Stiglitz in The Times: A Study in Confusion

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In today’s New York Times, Joseph Stiglitz, a Nobel Prize winner in economics, has an article titled “How to Fix the Global Economy.” Judging from his article, Stiglitz appears to believe that the main problem of the global economy is ”global financial imbalances.” By this, he means “America’s enormous trade deficits,” which he states are close to $3 billion a day, and “China’s growing trade surplus of almost $500 million a day.”

An indication of the level of analysis to expect in the article is given in its second paragraph, when he says that while the United States blames China’s undervalued currency for its trade deficit, “the rest of the world singles out the huge American fiscal and trade deficits.” The meaning of this statement, and of its acceptance by Stiglitz without challenge, is that it is legitimate to argue that what is to be blamed for America’s trade deficit is America’s trade deficit — at least in large part. Whether or not this is Stiglitz’s own view is irrelevant here. What is relevant is that he’s willing to let it go by as though it were legitimate and required no comment.

In typical Keynesian fashion, Stiglitz confuses saving with hoarding, as when he says, “No one seriously proposes that businesses save money instead of investing in expanding production simply to correct the problem of the trade deficit . . . .” How can saving itself not mean investment, unless the savings are hoarded? How can saving be an alternative to investment, unless saving means simply non-spending, i.e., hoarding? Indeed, Stiglitz makes no secret of his Keynesianism. He concludes his article by urging the imposition of an updated version of Keynes’ scheme for global credit expansion based on a new global currency. Only that will allegedly solve the “fundamental structural problems with the global reserve system” and end the “imbalances that threaten the financial stability and economic well-being of us all.”

Until then, the best that we can do, according to Stiglitz, is impose a Keynesian-inspired scheme of government “expenditure cuts combined with an increase in taxes on upper-income Americans and a reduction in taxes on lower-income Americans. The expenditure cuts,” says Stiglitz, “would, of course, by themselves reduce spending, but because poor individuals consume a larger fraction of their income than the rich, the ‘switch’ in taxes would, by itself, increase spending. If appropriately designed, such a combination could simultaneously sustain the American economy and reduce the deficit.”

The content of this last paragraph needs to be gone over carefully. The government will cut its spending. (Amazing that Stiglitz would even consider this.) This will not reduce overall, economy-wide spending, however, because it will be accompanied by tax reductions. As the result of reduced taxes, the taxpayers will spend more while the government spends less. So much is true, and good for Stiglitz for recognizing so much as the possibility of this happening. But Stiglitz thinks it’s essential that the taxpayers be poor, low-income tax payers, because only such taxpayers, he believes, engage in significant spending. What do the richer, higher-income tax payers do with their funds? All they do, Stiglitz thinks, is hoard them. That’s why, when their taxes are increased, Stiglitz sees no fall in spending anywhere. All he sees is funds coming into the hands of the government and reducing its deficit — funds that allegedly would otherwise have been hoarded.

The fact is, of course, as John Stuart Mill pointed out in the middle of the 19th Century, that what is saved, i.e., not spent in purchasing consumers’ goods, is spent. But it is spent productively, i.e., in buying capital goods and in paying the wages of workers employed by business firms. These workers, of course, then consume their wages.

Moreover, some significant part of the funds that are saved is lent to consumers. It should be realized that it is only on a foundation of savings, partly their own, but mainly those of others, which they borrow, that most people can afford to buy expensive consumers’ goods. In this category are major appliances, automobiles, and, above all, homes. Such consumers’ goods, which cost the income of months or years, could not be purchased in any other way except on a foundation of savings — either those of the purchasers themselves or those from whom the purchasers borrow.

Because their funds are spent in these ways, taxing the rich to reduce the government’s deficit actually means reducing the spending of business firms for capital goods and labor, the spending of business’s employees for consumers’ goods, and the spending of all consumers for expensive consumers’ goods.

Because what is saved is spent, simply reducing government spending, and thus the government’s need to borrow, makes correspondingly more funds available to business firms and consumers to be spent in these ways. The savings the government would have absorbed through its sale of securities are instead available for these vital purposes. There is no need to complicate matters with accompanying tax decreases and tax increases, especially when the tax increases have the negative effects that I’ve shown.

