Response to Avishai: Round III Print
Dean Baker
TPMCafé, October 30, 2010

See article on original website

Bernard Avishai covers a great deal of ground in his last response. Fortunately it can be boiled down to two simple misunderstandings:

  1. a government debt built up in a period of high unemployment does not create a burden for the economy or future taxpayers; and

  2. globalization makes us richer, not poorer.

The first point about budget deficits is extremely important in current debates, so I'm glad that Avishai has given me an opportunity to explain it.

In an economy that is operating well below full employment, like the U.S. economy at present, there is no reason that the Federal Reserve Board cannot simply buy and hold the bonds used to finance a government deficit. If the Fed holds the debt this means that the interest is paid from the Treasury to the Fed. The Fed in turn refunds the money to the Treasury at the end of the year. In this way the debt creates no burden on the economy or future taxpayers - the interest is simply paid to ourselves.

In ordinary times this would be a risky policy since it would likely to lead to inflation, but at present our bigger concern is deflation, or at least an inflation rate that is too low. Therefore, any inflation that might result from the Fed's holding of debt is actually beneficial to the economy. (This is the part of the rationale for the Fed's QE2.)

Japan has followed this path quite aggressively with its central bank holding an amount of debt that is more than its GDP ($15 trillion in the case of the U.S.). While the IMF projects that Japan will have a gross debt of 227 percent of GDP at the end of this year, its debt net of the holdings of the central bank and other governmental entities is a considerably lower 122 percent of GDP. Japan's economy may not be the model that we want to follow, but this massive purchase of debt by the central bank clearly did not cause a problem of inflation, as prices continue to fall in Japan.

The lesson here is that running up debt in a time of severe recession such as the present need not create a burden on the economy, now or in the future. We are simply putting to use resources that would otherwise be idle, not pulling resources away from the private sector. And of course insofar as we improve our infrastructure, increase the energy efficiency of our economy, improve the skills and education of our workforce, then we will be richer in the future as a direct result of deficit spending.

On the second point, Avishai seems to feel that the United States is more disadvantaged going forward because we have wealthy trading partners, as compared to the post-World War II era, when the United States was the undisputed leader of the world economy. This view is 180 degrees at odds with standard trade theory. The fact that we can get many good and services more cheaply from abroad than we can produce them at home makes the United States richer, not poorer. In many ways it is comparable to finding processes that allow us to produce goods or services more efficiently here. As a result of trade, for the same amount of our labor, we are now able to buy more goods and services.

The way we have selectively opened the economy for trade has hurt many workers. While it is very easy for Wal-Mart to buy clothes and toys from the lowest-cost producers in the world or for GM to buy steel from the lowest-cost producers, it is very difficult for universities to bring in the lowest-cost qualified professors in the world or hospitals to bring in the lowest-cost qualified doctors in the world. [Note the word "difficult" does not mean impossible - save the electrons required to tell me that your doctor is from India - if we had free trade in professional services, everyone's doctor would be from India.]

Our trade and immigration laws have been deliberately designed to protect people in the highly paid professions from international competition while quite explicitly putting less-educated workers in direct competition with the lowest-paid workers in the developing world. This is why the wages of more educated workers are much more out of line with workers elsewhere in the world.

Going forward, the country can accrue enormous gains by exposing these highly paid workers to the same sort of international competition that less-educated workers already face. This will hugely lower the price of medical care, legal services, and the other goods and services produced by these workers. We can take advantage of the vast pool of low-paid highly educated workers elsewhere in the world precisely because countries like India and China are developing rapidly. That is why globalization makes us richer, not poorer.

Of course the immediate reason that we suddenly find ourselves with 9.6 percent unemployment has nothing to do with skills and globalization. It has to do with the fact that the bozos running the economy were too incompetent to recognize the $8 trillion housing bubble that wrecked it. The necessary skills for an economy do not change that quickly. These people were working three years ago; if we had enough demand in the economy there is no reason to believe that the vast majority of them would not also be working this year.

It may be comforting to the folks responsible for this astounding act of economic mismanagement to blame workers for lacking skills, but there is zero evidence to support this line of argument. It would be great to upgrade the education and skills of our workers and that should be a top priority. But the reason that so many workers don't have jobs today is not due to their own lack of skills, but rather to the lack of skills of the people making economic policy.