A Better Budget Process

If I were to design the budget of a country I would do it completely differently from how any country in the world does it. I would throw out the opinion polls (which can easily be manipulated) and close the doors to lobbyists and interest groups for the drafting process, in order to prevent corrupting the entire system. A group of economists would then be tasked with estimating the multiplier effects of every government program and modeling how the multipliers decline following the law of diminishing marginal utility as you get more of a good, the amount of added benefit declines. This is how we determine whether the government should spend $1 million or $1 trillion on education, whether we should give a universal basic income of $0, $1000, or $5000 per capita to maximize the well being of our country.

The computer model would then list the multipliers of every government program. This is different based on different government programs, food stamps have a multiplier of 179% while the military has a multiplier of around 50%, every type of spending has this metric which is one way we should guide how we design our budgets. We would start off with estimates of how much the multiplier is for every dollar and then claculate the budget increasing spending until the marginal benefit of the last dollar spent is equal to the marginal cost of the different types of taxes and government borrowing to finance the government spending. The computer would keep increasing spending in one program until the multiplier is equal to the expenditure of the next valuable program and keep increasing spending until the marginal benefit of government spending is equal to the marginal cost of taxes and borrowing. This will help money move to more productive uses and grow our economy as much as possible. Every year we would get a better understanding of how different forms of government spending and taxes behave in the real world and adjust spending accordingly. During a recession we would likely continue to practice counter cyclical fiscal policy to make our economy run smoothly.

Another guiding principle to government spending will also be to reduce risk for the economy as whole so that the decisions people make will take in externalities as much as possible. We will almost certainly have a carbon tax with such a plan, as well as a rule of no bailouts under any circumstance with this guiding principle of people seeing the consequences of their actions.

After the model budget is proposed it would then go to a vote in Congress and be available for public comment, but such a budget would be better for the economy as a whole, and if we have a good Congress working for the benefit of the country would hopefully vote for such a budget. Some programs for public safety might be implemented on top of the budget if they are not covered by the number crunching computer, it is hard to tell without building the model. It is likely the media would manipulate public opinion against such a plan, meaning the enacted budget would probably be worse than our optimum budget. At the end of the day however, it is better to start with the best plan possible to get our most optimal final result.

4 things that mystify me about laissez-faire economists

I was watching a few videos on youtube, which had Paul Krugman in "debates" with people who oppose Keynesianism. The first video is a meeting where someone asked Krugman a question, and the second video is a discussion on a British TV show. There are some problems that they doesn't quite understand:

1. Inflation as theft is inaccurate, it is a redistribution of income between debtors and lenders. When interest rates are higher lenders are better off and borrowers can't borrow as much, when interest rates are lower the opposite happens. It isn't so much theft as a redistribution of wealth which are different things.
2. The real key point which Krugman got close to is that yes, inflation is important and extremely high inflation can destroy economies, but the big question is how high is our Real GDP per capita growth rate*, meaning is our economy growing after inflation and population growth? In this sense, the US and Canada are doing better than most of Europe. Canada's stayed the same, and the US declined by only -0.3% last year. This is compared to Greece which has seen its inflation collapse and go into negative territory to correct the immense collapse in demand (demand has collapsed forcing prices to drop which is negative inflation) which is the invisible hand at work correcting the collapse in the demand curve, but it has taken the invisible hand 5 years to correct the implementation of austerity. Looking at Real GDP per Capita is a much more accurate measure to determine whether the economy is growing because it corrects for population growth and inflation which are important points. Any one of the three inputs, GDP, inflation, and population growth give us only part of the picture. Because it is Real GDP per Capita that is important at the end of the day it tells us one very important lesson on inflation which is that if you increase inflation by 1% but your GDP growth rate rises by 2% your economy is better off at the end of the year with the higher inflation and higher growth than having a stagnant economy. This is one reason why government spending to counter a collapse in consumer demand works, along with my next point.
3. Government spending to offset consumer spending and private investment is important because of how GDP is calculated. GDP is calculated by multiple methods, but the expenditure approach is the sum of consumer spending, private investment, net exports, and government expenditure. This fixes many problems that one has when looking at an economy. Even if you are an economy that imports a lot (like most developed countries) if your GDP growth is positive that is not such a large issue because your economy is producing more than it is purchasing from abroad. It teaches us that if the consumer spending collapses (like happened when almost 5% of Americans lost their jobs between 2008 and 2009) the government needs to rebuild that loss in the economy and it can because the government is part of the economy too.
4. The last and most important thing people frequently don't understand is there is the multiplier effect of employment, similar to how there is a multiplier effect for money printed. The classic economic example is how the Federal Reserve (or really any central bank) creates money is that it will lend out to a bank which will lend to other banks and because our money supply is only 1/3 dollars for every dollar the Federal Reserve prints it injects more than $1 into the economy through lending and IOUs. A similar thing happens with businesses. One thing that the people from the second video surprisingly don't understand is that businesses need to make a profit, or at least have enough capital saved to survive if they don't make enough money to cover expenses. Even the most caring employer cannot stay in business if he/she has no customers to provide revenue, and investments from investors have to be paid back so are a very different to a businessman from actual hard income. When the government hires people into the public sector they will spend most of their income in the private sector generating demand for goods and services. When businesses and entrepreneurs find that there is demand for a good and a profit to be made someone will identify the market, hire employees, and provide the service. No entrepreneur on Earth can run a business without demand, and merely having a great product isn't enough if people don't want it, because demand is both ability and desire. With the increase in demand from public employees for private sector goods businesses will have more income and a similar multiplier effect will happen in the economy as happens in the federal reserve. The government may only spend a billion dollars to hire the workforce needed to get a project done, but those billion dollars (minus taxes which are usually minimal) will then be spent in the private sector increasing private sector revenue, and the multiplier effect will come into play. I honestly don't know how people who deny Keynesian policies think private businesses will be able to afford to hire employees when there is no one to purchase their product.

