by Adam Tooze
Other Asia
13.5
19.5
16.9
Europe
2.3
12.6
11.9
US
66.5
32.8
35.9
ROW
10.2
17.1
13.9
100
100
100
Sources: Author’s calculations from IMF, “Update on Fiscal Stimulus and Financial Sector Measures,” April 26, 2009, combined with PPP GDP data from Maddison Project, http://www.ggdc.net/maddison/maddison-project/home.htm.
Chapter 12
STIMULUS
Down a “road to hell” was where the United States was headed.1 Those were the words of Mirek Topolánek, the lame duck prime minister of the Czech Republic, addressing the European Parliament on March 25, 2009. The embarrassment was that he was not just another Central European conservative. He was speaking in his capacity as president of the European Council just days ahead of the London G20. The economic policies of the Obama administration would destroy confidence, the Czech pressed on. Surging deficits and giant bond sales would “undermine the liquidity of the global financial market.”2 They were fighting words. Everyone knew that conservatives on both sides of the Atlantic were suspicious of Obama’s administration, but a “road to hell”? Some wondered whether the translators could possibly have got it right. The New York Times reached for history. Perhaps as a survivor of decades of Communist tyranny, Topolánek had a particular allergy to state intervention. President Sarkozy didn’t care. He was furious. How could a jumped-up East European minnow be talking about America that way, and on behalf of Europe, to boot? In London Sarkozy upbraided the Czech about his inappropriate tone. On the back foot Topolánek offered a rather less trite and more disarming explanation. Far from being inspired by the horrors of Stalinism, the phrase had popped into his head after an evening spent listening to the heavy metal classic Meat Loaf’s “Bat Out of Hell.”3
Whatever the idiom they expressed it with, what stirred conservatives on both sides of the Atlantic in early 2009 was outrage at the first major legislative initiative of the Obama administration: what would become known as the “Obama stimulus,” the American Recovery and Reinvestment Act. Pushed with urgency by the Democrats, it passed the House already on January 28, 2009. At the new president’s insistence it was debated in the Senate in a special weekend session and voted through on February 10. A week later, on February 17, Obama signed the spending package into law. It was the largest measure of fiscal stimulus undertaken in the West in the wake of the crisis and the largest in American history. By the same token, it instantly polarized the economic policy arena on both sides of the Atlantic.
I
Obama’s team never doubted the need to act. Over the winter of 2008–2009 America’s economic situation was deteriorating fast. Jobs were hemorrhaging. Detroit was on its knees. There was a pervasive sense of crisis and a need for renewal. The political stakes were obvious. It was the drama of the financial crisis in September and October 2008 that had broken McCain’s campaign and handed a huge electoral victory to Obama. The atmosphere of hope and expectation that surrounded his inauguration was electrifying. Many projected onto the new president expectations of almost revolutionary change. Not only had Obama brought the advancement of African Americans to a new stage, evoking memories of Martin Luther King Jr. Coming into office in the midst of the financial crisis, he could not escape comparisons to FDR and his famous first “hundred days.” And as if King and FDR were not enough, the newly elected president invoked another era of Democratic Party optimism. He wanted to offer the new generation a Kennedy-style moon-shot mission.
Whatever the Obama administration did, it would have to be huge for the simple reason that the twenty-first-century American economy is huge. GDP in 2008 was c. $14.7 trillion. To have a meaningful impact the stimulus would, therefore, need to be enormous. The problem was that Congress had a hard time dealing with this elementary fact. As the controversy over TARP indicated, a proposal that the federal government should spend a trillion dollars on work creation was likely to cause indignation, panic or both. So the approach the transition team devised was cautious. They would propose $775 billion to the Democratic Party leadership and hope that the notorious log-rolling tendencies of Congress would take the final total close to $1 trillion.4 If Republican support could be bought with further tax cuts or more spending, the more the better.
