A professor of economics and co-director of the Political Economy Research Institute at the University of Massachusetts, is co-author of Green Recovery: A Program to Create Good Jobs and Start Building a Low-Carbon Economy.

This article (written November 6, 2008) appeared in the November 24, 2008 edition of The Nation.

Ed.Note: This article was interesting because it contains many of the points of the Obama Recovery Stimulus of 2009.  The article was slightly reformatted without omission or distortion of meaning to read easier online. 

Bolded passages are of particular interest; italic notes are my notes added for clarity.

A Green Public-Investment Stimulus

Recessions create widespread human suffering. Minimizing the suffering has to be the top priority in fighting the recession. This means expanding unemployment benefits and food stamps to counteract the income losses of unemployed workers and the poor. By stabilizing the pocketbooks of distressed households, these measures also help people pay their mortgages and pump money into consumer markets.

Beyond this, the stimulus program should be designed to meet three additional criteria.

1.      We have to generate the largest possible employment boost for a given level of new government spending.
2.      The spending targets should be in areas that strengthen the economy in the long run, not just through a short-term money injection.
3.      Despite the recession, we do not have the luxury of delaying the fight against global warming.

To further all these goals we need a green public-investment stimulus to
1.      defend state-level health and education projects against budget cuts
2.      finance long-delayed upgrades for our roads, bridges, railroads and water management systems
3.      underwrite investments in energy efficiency-including  building retrofits and public transportation-as well as new wind, solar, geothermal and biomass technologies.

This kind of stimulus would generate many more jobs–18 per $1 million in spending – than  would programs to increase spending on the military and the oil industry (i.e., new military surges in Iraq or Afghanistan combined with “Drill, baby, drill”), which would generate only about 7.5 jobs for every $1 million spent.

There are two reasons for the green program’s advantage.

1.      The first factor is higher “labor intensity” of spending-that  is, more money is being spent on hiring people and less on machines, supplies and consuming energy. This becomes obvious if we imagine hiring teachers, nurses and bus drivers versus drilling for oil off the coasts of Florida, California and Alaska.

2.      The second factor is the “domestic content” of spending-how much money is staying within the US economy, as opposed to buying imports or spending abroad. When we build a bridge in Minneapolis, upgrade the levee system in New Orleans or retrofit public buildings and private homes to raise their energy efficiency, virtually every dollar is spent within our economy. By contrast, only 80 cents of every dollar spent in the oil industry remains in the United States. The figure is still lower with the military budget.

What about another round of across-the-board tax rebates, such as the program the Bush administration and the Democratic Congress implemented in April?

A case could be made for this in light of the financial stresses middle-class families are facing. However, even if we assume that the middle-class households will spend all the money refunded to them, the net increase in employment will be about 14 jobs per $1 million spent-about  20 percent less than the green public-investment program (the main reason for this weaker impact is the lower domestic content of average household consumption, i.e. much of the consumption will be for foreign-made goods).

Also, it isn’t likely that the households would spend all their rebate money. Just as with April’s rebate program, households would channel a large share of the money into paying off debts. (paying off debts is not necessarily bad – it releases discretionary income for the family and increases reserves for the banks and credit card companies to extend more credit to others).

The Matter of Size

This is no time to be timid. The stimulus program last April totaled $150 billion, including $100 billion in household rebates and the rest in business tax breaks. This initiative did encourage some job growth, though as we have seen, the impact would have been larger had the same money been channeled toward a green public-investment stimulus.

But any job benefits were negated by the countervailing (counteracting) forces of the collapsed housing bubble, the financial crisis and the spike in oil prices. The resulting recession is now before us. This argues for a significantly larger stimulus than the one enacted in April.

But how much larger?

One way to approach the question is to consider the last time the economy faced a recession of similar severity, which was in 1980-82, during Ronald Reagan’s first term as president. In 1982 gross domestic product (GDP) contracted by 1.9 percent, the most severe one-year drop in GDP since World War II. Unemployment rose to 9.7 percent that year, which was, again, the highest figure since the ’30s.