*The only drawback to using Real GDP per Capita growth rate is that it doesn't take into account income distribution which is an important part of having a stable economy where people have purchasing power, but its the best one I have seen to date.

Sources:
Wikipedia
http://www.stat.ee/29958

Austerity is turning out to be Merkel wasting German taxpayer dollars

http://www.bbc.co.uk/news/business-25291036

I am reading this article and the one thing that comes to my mind is none of this had to happen. Everything that has happened with the European economy over the past few years was always completely unnecessary and all of the responses have been wrong.

If we review the European economy in 2008 the picture was very different. Greece and Germany (the "model good" and "model bad" economy the media loves to talk about) were doing just about as well in their economic statistics, and one wouldn't anticipate anything that Merkel has turned out to be for the world.

Then the economic collapse of the world happened. Greece and the United States had been having good economies for a good long while on paper, and all three had been running annual deficits since 2001 when the so-called "fiscal conservatives" were in power in these countries.

The reason Greece had a deficit in the first place is that the government didn't have income to pay for the goods and services people in developed countries expect. It is the same in every country where some people get all the benefits of being in the country but hide their money in income tax free countries to avoid paying money. This was why they had a deficit and besides that one factor, everything else in 2009 was not looking unusually terrible. All of the countries in the EU were looking really good.

Today there are riots on the street in Greece and Spain because their economies is so poor today.

The EU government (led by the European People's Party, EPP, the right wing organization) decided the solution to the lack of revenue for the government to provide countries was to fire millions of public workers and somehow through magic this was going to balance the budget.

But the problem was that firing millions of employees was going to dry up their spending, and the contraction expanded to the private market, which is why Spain and Greece have unemployment rates north of 20%. The only major change over the past few years has been the austerity, with crashing demand for services and businesses folding as they are unable to get income to stay afloat as the economy contracts which feeds on itself.

The European Union government took a situation that was not ideal and turned it into a depression.

What should have been done is look at the issue, Greece needs to keep borrowing more money to pay the previous borrowers which means the interest will be compounded, and if Greece was ever unable to get borrowers (which I am unaware of any time this has ever happened, it sure didn't happen to Japan with their Debt/GDP ratio over 200%, the highest in the world) it would mean they would need to find some way to pay creditors, but this wasn't happening. If Greece wanted to pay off its debt it would need to find a way to cover the debt (which is preferable and keeps a high credit rating) or write it off (and no one would ever lend to the Greek government again). The solution then is to find revenue to cover expenses. This is not what the EU Parliament mandated however, and Greece has found their economy contract in an epic proportion, because they tried to screw a screw with a chainsaw.

