Here's how he starts off...
Like many American economists, I've learned macroeconomics from an American perspective. But America is a very unusual country. For instance, US RGDP growth has averaged about 3% for the past 120 years, if not more. Most business cycles are fairly small, partly reflecting the fact that our economy is well diversified. If Nevada is in recession, Massachusetts may be growing, or vice versa.At first glance this doesn't seem unreasonable. We have around 50 states... and each state helps us hedge our bets... so as a country we're pretty safe.
But at second glance... each state is a collection of counties... and each county is a collection of businesses... so why should we be seeing any cycles?
Sumner is essentially arguing that the country is diversified... but the states are not...
1st tier (country) = diverse
2nd tier (state) = uniform
Nevada only supplies gambling... and Florida only supplies oranges. If there's a bad freeze in Florida... the entire economy is still ok because Nevada's gambling adequately offsets the loss of Florida's oranges.
Here's some confirmation...
If all the booms and busts of recent years have taught states anything, Muro said, it’s that it is dangerous to rely too much on one industry for economic growth—especially if that industry is as volatile as real estate or oil. After the last time oil prices crashed, in 1986, bringing the Texas economy down with them, the state government made a point to broaden its economy into other areas. In the wake of the recent recession, the governor’s office and others claimed that Texas has successfully expanded into industries outside of the oil sector—especially the kinds of newer, fast-growing ones, such as tech, that have made places like Silicon Valley so successful. The Internet scene in Austin was particularly celebrated. “Texas has made a concerted long-term effort to build a broadly diversified economy that allows job creators from a wide variety of sectors and industries to thrive here,” Lucy Nashed, a press secretary for Perry, told me. She said that “will allow the state economy to weather the inevitable ups and downs of the economic cycle better than less diversified economies.” But, Muro noted, “The question is, given what is happening in oil and gas, how far along has that diversification proceeded in Texas?” - Vauhini Vara, How California Bested Texas
Clearly it's possible for any entity... from individuals to states to countries to the world... to be inadequately diversified. Back to Sumner...
Other economies don't seem to adhere as closely to a stable trend line. Japan did very poorly in the 1940s, then raced ahead for decades, and has seen little growth since the early 1990s. Even smaller economies such as Latvia, Estonia, Iceland and Greece have seen spectacular booms followed by huge busts.
Ok. These smaller countries are inadequately diversified. Therefore, the solution should be to increase their diversification. Right? Well...
America would be able to support a public debt equal to 100% of GDP. But unlike Krugman, I believe the Greek situation in 2007 was "wildly irresponsible." Greece needed to run budget surpluses during the boom years, so that it would have the resources to do fiscal stimulus during a depression. Instead they ran a very large budget deficit during the boom period.
Eh? The solution isn't to increase diversification? The solution is fiscal stimulus? Here's more of the same...
I would certainly not believe a 10% over capacity estimate for the US economy in 2007, but I don't find it all that implausible for Greece. Suppose your economy is sucking in lots of foreign workers for a real estate boom. The boom ends and the foreign workers leave. Now your "natural rate of output" is lower, as you have less labor. The outflow of Mexican labor after 2007 was not enough to cause a big drop in the US natural rate, but in a smaller economy like Greece, or Nevada, or Dubai, that sort of shock to capacity output could be much more significant.
In the 1999-2000 boom the US government did run a budget surplus, and I believe Krugman supported that policy. He once suggested that President Bush made a mistake by cutting taxes and putting us back into a structural deficit. I'd argue the same applies to Greece (and Iceland, Estonia, etc.). Countries with those sorts of wild swings between boom and bust need to run surpluses during the good years. Because Greece did not do so, it is now forced to beg for loans from others. Its creditors know that it is unlikely to be able to repay those loans, and not surprisingly are reluctant to grant even more loans without some pretty strict conditions attached.
Sumner starts off his blog entry by saying that America doesn't have wild swings because we are adequately diversified. But here he's saying that countries with wild swings need fiscal stimulus.