Despite the radical expectations projected onto him, Obama was by inclination a bipartisan centrist. What he had not reckoned with was the sheer violence of the conservative hostility toward him. There was no possibility of bipartisanship. Whereas at least a minority of Republicans had voted with the majority of the Democrats to pass the Fannie Mae and Freddie Mac bailouts and TARP, in January 2009 in the House of Representatives not a single Republican voted for the American Recovery and Reinvestment Act, despite the tax cuts with which it was festooned.5 In the Senate only three did. It was a warning of the depth of partisan hostility the Obama administration would face. From the outset of his presidency, a large section of Republican opinion effectively denied the legitimacy of Obama’s leadership. At the grassroots this expressed itself in the “birther” conspiracy, doubting Obama’s status as a natural-born citizen. In Congress it manifested itself in a stance of absolute opposition. America’s right-wing think tanks mobilized in force to denounce the bailouts and to discredit the stimulus and the financial regulations to come. By the spring the wave of antigovernment indignation that dubbed itself the “Tea Party movement” would roil the base of the Republican Party and hog the television news cycle. In the background, billionaire “dark money” donors, led by the Koch brothers, stirred the pot.
In 2009 the Republicans were in a minority in both the House and the Senate. But their relentless guerrilla war and the drumbeat of their media outlets had real and immediate effects.6 Above all they shifted the balance within the broad-church coalition of the Democratic Party. The fact that the administration needed the Democrats to vote en bloc in favor of the stimulus gave leverage to so-called moderates—the Blue Dog Coalition and the New Democrat Coalition—free-market, antispending Democrats who were anxious to preserve their hard-won probusiness credentials.7 As a result, rather than bidding the stimulus up from $775 billion, the congressional “moderates” tended to whittle it down. The result was less substantial than the Obama team had hoped for and less than the US economy needed. The headline for the American Recovery and Reinvestment Act was $820 billion. In actuality it was more like $725 billion in new money, $50 billion less than where the Obama team had started.
Politics dictated not just its size but its shape. The president wanted big-ticket items of innovation. But Obama’s chief of staff, Rahm Emanuel, and his political team were always skeptical that the president’s infatuation with the environmental agenda and green growth would sell. What Capitol Hill wanted were tax cuts and spending programs targeted to please key constituencies. Ultimately, $212 billion of the stimulus went into tax cuts and $296 billion toward improving mandatory programs such as Medicaid (health coverage for lower-income groups) and unemployment relief. This left $279 billion for discretionary spending, of which the president’s priorities of green energy and improvements to broadband received $27 billion and $7 billion, respectively.8 Altogether, the stimulus would patch up or replace 42,000 miles of road and 2,700 bridges. But unlike in the era of the New Deal, there would be no eye-catching lo
gos, no charismatic monuments like those left by the Works Progress Administration.9
Nevertheless, it was substantial. In absolute terms it was on a par with the spending of the New Deal. Though it was smaller in relation to a much larger national economy, the Obama stimulus was concentrated over a shorter space of time.10 In 2009 it placed America alongside the Asian states in the league of activists, outstripping any discretionary fiscal measures taken in Europe. And it worked. Despite the protestations of “freshwater” free-market economists and the complex economic arguments directed against “naïve” Keynesian “pump priming,” every reputable econometric study found that the Obama stimulus had a substantial positive impact on the US economy.11 Estimates by Obama’s Council of Economic Advisers put the number of jobs created at 1.6 million per year for four years, for a total of 6 million job-years.12 The multiplier was positive and above 1. This implies that the effect of government spending on the economy was not just positive. More private economic activity was stimulated than the government originally contributed. So the impact of the government’s spending was to shrink the government’s share in overall economic activity.