Greece today has a demand curve that has shrunk which means there is no money to be made by starting a business (which is how economies grow) and it needs to grow somehow.  Being part of the Eurozone, it is represented in parliament and the decisions with the central bank are made together, and as long as the EPP controls parliament they are unlikely to do measures that will move the demand curve north so that starting businesses becomes profitable. People won't start making businesses in Greece if they are basically destined to fail. They need to adopt Keynesian economics and expand the demand curve by hiring unemployed Greeks and Spaniards so that it becomes profitable to start businesses because that is the only way the economy will grow.

On top of all these mistakes the northern states now need to subsidize the southern states to grow their economies so the EU can stay strong, which will waste French and German taxes on something that never had to happen. Fiscal conservatism at its finest.

Unless if the EPP wants to destroy the EU, and if that is the goal they are doing exactly what they would want to do, because continuing austerity from parliament will turn into so much apathy towards the north and parliament (and the majority of Europeans live in the North) which has the potential to divide the European Union. The resentment has the possibility of being a powerful force to drive Golden Dawn and other xenophobic parties into power in Greece and Spain (think Franco) on the anger towards Northern European governments which will be bad for the world.

I would rather see the EU work towards getting Greece, Spain and now Cyprus on their feet. Merkel (the de facto leader of the EPP and EU) saying that they will not support Cypriot banks is what really caused the current recession which was completely unnecessary and poorly though out. If someone wanted to destroy the Europe Union they would vote for the EPP because that is exactly what they are doing. If someone wanted to start a fascist revolution the first step would be removing the Schengen Treaty and Council of Europe which will remove the peaceful regional means of communication between national government and remove the peaceful means of reconciliation which can't lead to anything good.

I really hope the EPP is removed from power in the next election after their brutal mismanagement of the world's richest continent. I may be American, but Europe is our strongest ally and largest trading partner and I plan on going back to Europe ASAP, so I have a lot riding on the next election as does everyone in the world.

One extra source:
http://www.csmonitor.com/Business/The-Circle-Bastiat/2010/0503/Why-are-Greeks-not-paying-their-taxes

The early 1980s recession, a non-apologetic summary

I'm working on another post when I started looking at the 1980s recession. My primary reading is Wikipedia which is pulling from the CBO (since I don't want to spend hours doing this project).

The recession began in January 1980 by GDP growth which was quickly reversed by an expansionary economic policy by President Carter and the Federal Reserve which moved the economy back to above-average economic growth. When President Reagan got into office the unemployment rate had stabilized and the economy was growing until August 1981 when the Reagan administration arrived and the interest rate jumped to record highs. The economy entered recession until late 1982 with this policy unemployment hit its highest post-World War II levels peaking at 10.8% (0.8% higher than October 2009, the peak of the last recession). The short way to put this is they did exactly what Keynes would say not to do and the response was exactly what Keynes said would happen. They then reduced the interest rates and raised taxes in 1982 during the worst point of the recession. and the unemployment rate collapsed and growth was restored, exactly as Keynes predicted.

Shame on the Keynesians who didn't point this out and boast in the early 1980s, but if we are to blame anyone we need to blame the Democrats for not making this failure of policy which really disproved laissez faire and proved the efficacy of Keynesianism in the most effective way (trying both solutions and finding normal results) a major tenant of the 1984 election which both the economists and politicians of the day failed to do.

The 1980s should be seen as the triumph of Keynesianism, but since there were clearly no great economists in that era a golden opportunity to make some amazing papers on what types of policies should be practiced in different times. This needs to be public knowledge, and the policy that Reagan did that really brought the economy to recovery was Keynesian policies. It is unbelievable we took this recession as proof that neoliberal policies work because we should take the exact opposite meaning out of it.

Unemployment: http://www.google.com/publicdata/explore?ds=z1ebjpgk2654c1_#!ctype=l&strail=false&bcs=d&nselm=h&met_y=unemployment_rate&fdim_y=seasonality:S&scale_y=lin&ind_y=false&rdim=country&idim=country:US&ifdim=country&tstart=202287600000&tend=728380800000&hl=en_US&dl=en_US&ind=false

Interest rates: http://research.stlouisfed.org/fred2/graph/?id=FEDFUNDS

Reagan's tax policies of the era:

Tax cuts that preceded recession: http://en.wikipedia.org/wiki/Economic_Recovery_Tax_Act_of_1981

Tax increases that preceded recovery: http://en.wikipedia.org/wiki/Tax_Equity_and_Fiscal_Responsibility_Act_of_1982