The point here is that to reduce the government’s budget deficit, all that needs to be done is to reduce its spending, nothing more. It would be a further improvement if government spending were reduced not only to the point of eliminating its deficit, but to the point of making possible the radical reduction, indeed, complete elimination, of taxes that fall on savings and the greatest possible decrease in taxes that fall on private consumption. In that way the demand for capital goods and labor by business would be at a maximum consistent with the citizens’ degree of time preference, and everyone would enjoy as much as possible of the benefit of his own wealth and income. The effect of the rise in saving and investment would be a sharp increase in the rate of economic progress in the United States. A further, indirect effect would be an increase in the size of the American economy relative to that of the rest of the world.

It never occurs to Stiglitz that America’s trade deficit is actually benign and doesn’t need to “fixed”—by him or anyone else. In part it is the result of the fact that the US dollar is a global currency. As the supply of dollars is increased in the US, a substantial proportion of them flows abroad, where they are held by individuals and businesses who do not want to hold the more rapidly inflated currencies of their own countries. These individuals use these dollars to a considerable extent in making purchases in their own countries, from other individuals who are eager to acquire them. To the extent that these dollars leave the US in the purchase of goods and services from abroad, they represent imports. The fact that they are then held abroad and do not return, means that there are no corresponding exports. Hence, the balances of trade and payments are “unfavorable.”

Of course, there is nothing really “unfavorable” to the United States about such a situation. It exports paper dollars that cost it virtually nothing to produce in exchange for actual goods and services. It is in the position of a gold-mining country under an international gold standard, with a principal difference being that it does not incur the substantial costs of gold mining.

To be sure, there is a major danger in this situation. And that is, that the United States government will increase the supply of dollars rapidly enough to deprive them of their desirability for being held abroad. In that case, the dollars that have gone out will come rushing back in. We will then have to exchange a mass of goods and services for these little pieces of paper. Our economy will be impoverished, but the goods and services leaving in exchange for the little pieces of paper flooding back in will count as “exports,” and so our balance of trade will turn from “unfavorable” to “favorable.” Then, in the midst of impoverishment and major inflation, we shall allegedly know the meaning of prosperity — Keynesian style.

It should be obvious that the present “unfavorable” balance of trade is much preferable to such a “favorable” balance of trade.

For the rest, our “unfavorable” balance of trade is the result of nothing more than the relative desirability of the United States as a country in which to invest. Despite our substantial and continuing loss of economic freedom and respect for property rights, the United States still compares very favorably in these vital respects with practically all other countries. The laws here still cannot be changed at the whim of a government official. Contracts are almost always still enforced. As a result, the United States continues to be the best country in which to invest for enough people, enough of the time so that each year substantially more capital enters the country from abroad than leaves it. This net investment of foreign capital is what mainly finances our continuing excess of imports over exports.

The way to grasp the connection between foreign investment and our trade deficit, in terms of principle, is to think back a few generations, to the time when Western geologists first discovered vast oil reserves in Saudi Arabia. At the time, that country was essentially an empty desert. Oil wells, refineries, and pipelines did not yet exist there. They first needed to be built. To do this, a mass of construction equipment and construction materials needed to be brought into the country, along with substantial supplies of consumers’ goods for the Western construction workers required. All of these goods coming in were imports. They were also the physical constituents of the capital being invested in Saudi Arabia.

Could Saudi Arabia possibly have avoided an “unfavorable” balance of trade? It could not even if it had exported all of the sheep, goats, tents, and camels in the country. In fact, of course, it did not have to export anything to pay for these imports — not until the oil began flowing, and then it exported that. Its “unfavorable” balance of trade and the accompanying foreign investment were in fact as genuinely favorable an economic development for that country as it is possible to imagine.

Like all foreign investment, the foreign investment coming into the United States today is necessarily in the form of an excess of imports over exports. It and the capital accumulation it makes possible is no more genuinely unfavorable to us than was the excess of imports over exports that came into Saudi Arabia, and the capital accumulation it made possible.

Unfortunately, today, in the United States, part of the foreign investment being made finances our government’s budget deficits. But in so doing it prevents those deficits from stripping away savings and capital from the rest of the economic system. It would certainly be much more desirable if those deficits could be eliminated. Then that foreign capital would simply add to the savings and capital invested in our country, instead of, to a considerable extent, merely maintaining it. Foreign investment and the excess of imports over exports that it makes possible also serves to make up for the lack of savings and capital accumulation on the part of the United States’ own citizens. Our economy would be vastly worse off without it.

Such global “trade imbalances” are not a problem. They are a profoundly important means of preventing problems. What will cause a problem is allowing wreckers, devoid of serious knowledge of economics, to “fix” things.

George Reisman [send him mail] is Pepperdine University Professor Emeritus of Economics, and is the author of Capitalism: A Treatise on Economics. Visit his website.

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