Saturday, August 13, 2011

Reflections on the Conservative Approach

It's very hard for people on my side of the spectrum to tell to what extent Republicans are sincere in believing that immediate, deep spending cuts will be economically beneficial and to what extent they are engaging in deliberate sabotage (consciously or unconsciously). But I will stick to addressing consevatives who are sincere.

The less sophisticated appear to believe that immediate, deep spending cuts will bring about immediate improvement by freeing up resources for more productive use. The problem, of course, is that a recession by definition means that significant economic resources are going unused. The short-term effects of deep cuts in government spending are that even more resources will be unused. But others, more sophisticated, recognize that cuts will mean short-term pain and argue that short-term pain is worth the cost. That is the argument I want to address -- including why these more sophisticated conservatives are so enthusiastic acout short-term pain.

Megan McArdle, speaking of Ireland, argues that shrinking government spending, despite the painful cuts, depressed economy, and even large deficts that result, is worthwhile to avoid the worse consequences of an outright default, "[F]iscal crises are much, much worse than austerity budgets. Fiscal crisis means that rather than unpleasant cuts, you have sudden, unmanageable collapses in things like public pension plans. The resulting suffering is not unpleasant; it is disastrous."

To this a liberal critic responds that cutting spending to fend off a future default doesn’t work – by shrinking the economy, it depresses tax revenues and thereby increases the deficit. The trouble with this argument is that ultimately cutting ca balance the budget, albeit at geat cost, and some conservatives advocate this approach. Suppose, for instance, that President Bachman actually keeps her promise and refuses to raise the debt ceiling, necessitating an overnight 40% cut in spending. The results would be catastrophic as McArdle herself acknowledges. But the economic contraction is so severe as to cut revenues by two-thirds, the deficit will shrink. It will not disappear because the shinking economy will mean less revenues, necessitating more cuts and continuing the cycle. Eventually, though, an end point will be reached. The budget will balance and the economy will presumably bottom out, albeit at considerable cost, possibly including the collapsing pension plans and disasterous suffering that we are trying to avoid by balancing the budget.

This is not merely theoretical. Something like it happened to Chile in the Great Depression. Faced with collapsing export prices, the Chileans cut and cut and cut, shrinking their economy by half, but eventually its credit was restored, and it bottomed out and began to recover. The top current examples, much touted as positive models by conservatives, are the Baltics, Latvia, Estonia and Lithuania. All three countries maintained their currency pegs and balanced their budgets. Not coincidentailly, these three also suffered the worst relative economic declines of any country in the recent crisis, but they did ultimately bottom out and start to recover. Conservatives eagerly call on the rest of us to emulate them.

The same dynamic applies to mortgage foreclosures. Liberals warn that without some sort of mortgage relief, the market will be flooded with foreclosed houses, further driving down prices. The drop in prices will cause even more homeowners to be under water, leading to more foreclosures, and perpetuating the cycle. But eventually it has to run out of people to foreclose on. Some people, after all, have paid off their mortgages. Others have mortgages close enough to being paid to be worth almost any sacrifice to own the house free and clear. So ultimately the wave of foreclosures will have to cease. Since banks will not be able to sell their homes for more than market price, they will take their losses either way. The difference will be that without debt relief housing prices will fall much lower and many more people will lose their houses without debt relief than with it.

So it seems fair to ask, given the severity of their downturns, why do conservatives think the Baltics are such wonderful models to follow? And given that it will cause great suffering to home owners, no gains to the banks, and losses to everyone’s property values including their own, why are conservatives so dead set against mortgage relief?

One reasons, I suspect, is that they believe there is an inevitable bottom we have to hit, and any attempt avoid sinking so low merely prolongs the pain. The faster we bottom out, the quicker we can start recovery. But more than that, I think they regard any suggest that proper intervention may make the bottom less low is cheating and attempting to thwart the will of the free market.

And that, I think, leads to the deeper answer. They see these as moral issues. Economic conservatives, so far as I can tell, regard the primary moral issues in economics (aside from shrinking government, of course), as paying debts and making sure no one escapes punishment for bad decisions. Human suffeinrg ranks much lower on their scale of moral priorities. And as for collateral damage to the innocent, well it takes balls to execute an innocent man.

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