The Reagan administration responded with a massive stimulus program, even though its alleged free-market devotees never acknowledged as much. They preferred calling their program of military expansion and tax cuts for the rich “supply-side economics.” (supply creates demand – see Trickle, Trickle, Up, Down, part I)

Whatever the label, this combination generated an increase in the federal deficit of about two percentage points relative to the size of the economy at that time. In 1983 GDP rose sharply by 4.5 percent. In 1984 GDP growth accelerated to 7.2 percent, with Reagan declaring the return to “morning in America.” Unemployment fell back to 7.5 percent.

In today’s economy, an economic stimulus equivalent to the 1983 Reagan program would amount to about $300 billion in spending-roughly double the size of April’s stimulus program, though in line with the high-end figures being proposed in Congress. A stimulus of this size could create nearly 6 million jobs, offsetting the job-shedding forces of the recession.

Of course, the green public-investment stimulus will be much more effective as a jobs program than the Reagan agenda of militarism and upper-income tax cuts. This suggests that an initiative costing somewhat less than $300 billion could be adequate to fight the job losses. But because the green public-investment stimulus is also designed to produce long-term benefits to the economy, there is little danger that we would spend too much. Since all these investments are needed to fight global warming and improve overall productivity, the sooner we move forward, the better. Moreover, under today’s weak job market conditions, we will not run short of qualified workers.

How to Pay for All This?

Let’s add up the figures I have tossed around. These include the $700 billion bank rescue operation being engineered by the Treasury, the $540 billion with which Fed chair Bernanke has pledged to bail out the money market mutual funds, along with unspecified additional billions to buy unwanted business debts held by banks. On top of these, I am proposing $300 billion for a second fiscal stimulus beyond last April’s $150 billion program. At a certain point, it is fair to wonder whether we are still dealing with real dollars as opposed to Monopoly money.

In fact, the whole program remains within the realm of affordability, albeit approaching its upper bounds. But major adjustments from the current management approach are needed. In particular, the Federal Reserve has to continue exerting control over the Treasury on all bailout operations. That is, we need more initiatives like Bernanke’s $540 billion program to stabilize the money market mutual funds and less Treasury fumbling with taxpayers’ money to buy either the private banks’ bad assets or ownership shares in the banks.

We need to recognize openly what has largely been an unspoken fact about these bailout operations: that the Federal Reserve has the power to create dollars at will, while the Treasury finances its operations either through tax revenues or borrowed funds (which means using taxpayer money at some later time to pay back its debts with interest).

The Federal Reserve does not literally run printing presses when it decides to inject more money into the economy; but its normal activity of writing checks to private banks to buy the banks’ Treasury bonds amounts to the same thing.

When the banks receive their checks from the Fed, they have more cash on hand than they did before they sold their Treasury bonds to the Fed. Especially during crises, there is no reason for the Fed to restrain itself from making good use (though of course not overuse) of this dollar-creating power.

The Fed is also supposed to be the chief regulator of the financial system. Now is the time to make up for Alan Greenspan’s confessed failures over twenty years in this role.

In exchange for the Fed protecting the private financial institutions from collapse, Bernanke must insist that the banks begin lending money again to support productive investments, while prohibiting them from yet another return to high-rolling speculation.  

Special measures are also needed to keep people in their homes.

The Deficit Looms

When the economy began slowing this year, the fiscal deficit more than doubled, from $162 billion to $389 billion. We cannot know for certain how much the deficit will expand. It could rise to $800 billion, $1 trillion or even somewhat higher, depending on how the bailout operations are managed.  Of course, it would be utterly self-defeating for the United States to run a reckless fiscal policy, no matter how pressing the need to fight the financial crisis and recession.  But in the current crisis conditions, even a $1 trillion deficit need not be reckless.

Let’s return to the Reagan experience for perspective. In 1983 the Reagan deficits peaked at 6 percent of the economy’s GDP. With GDP now around $14.4 trillion, a $1 trillion deficit would represent about 7 percent of GDP, one percentage point higher than the 1983 figure.

Of course, the global financial system has undergone dramatic changes since the 1980s, so direct comparisons with the Reagan deficits are not entirely valid.

One change is that government debt is increasingly owned by foreign governments and private investors. This means that interest payments on that debt flow increasingly from the coffers of the Treasury to foreign owners of Treasury bonds.

