Paul Krugman’s talk on the failures of the economics profession during the financial crisis got me thinking a bit about the related, but, in my view, much less excusable, failures of policymakers during the financial crisis.
These proposals tended to be presented in sharp contrast to one another, and perhaps, on a theoretical level, they did represent a sharp contrast. But for policymakers, there was no either/or choice. Everyone agreed we needed deficit reduction later. Almost everyone agreed that America could benefit from infrastructure investment now. And, as we’ve seen, there was at least some agreement that a payroll tax cut could help the economy. These were great tastes that went great together.
The compromise was clean and obvious: Investments and tax cuts now, coupled with a much-larger deficit reduction package that would kick in once unemployment fell below, say, 7 percent.
No matter what theory of recovery you believed, this package would satisfy it. Stimulus? Check. Long-term investments in competitiveness? Check. Business confidence stemming from a certainty about the path of future budgets? Check. And then there’s the very real policy uncertainty it would have prevented, including the August debt-ceiling debacle, and the coming dual-trigger nightmare.
What doomed this package wasn’t a theoretical divide. I spoke with many freshwater economists who thought a package like this would be sensible. Rather, it was politics wot done it. Policymakers couldn’t agree on a package. The basic divide was that Democrats wouldn’t permit a major deficit-reduction plan that didn’t include taxes, and Republicans wouldn’t permit one that did. But it wasn’t just that. Republicans began arguing that payroll tax cuts -- which they had supported both in January of 2009 and in December of 2010 -- were ineffective and, unlike other tax cuts, needed to be paid for. Infrastructure, which could have been a point of bipartisan compromise, instead got wrapped into the GOP’s efforts to greenlight the Keystone XL pipeline.
The Obama administration, in my view, made some strategic errors during this period. They missed an opportunity on Simpson-Bowles, and they did too little to force the idea that deficit reduction and job creation could go together. In retrospect, I think Peter Orszag was right to argue that secondary stimulus proposals should include a long-term deficit reduction component. But while one can second-guess their tactical decisions, intransigence wasn’t among their major failures.
A simple model of negotiations over the last year could look like this. Imagine every policy proposal can be ranked on a scale from 1-10, with 1 being very liberal, 10 being very conservative, and 5 being perfectly in the middle. The Obama administration is liberal, but they also place a very high premium on getting something done. So they would have permitted a range of outcomes from 1 to 6.5, or perhaps 7. Congressional Republicans are very conservative, and they put a high premium, intentionally or not, on keeping the Obama administration from getting things done. So they retreated to a range of outcomes from 9-10 -- one example being the Ryan budget, which was far more conservative than anything the Republican Party had endorsed in the previous decade. And so compromise wasn’t possible.
This is all entirely explainable within a simple framework of political incentives. Congressional Republicans were right about the politics of compromise. It would have been worse for them if President Obama signed legislation combining deficit reduction and infrastructure investment while a bipartisan group of legislators cheered him on. It would have undermined the GOP’s arguments about the failure of the Obama presidency while restoring the president’s postpartisan brand.
Senate Minority Leader Mitch McConnell said as much to the Atlantic in January 2011. “We worked very hard to keep our fingerprints off of these proposals, because we thought — correctly, I think — that the only way the American people would know that a great debate was going on was if the measures were not bipartisan.”
What should worry us most about this quote is that McConnell was and is correct, and that the incentives he sees so clearly are true for any political minority in any extended economic crisis. I take this story less as a failure of Republicans than as a failure of the incentives of our political system, which is much more serious.
Nevertheless, the fact that these failures were explainable does not make them excusable. Krugman is right that the muddied message coming from the economics profession did not help. But the fact is that the muddied message nevertheless offered a fairly clear path to policymakers. It was a path that economists from both sides of the divide supported, and a path that was explicitly included in the deficit-reduction reports of the Simpson-Bowles commission and the Bipartisan Policy Center’s debt-reduction task force. It was a path that would have helped the economy recover more quickly and prevented potential crises down the road. And it was a path that was blocked primarily by partisanship, not a serious philosophical or intellectual disagreement.
As I see it, our system was tested in the initial months of the financial meltdown and it performed relatively well. But then it was tested again in the recession and it performed horribly, and it did so for structural reasons that are likely to repeat during future periods of extended crisis.