But if this was the case, if the stimulus worked, why didn’t the Obama administration ask for more?13 There were political risks in asking for a figure bigger than $1 trillion. But there were risks to undershooting as well. By 2010, America’s unemployment was still stuck above 10 percent. Foreclosures and forced sales were destroying entire communities. Millions of young people left schools and colleges without jobs. Men and women in the prime of life were shut out of the workforce. Many would not return. In the elections of 2010 and 2012 the Democrats fought on the back foot against the backdrop of a limping economy and resurgent Republican activism. They retained the presidency but lost control of Congress. Obama’s administration never built the constituency of Democrats-for-life that was shaped by Roosevelt’s New Deal. Given that they commanded majorities in both the House and the Senate in 2009, why did the Obama team not set the bar higher and pitch for an even larger number? If maximum force was the best approach to financial stabilization, why, when it came to fiscal policy, was the approach so penny-pinching?
Part of the answer is that the transition team did not fully grasp the scale of the tsunami that was descending on the US economy. From preparatory documents circulated within the transition team in early January 2009, we know that the worst-case scenario envisioned by Obama’s staff was for unemployment to reach 9 percent with no stimulus.14 In fact, even with the largest government-spending program in American history, unemployment topped 10.5 percent. But despite this underestimate, it is clear that the top macroeconomists in the Obama transition team did, in fact, realize that the stimulus ought to be bigger. On December 16, 2008, Christina Romer submitted a report intended for the president-elect arguing that to close the “output gap” by the first quarter of 2011 would require a discretionary stimulus of $1.7–1.8 trillion. Romer’s modeling was conventional. Her figures were sound. Her proposal was a trillion dollars larger than the figure the Obama team ultimately pushed through Congress. What decided the issue was politics, or rather the self-censorship of the economics team in the name of politics. Second-guessing the attitude of Chief of Staff Rahm Emanuel and his political operatives, Larry Summers, as head of the National Economic Council, was convinced that he and Romer would lose all credibility if they suggested anything even close to the figure she thought necessary. The results of Romer’s calculation were, Summers quipped, “nonplanetary.” He did not want to jeopardize the influence of the economics team by appearing naïve and “unsavvy.” The effect was to skew the argument from the start. No figure in excess of $900 billion, half of Romer’s baseline, was ever proposed. A similar deflationary calculus ruled out any dramatic and direct action on home-owner debt.
The great political might-have-been of the early Obama administration is why, alongside TARP and the fiscal stimulus, the White House did not start by pushing a comprehensive relief program for home owners.15 While the banks and lenders were bailed out, 9.3 million American families lost their homes to foreclosure, surrendered their home to a lender or were forced to resort to a distress sale.16 The measures that the administration did develop to offer mortgage rescheduling were derisory in their impact. In response to criticism, Larry Summers has subsequently insisted that the question of home-owner relief was a constant subject of debate within the administration.17 He convened regular monthly meetings with the Treasury and the other key agencies to challenge them to come up with better options. No mechanism that was effective, efficient and politically feasible emerged. There were basic obstacles. A program to help millions of distressed borrowers would have had to have been gigantic in scale. Forgiving loans on a substantial scale would have implied losses for the banking system at a time of financial uncertainty. And it would have caused a huge uproar in Congress, where the administration needed to husband its political capital, not so much with Republicans, from whom nothing was to be expected, but with the moderate congressional Democrats. It was a price that Summers, Emanuel and Treasury Secretary Geithner were not willing to pay.
What became evident in the spring of 2009 was that the historical memory that was most alive in the Obama administration was not that of FDR or JFK but that of the last Democratic administration, under Bill Clinton in the 1990s. It was the Hamilton Project’s vision that prevailed in the Obama camp. In the face of the crisis the Democrats would prove themselves not as bold or imaginative but as sound managers of the economy whose task it was to put right another era of Republican misrule. Though in 2009 no one dissented from the need for an immediate stimulus, the Obama team was profoundly committed to the legacy of their mentor, Robert Rubin.18 Summers, Geithner and Peter Orszag, Obama’s director of the Office of Management and Budget, were all veterans of the 1990s Treasury. Orszag and Rubin had argued in 2004 that government deficits would not only squeeze private investment but could set up a negative spiral of confidence and expectations and might trigger a sudden panic in financial markets.19 Faced with the huge deficits produced by the financial crisis of 2008, there was, thus, no contradiction between the maximum-force approach to bank stabilization and the cautious approach to fiscal policy. Concern for confidence in the financial markets was their common denominator.
