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Thinking clearly about demand declines -- and what to do about them

Tyler Cowen's post separating types of demand problems is really worth reading. There are at least three ways in which demand can decline, he says, and each suggests different solutions.

The first is the most basic: Spending goes down for a bit. You can fix that with stimulus.

The second is also intuitive, but more worrying: Spending readjusts to a permanently lower level. That one is harder to fix. You need to make people wealthier again, or shift your economy away from consumption.

The third is a bit more complicated: Demand for certain items -- say, consumer goods that people don't necessarily need to purchase -- falls, and you need to wait for people's wealth situation to change or for them to wear holes in their shoes.

The economy, of course, can experience all three. The chaos of the initial financial crisis pushed spending way below the level we could support, and so stimulus made perfect sense as a way to close the gap between where demand was and where it should've been. But in the aftermath of the credit bubble, we really are less rich than we thought we were. We can't support the debt-based consumption that drove the economy in the early-years of the century. That requires thinking about the economy somewhat differently. It requires a long-term strategy.

The stimulus actually had some of this. There were a raft of policies investing in green technology, high-speed rail, medical research, health information technology, education and other areas that won't pay off in the next year or so, but are meant to help birth new industries and generate a more stable economic foundation in the future. Those policies are now being attacked because they didn't spend out as quickly as the tax cuts, but I consider them economically wise, even if they were politically unwise.

What I'd really like to be talking about right now are long-term proposals to help deal with long-term growth. Things such as early-childhood education, a permanent extension of the R&D tax credit, a large investment in our public universities (particularly given the cuts they're experiencing right now), much more attention to retraining, and so on. But the opposite is happening, and short-term economic and political considerations are actually handicapping long-term policies: States are cutting school funding and various Republican senators are trying to divert unspent money in the stimulus bill's long-term investments to deficit reduction.

By Ezra Klein  |  August 18, 2010; 10:15 AM ET
Categories:  Economic Policy  
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Mitt Romney tries to lay out a plan in the Boston Globe today. Of course, like any politician's op-ed, it needs to be tested by a knowledgeable interviewer, as Ezra would say. Apparently Romney has decided it is time to steal Paul Ryan's thunder and step into the GOP leadership void.

Posted by: jduptonma | August 18, 2010 11:22 AM | Report abuse

Agree with your sentiment. The economy needs to restructure and that's inherently slow.

Another dimension that could be encouraged is toward more locally delivered goods and services. Examples: a) locally generated power built and maintained by people in the community (more local labor, less capital intensive), b) local banks and credit unions that offer national quality services, c) locally (or domestically) manufactured goods made possible by micro-manufacturing tools and broad distribution networks, d) etc, etc, etc. There are possibilities that didn't exist even 10 years ago thanks mostly to maturity of the internet. This is a take on keeping jobs local which doesn't have to be anti-free trade. Not sure how much a role government could play, maybe some.

Posted by: BHeffernan1 | August 18, 2010 12:02 PM | Report abuse

"What I'd really like to be talking about right now are long-term proposals to help deal with long-term growth."

Yes, but such issues have some complexity, so instead the media and the politicians prefer to focus on an Islamic community center in lower Manhattan.

Thanks, Ezra, for trying to focus your blog on matters of genuine significance to our nation, and not allowing the discourse to be entirely hijacked by the du jour wedge issues (see Plumline).

Posted by: Patrick_M | August 18, 2010 12:42 PM | Report abuse

What?! Demand can never decrease! We just need to make it easier for people to invest and access capital!

Lower taxes! Supply-side! Supply-side! Supply-side! Lower taxes! LA LA LA I'M NOT LISTENING!


Posted by: will12 | August 18, 2010 1:11 PM | Report abuse

"Mitt Romney tries to lay out a plan in the Boston Globe today."

A plan beats no plan. Hmm, where did I read that?

Posted by: tuber | August 18, 2010 2:45 PM | Report abuse

"But the opposite is happening, and short-term economic and political considerations are actually handicapping long-term policies..."

This short-term thinking has been going on long-term. At least since the '70s with the inflation caused by President Johnson's policy to have both guns AND butter by funding both the Viet Nam war and the Great Society.

Even after inflation was whipped by Paul Volcker's recession in the '80s, the short-term mentality took hold on Wall Street which demanded better quarterly — rather than yearly — performance from businesses and industries. Greed was indeed good.

The leaders of those businesses and industries took the bate and became more worried about Wall Street's short-term expectations than their own long-term health. And to show an ever rosy bottom line, many CEOs, rather than grow their own business, turned to conglomeration and take-over funded by Wall Street's cheap junk bonds. At least 50% of those deals failed, and many of the affected companies faded away, many of them old-line business that had lasted for nearly a century or more.

For those that survived the biggest factor in any business is its employees, their wages and benefits. So downsizing, off-shoring and outsourcing began in earnest in the '90s to continue ringing out better quarterly performance reports.

As has been noted by many (primarily Paul Krugman) worker's wages — for those who weren't downsized or outsourced — have stagnated since the 1980s, while the top income brackets, populated mostly by Wall Street financiers and corporate CEOs, have enjoyed the benefits of the worst income distribution since the Roaring Twenties.

Now we face deflation, where workers face stagnant or diminished wages, while income distribution towards the top continues to grow worse. Unfortunately, most business leaders and politicians (both dependent on economic results to keep their jobs) refuse, as you point out, to think and act long-term, not while Wall Street demands high short-term profits.

Until Wall Street changes its desire for short-term performance, we will continue to suffer the long-term consequences. And for older workers (like me) the future is a vastly different — and dangerous — place than we ever could imagined when we started our careers.

Posted by: tomcammarata | August 18, 2010 2:53 PM | Report abuse

How about confronting the assumption that higher consumption is good?

With diminishing natural resources, pollution, population growth and global warming, perhaps lower consumption per capita is the goal?

Posted by: langnerj | August 18, 2010 7:07 PM | Report abuse

"Thinking clearly about demand declines..."

Yes, it seems that the ability to think clearly about demand is now in decline.


Posted by: Patrick_M | August 18, 2010 7:58 PM | Report abuse

Wouldn't direct gov't hiring of the 99ers (those with extreme long term unemployment) be a good opportunity for retraining?

Instead of just handing out another round of checks, direct employment would allow the taxpayer to recoup something in return and gov't could provide training into a new field that these people obviously need. I would especially emphasize training in health care via the VA. These people could "graduate" in a year or so with actual marketable skills.

Posted by: Jamesaust | August 18, 2010 8:42 PM | Report abuse

While Congress moves forward on making the R&D Credit permanent, the IRS continues to penalize tax payers who claim a Credit without supporting, project-level documentation.
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Posted by: BrianLefever | August 19, 2010 12:00 PM | Report abuse

I agree, there seems to be a decline in demand for clear thinking.

I'd love to see a permanent reduction in student:teacher ratios as a way to invest in our future and as an employment strategy. Efforts to improve educational outcomes seem to always overlook what research shows: smaller class sizes = better student achievement.

Posted by: lroberts1 | August 19, 2010 3:14 PM | Report abuse

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