At the same time, as one feature of the crisis, Treasury bonds are, and will remain for some time, the safest and most desirable financial instrument in the global financial system. US and foreign investors are clamoring to purchase Treasuries as opposed to buying stocks, bonds issued by private companies or derivatives.

This is pushing down the interest rates on Treasuries. For example, on October 15, 2007, a three-year Treasury bond paid out 4.25 percent in interest, whereas this past October 15, the interest payment had fallen to 1.9 percent (currently 1.125 percent). By contrast, a BAA (investment grade) corporate bond paid 6.6 percent in interest one year ago but has risen this year to 9 percent (currently 8.24 percent).

As long as the private financial markets remain gripped by instability and fear, the Treasury will be able to borrow at negligible interest rates. Because of this, allowing the deficit to rise even as high as 7 percent of GDP does not represent a burden on the Treasury greater than what accompanied the Reagan deficits.

There is, then, no reason to tread lightly in fighting the recession, with all its attendant dangers and misery. Indeed, severe misery and danger will certainly rise as long as timidity-the path of least resistance-establishes the boundaries of acceptable action.

The incoming Obama administration can take decisive steps now to defend people’s livelihoods and to reconstruct a viable financial system, productive infrastructure and job market on the foundation of a clean-energy economy.

Political analysts and reporters keep talking about “trickle-up” and “trickle-down” economics.  What do these terms mean?  Personally, I’m interested only in “trickle to my pocket.”  But as far as taxes are concerned, I pay what the government says to pay.  They decide how to apply the money.

President-elect Barack Obama has spoken in multiple election speeches about trickle-down economics and how it has often had the opposite of its intended result, stating: ” … instead of prosperity trickling down, the pain has trickled up – from the struggles of hardworking Americans on Main Street to the largest firms of Wall Street.”

The trickle-down economics viewpoint cherished by the Republican Party sees tax breaks that benefit mostly the wealthy, who will invest it in companies that will expand operations, increase employment, and produce cheaper goods resulting in a higher standard of living for all.

This economic model relies on each step acting according to plan.  The tax break-generated extra income must be large enough that the wealthy individuals invest it instead of saving it or spending it on personal consumption. 

The public company receiving the investment must use it to expand existing operations, instead of buying back stock or buying competitors.  The expansion must result in increased domestic employment, rather than outsourcing.  Finally, the business expansion must result in profits on cheaper goods purchased by the public. 

But does it work?

The Richard Nixon administration did not cut taxes.  He thought the incentive for the wealthy to invest in the market was zero.  Instead, the government controlled wage and price increases, but not interest rates.  The economy ground to a halt with high inflation, a condition known as stagflation. 

The Ronald Reagan administration Federal Reserve chairman Paul Volcker, squeezed inflation from the economic system by raising the federal funds rate to 20%, deliberately causing a recession.  As interest rates were gradually lowered, the administration cut taxes by $479 billion over five years, and pulled the economy out of the recession, recouping $476 billion over the five years from increased tax revenues.

The George W. Bush administration avoided an impending recession in 2001, lowering taxes as an economic preemptive strike.  In spite of the bursting of the dot-com bubble just before he took office, the 2001 9/11 attacks, and wars in Iraq and Afghanistan, President Bush managed to keep the country out of recession, until the bursting of the U.S. housing bubble at the end of his second term. 

It has been 17 years of growth.

The $1.35 trillion in tax cuts over ten years was expected to be mostly repaid by the time they ran out in 2011.  The recouping of the ten-year tax breaks is now a new ball game, depending on when the current recession will end, and how close to pre-bubble levels we return.

Does supply-side economics work? 

Tax cuts are the key. 

In the three cases cited, Nixonomics failed due to no tax breaks, Reaganomics and Bushonomics succeeded because of tax breaks, even though Reagan had to pull the country out of deep recession first.

Trickle up

Keynesian economics, also known as the trickle-up effect and favored by the Democrats, is a different type of macroeconomic philosophy that holds that:

1.      Tax cuts can be used as an economic stimulus if spread across the entire economy, not just toward one specific group (like the wealthy). 

2.      Tax cuts should be used to increase demand, not supply, and should be targeted at cash-strapped, lower-income earners, who are more likely to spend the additional income.

