Ed Koch and the Planned Shrinkage of the US Economy: Two Tales of Austerity, Part 1

Posted on February 2, 2013

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Two seemingly unrelated events of note happened Friday—former New York City Mayor Ed Koch passed away and the U.S. Department of Commerce announced that the U.S. economy shrank for the first time since 2009. The contraction may have come as a surprise due to the economic growth (3.1%) in the previous quarter.

As you can see in the graph published by the New York Times, military spending dropped by 22%, dwarfing the almost 6% decrease in exports.

NYT GDP Shrinks, 2

This drop obscured the more positive economic developments such as an increase in personal consumption (2.2%), nonresidential investment (8.4%), and private residential investment (15.3%).

Of course, Republicans and Democrats have reduced themselves to the usual finger pointing after the Commerce Department released the unfavorable findings. However, there are two things that are interesting about this “stunning” and “unusual” development. One, it is possible that the contraction in the US economy should not have come as a surprise. This case of the negative economic growth, I suggest, may represent a case of “planned shrinkage.” Coined by New York City’s Housing administrator, Roger Starr, during the city’s fiscal crisis of the 1970s, planned shrinkage was a strategy of redistributing resources from one sector of government to another, which amounted to drastically cutting government services for the poor. Starr was heavily criticized for floating the idea, but members of the city’s crisis regime–the Emergency Financial Control Board (EFCB) and the Municipal Assistance Corporation (MAC), and eventually Mayor Ed Koch adopted the austere spirit in the approach. They planned to reestablish NYC’s solvency by shrinking the city’s welfare state.

Fast-forward a few decades…

Remember when Democrats allowed the Republicans to manufacture a crisis because they did not raise the debt ceiling after the midterm elections in 2010? Also, remember when the Republicans and Democrats devised a strategy of dealing with the deficit that included implementing steep cuts in federal spending if they did not address the national debt?  Well, we just saw Starr’s strategy of planned shrinkage at work since Republicans and Democrats could not come to an agreement in 2011 (See my previous post on the “rolling crisis”).

Two questions emerged after learning yesterday’s report. Should Americans continue to see austerity a viable strategy in addressing economic crisis, even in the face of a long-term deficit? And who pays the price for economic growth?

Some conservatives lament that raising taxes, especially those in the higher tax brackets, in a recession deters investment, job creation, and thus recovery and growth.  Some liberal economists like Paul Krugman and Robert Reich argue that austerity is bad short-term policy because government cuts will stymie recovery and hamper the government from taking more proactive steps in confronting economic crisis (i.e. hiring workers to perform needed tasks such as redeveloping infrastructure). Several observers addressed the first question and echoed the first part of the above argument  in the wake of the bad news (bad, depending upon who you ask).

The Daily Beast’s Daniel Gross wrote:

“But the real culprit this time was the federal government. We’ve noted this time and again, but it bears repeating. We are having a conservative recovery. Federal government spending may be up, on health care, entitlements, and benefits. But pretty much everywhere else in the vast government sector, spending is down – especially on employment. Since May 2010, some 1.072 million public-sector jobs have been cut.

Austerity, it turns out, detracts from growth. In the fourth quarter, declining state and local government spending reduced GDP by 8 basis points. But the real drag on growth in the fourth quarter was the federal government, and especially the Pentagon. Defense spending plunged 22.2 percent, subtracting 1.28 percentage points from the growth rate. The decline is partly due to the continuing drawdowns from Iraq and Afghanistan, and partly due to seasonal spending factors (defense spending in the third quarter actually rose sharply.) But there’s a third factor at work: ‘A likely explanation for the sharp decline in Federal defense spending is uncertainty concerning the automatic spending cuts that were scheduled to take effect in January, and are currently scheduled to take effect on March 1st,’ [head of President’s Council of Economic Advisers] Alan Krueger noted.”

In the New York Times story on the economic contraction, economist Nigel Gault said that the economy would have expanded if it were not for the drop in government spending. Gault, according to the NYTs, proceeded to argue that “steep cutbacks make for risky economic policy” in the short term.

In a story published on The Hill, Mark Zandi, chief economist at Moody Analytics  maintained that the Commerce Department may revise its numbers for the final quarter. However, he too argues that the package of spending cuts on the horizon—the March 1 sequestration—will also have a negative effect on the economy. The cuts “are going to hurt,” Zandi said.

It is ironic is that I, as someone who does not support war making, am talking about military spending cuts. Some may think of this development as a case of chickens coming home to roost–in one way, the Defense Department is taking a hit for due to the ending of $1 trillion “wars on terror” in Afghanistan and Iraq during the Bush years. I agree. But we should not get too carried away with this sort of poetic justice.  Thanks to the impending sequester on March 1, we are staring cuts in non-defense programs like students loans and medicare (cuts for providers) in the face. So, for anyone who is thoroughly anti-defense, or just skeptical of a growing military-industrial complex, yet pro-growth, then there is a chance that more cuts could hinder a slowly recovering economy. Ultimately, though, the persistence of austerity means that many of us workers, students, and in this case, medical providers will continue to pay the price for recovery.

So much for the “crazy” Paul Krugman, Robert Reich, and Joseph Stiglitz remaining the lone voices in the wilderness warning us about austerity.

I will post a discussion Ed Koch’s legacy more on Monday or Tuesday.

Coda

Economic observers predict that the economy will pick up in this quarter in during this year (Some point to housing and investment in Hurricane Sandy recovery representing two reasons. Yay for creative destruction!). Unfortunately, it may be less likely that the idea of austerity will appear less logical after the Commerce Department’s findings. And with austerity and a fixation on the long-term deficit remaining the only strategy for growing the economy in the short-term,  we remain caught in an upsetting bind.  We watch some “anti-government” politicians, as President Bill Clinton refers to them, restrain the federal government from taking on a reasonable role in pulling Americans out of recession (i.e. employing Americans to rebuild infrastructure), while many corporations in the private sector continue to withhold cash they could use to invest in jobs. Of course, they wait for a “better business climate”–basically more deregulation and supply-side tax policies, which actually played a role in creating the recent economic crisis. 

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Posted in: Politics