence on a form of trickle-down theory. If the goal is merely to stimulate the production of GDP, government will provide incentives to companies to hire workers and to banks to provide credit. The former alternative consists of tax breaks and the latter of gifts of liquidity to the banks. We have seen that these policies do not work. The financial incentives do not trickle down to wage earners because employers will not hire and lenders will not lend to households with strikingly insufficient purchasing power. In a word, the problem is lack of effective demand.

The aggregate demand approach is what has passed as Keynesian policy since the end of the Second World War. Liberal champions of fiscal policy have sought to stabilize household incomes and consumption, and investment. There has been no direct effort to "stabilize", i.e. boost, employment. Jobs would be created, it was assumed, as a byproduct of stimulating household and business spending.

The Inadequacy of Conventional Market-Based Aggregate Demand Fiscal Policy

Is there any reason to believe that macroeconomic pump-priming has over the years significantly ameliorated capitalism's nagging unemployment problem? The key challenge here is to find a measure that gives a revealing picture of the situation of the unemployed over a three or four decade period. The recent record has been unarguably dismal. Obama's stimulus, The American Recovery and Reinvestment Act (ARRA) of early 2009, was touted as the launch of a strong jobs recovery. The Romer-Bernstein Report, released shortly after the ARRA legislation was passed, argued that without ARRA the unemployment rate would have peaked at 9 percent, and projected that with the stimulus unemployment would peak at no higher than 8 percent and would quickly fall through 2009 and into 2010. In fact, unemployment peaked at 10 percent after ARRA was passed and has hovered between 9 and 10 percent ever since.

To the extent that the unemployment rate has stabilized, i.e. not risen further, the predominant causal factor has been the great increase in discouraged workers who have given up looking for work. We are now witnessing the longest running decline in the labor force participation rate in postwar history. The employment-to-population ratio has not been as low as it is now -58 percent- since the Reagan-Volcker recession of the early 1980s.

Two current trends suggest a good measure of the long-term effectiveness of conventional fiscal policy. We are seeing both the mass destruction of full-time jobs, many of which will never return, and record levels of long-term unemployment (unemployed for 15 weeks or longer). Most revealing is that long-term unemployment has been rising since the late 1960s, and the short-term unemployed have been a shrinking percentage of all unemployed throughout the entire postwar period. Looking at the business cycle over the last forty years, a striking and ominous trend emerges: in each business-cyclical expansion, the long-term unemployment rate remains either at or above the level of the previous expansion. In a word, for the last forty years the short-term unemployed have been a declining, and the long-term unemployed an increasing, percentage of all unemployed. Is this what we should expect from successful conventional fiscal policy? (1)

The Virtues of Effective Demand Policy and Elite Resistance To It

If we want to close the employment gap, i.e. the labor demand gap, and not merely the output gap, the agenda should be to boost effective demand, not just overall output. This sharpens the policy objective. The unemployed are not evenly distributed across the country, and all cities and states are not distressed in the same way. This particular labor market is especially loose, that particular city is in especially dire straits. To be sure, desperation is evident across the board, but many of the illnesses and so the remedies are so to speak site-specific. Keynes recommended stimulus where it is needed. Jobs are needed for this specific infrastructure project, in this region, which requires workers with these skills and equipment of this kind.

If boosting effective demand is the explicit goal of fiscal policy, then work projects and the jobs they require must be provided directly by government. A resurrected Works Progress Administration is what will do the trick. It's a reasonable bet that attempts to stimulate the abstraction Aggregate Demand will do nothing for working people.

Aggregate demand policies work through the market; effective demand policies are initiated and implemented by government. Obama has repeatedly affirmed that any politically acceptable remedy for intractable joblessness must be market-based. His administration is commited to the view that "[While] government has a critical role in creating the conditions for economic growth, ultimately true economic recovery is only going to come from the private sector." In the same speech, he admonished those who push for a government jobs program "to face the fact that our resources are limited…It's not going to be possible for us to have a huge second stimulus, because frankly, we just don't have the money." (Speech at "jobs summit", December 3, 2009) The "critical role" that Obama assigns to government is of course giving tax breaks to companies and cash to banks.

The Obama administration has thus rejected effective demand management. Washington has pledged allegiance to its owners, the owning class. Logical arguments and steel-trap reasoning will not move the ruling class to adopt a policy whose first priority is to meet the specific needs of the working class. A genuinely Keynesian fiscal policy was embraced by FDR only after the mass actions of the 1930s. The labor actions of 1934 came close to a general strike. In that year San Francisco longshoremen called a West coast strike in defiance of their union leaders. 14,000 longshoremen and 25,000 maritime workers struck from Seattle to San Francisco. On the East coast textile workers coordinated a strike all along the coast. There were strikes by Auto-Lite workers in Toledo and Teamsters in Minneapolis. Sufficient fear of worker radicalization was struck in FDR to motivate the creation of Social Security and the large-scale public spending, employment-generating New Deal projects initiated less than a year after the labor upheavals, in 1935.

The key issue for the Left is clear: what are the present obstacles to mass mobilization, and how can they be overcome?

Notes.

1. For a detailed discussion of the various forms of fiscal policy, see Pavlina R. Tcherneva, "Fiscal Policy Effectiveness: Lessons From the Great Recession", Levy Economics Institute, January, 2011.

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Alan Nasser is Professor emeritus of Political Economy and Philosophy at The Evergreen State College. His book, The “New Normal”: Persistent Austerity, Declining Democracy and the Globalization of Resistance will be published by Pluto Press in 2013. If you would like to be notified when the book is released, please send a request tonassera@evergreen.edu

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