3.      Spending on goods demanded by the public will result in business expansion, increased employment, raising of standards of living followed by more demand.

Keynesian or demand-side economics proposes that consumption or demand is the key to economic prosperity and that production or supply follows. 

Percentage-wise, it is obvious the wealthy spend less of their disposable income in the economic market.  Dollar for dollar, the working class will release more into the economic system than the wealthy, simply because there are more of us. 

The trickle-up effect states that directly benefiting the working class will cause them to spend their disposable income, buy more goods, encouraging more product output.  As the supply of goods and services increases in response to increased demand, the wealth of the society as a whole improves and benefits will “trickle up” to the wealthy.

John Maynard Keynes was a British economist who still remains the world’s foremost expert on recessions and depressions.  Although he died halfway through the 20^th century, his findings are still accurate today.  He knew how we got into recession, and he knew how to get out. 

People are conventional.

Keynes developed the theory that increasing government deficits stimulates an economy.  He also developed the theory that rational people in times of uncertainty fall back to conventions that give them comfort and assure them they are doing the right thing. 

Conventional behavior turns into group behavior reinforcing their assurance.  As an example, people think housing prices will return to their original values, and once we are out of this recession, the economy will grow again from the point it left off. 

That is uncertain.

Keynes approach was based on his conception of money as a “store of value” rather than a method of payment.  The desire to hold money with its perceived fixed value is a gauge of our distrust of our own calculations of the future.  We think the more we have, the more we are protected against future uncertainty.

Keynes said that this uncertainty theory extends to banks (and credit card companies), that will raise interest rates to borrowing consumers to increase their own “store of value” heedless of the guiding interest rate charged by the Central bank.

Private banks will eventually follow the Central bank’s leadership and slowly reduce their lending rates, but their reluctance to spend will initially clamp down on credit and liquidity.  This will leave the ball in the government’s hands to spend and stimulate the economy.

Government spending to “prime the (economic) pump” include infrastructure improvement programs (roads, bridges, dams, schools), tax cuts to workers, and the direct application of spendable cash.

Deficit spending

John Maynard Keynes was one of the first economists to advocate government deficit spending as part of a fiscal policy to cure a recession. His theory is that increased government spending in areas that give discretionary income to the worker class will raise demand and increase consumption. 

He argued that the solution to recession  or depression was to stimulate the economy with a combination of two approaches :

• Reduction(s) in interest rates led by the Central bank, to stimulate cash flow
• government investment in repairing, upgrading and improving the nation’s infrastructure employing many thousands, and providing discretionary income for their families. This results in more spending in the general economy stimulating more demand for goods, resulting in a upward cascading cycle of recovery.

Stimulus savings

The upward recovery cycle can be short-circuited with excessive saving throughout the population, reversing the upward cycle.

Excessive saving decreases investment and demand, causing companies to cut back, increasing unemployment and completing the circle by cutting  back on saving. 

Advocates of Keynesian economics hold that economic stimulus should be directed towards the lower-income worker class, as they are more likely to spend the money than to save it.

The purpose of the stimulation is to get the economy moving again. 

Economics against the tide

Keynes promoted countercyclical economic policies that act against the tide of the business cycle of economic expansion and contraction.  This means embracing deficit spending when a nation’s economy is in recession and unemployment is relentlessly high. 

We have already seen that fiscal stimulus increases the market for business output, raises cash flow and profitability, sparks employment and business optimism, and encourages investment, increasing gross domestic product (GDP).  This accelerator effect means that government and business can be complements of each other rather than substitutes. 

Government spending and investment in public goods not provided by profit-seekers, such as public healthcare, education, and infrastructure upgrade and repair will also encourage the private sector’s growth in suppliers and employment.

On the reverse side of the business cycle, in boom times with excessive demand-side growth, reducing government spending for public goods, raising taxes and interest rates to suppress inflation will cool the economy.

Herbert Hoover‘s 1932 tax increase making the Depression deeper, and Franklin D. Roosevelt‘s fiscal policies of public projects are examples pointing to the potential success of the trickle-up approach as a way out of our dismal economic situation.

Let’s hope a policy that works to dig us out comes soon.