II
Despite its notable scale, its effectiveness and the political controversy it stirred up, the Obama stimulus was hedged around by political compromise. Furthermore, despite the urgency with which Congress acted, the stimulus was bound to come too late. Spending programs take months, if not years, to be put to work. The discretionary spending component of the Obama stimulus did not begin in earnest until June 2009, at which point the labor market was close to bottoming out.20 The less commonly noted corollary is that the open-handed fiscal stance of the first year of the Obama administration was in large part an inheritance of decisions and nondecisions made in 2008, while the future president was still in the Senate.
In January 2009, as a result of the standoff between the Bush administration and congressional Democrats, the federal government was operating without a regular budget and was headed toward an unprecedented deficit in excess of $1.3 trillion. It was a political mess and a daunting fiscal hole, but, as far as the economy was concerned, it was precisely what was needed.21 Part of the reason why Congress had refused to approve the budget presented to it by the Bush administration a year earlier was because it thought it was based on hopelessly unrealistic economic forecasts. Even as the real estate crisis began to make itself felt, the White House projected a deficit of only $407 billion for 2009. The administration called for $3.1 trillion in spending, and at prevailing tax rates assumed that revenue would come to $2.7 trillion. Congress doubted both figures and was proven correct. Thanks to the recession, revenue between September 2008 and September 2009 slumped to $2.1 trillion. Meanwhile, spending soared to $3.5 trillion, including a $151 billion installment for TARP and a first tr
anche of $225 billion on the Obama stimulus. Fighting over TARP and the Obama stimulus made good political theater for all sides. The programs were significant in their economic impact. But the largest part of the fiscal stimulus of 2009 came as a result of the budget standoff of the preceding year and the collapse in tax revenue due to the recession.
Automatic stabilizers are the unsung heroes of modern fiscal policy. In the United States, no more than one third of federal government spending is discretionary. The rest is made up of mandatory expenditures required by existing “entitlements,” social programs such as unemployment and disability benefits, or retirement pensions. These tend to increase during a recession. Likewise, tax revenue flows into Treasury coffers at preexisting rates of taxation and contribution levels, driven not by political decisions but by the fluctuating fortunes of the economy. Dominated by these nondiscretionary flows, modern state budgets have a powerful stabilizing effect on the economy. As economic activity declines and the economy calls for stimulus, tax revenue falls, entitlement spending increases and the government deficit automatically expands.
Viewed in these terms, the effect of the crisis of 2007–2009 on the budgets of rich countries was spectacular. Whatever the politics of stimulus spending in Congress, the Bundestag or the House of Commons, the automatic stabilizers delivered a huge and timely stimulus. According to calculations by the IMF, if the US economy had been at full employment in 2009, the crisis-fighting policies adopted by the Bush and Obama administrations would have been enough to produce a deficit of 6.2 percent of GDP—this was the discretionary deficit. The actual general government deficit was 12.5 percent of GDP.22 More than half the support provided to aggregate demand was automatic or quasi-automatic. And this was typical of all advanced economies. According to the IMF’s calculations, of the vast increase in public debt in the developed world over the course of the crisis, just under half was due simply to the reduction in revenue produced by the contraction of the tax base. As profits, wages and spending all declined, this automatically generated a deficit and thus an offsetting public stimulus. This puts a rather different perspective on the fiscal policy battles at the G20. Though Germany, France and Italy steered clear of the kind of stimulus package launched by the Obama administration, let alone that trumpeted by Beijing, their deficits were widening too. As the private sector deleveraged and cut its spending, they too saw huge nondiscretionary deficits. Indeed, it would have taken a heroic and truly perverse act of austerity to prevent these automatic stabilizers from coming into effect. The net result was dramatic. Between 2007 and 2011, demand in the world economy was stabilized by the largest surge in public debt since World War II.