I find it hard to believe that Sumner is under the impression that Greece is too small to diversify. Perhaps he's implicitly assuming that diversification isn't, for whatever reasons, tenable?
My hero is Deng Xiaoping... so I'm definitely a huge fan of practical/marginal improvements. Allowing taxpayers to allocate 1% of their taxes? Awesome! A tiny step in the right direction is still a step in the right direction.
Hedging, however, is based on the premise that steps can be in the wrong direction. Pragmatarianism is a step in the right direction because it increases the quantity of steps and directions.
There's a subtle but important distinction that needs to be made. The heart of the issue really isn't to increase diversification. People are already diverse. Sure we could be more diverse as a species... but the real issue is that our natural diversity is blocked by top down control of the economy... aka "conceit".
Here's what Adam Smith wrote over 200 years ago...
If bankers are restrained from issuing any circulating bank notes, or notes payable to the bearer, for less than a certain sum, and if they are subjected to the obligation of an immediate and unconditional payment of such bank notes as soon as presented, their trade may, with safety to the public, be rendered in all other respects perfectly free. The late multiplication of banking companies in both parts of the United Kingdom, an event by which many people have been much alarmed, instead of diminishing, increases the security of the public. It obliges all of them to be more circumspect in their conduct, and, by not extending their currency beyond its due proportion to their cash, to guard themselves against those malicious runs which the rivalship of so many competitors is always ready to bring upon them. It restrains the circulation of each particular company within a narrower circle, and reduces their circulating notes to a smaller number. By dividing the whole circulation into a greater number of parts, the failure of any one company, an accident which, in the course of things, must sometimes happen, becomes of less consequence to the public. This free competition, too, obliges all bankers to be more liberal in their dealings with their customers, lest their rivals should carry them away. In general, if any branch of trade, or any division of labour, be advantageous to the public, the freer and more general the competition, it will always be the more so. - Adam Smith, Wealth of Nations
And here's what Jeffrey Friedman wrote a few years ago...
Clearly the regulators were predicting that steering banks’ leverage into highly rated MBS would be prudent. This prediction proved disastrously wrong, but the Recourse Rule heavily tilted the field toward banks that went along with the regulators’ prediction. Heterogeneous behavior among competing enterprises normally spreads society’s bets among the different predictions (about profit and loss) made by various capitalists. Thus, the herd mentality is a danger under capitalism, as under every other system. Yet regulation produces the equivalent of a herd mentality by force of law. The whole point of regulation is to homogenize capitalists’ behavior in a direction the regulators predict will be prudent or otherwise desirable. If the regulators are wrong, the result is a system-wide failure. “Systemic risk regulation” may be a contradiction in terms.
Neither capitalists nor regulators can use crystal balls to avoid making bad bets. That highly rated mortgage-backed securities would be prudent turned out to be a very bad bet. But we all suffered because this bet was imposed by financial regulators on the whole system. - Jeffrey Friedman, What Caused the Collapse?: An Exchange
... and here's what Joseph Stiglitz wrote...
Centralization is like putting all of one's eggs in one basket: just as we now recognize the greater advantages of portfolio diversification in allocating one's wealth, so, too, there are great advantages of diversification in allocating decision making powers. We need only dwell a few minutes on the evils wrought in this century as a result of the concentration of power in the hands of a few individuals. - Joseph Stiglitz, The Invisible Hand and Modern Welfare Economics
... compare it to what James Gwartney wrote...
A recent survey by the Federal Reserve Board indicated the wealthiest 2 percent of American households own 28 percent of the nation’s physical property. At first glance, this appears to be enormous power in the hands of a few people. However, reflection should cause one to question this view. This wealth, enormous as it is, is in the hands of 1.6 million households, representing diverse political, religious, ethnic, and personal interests. Unless it is used to provide services to others in exchange for income, the wealth of these property owners will shrink. Compare the power of these wealthy households with the power of 536 elected federal office holders. This latter group, comprising just .0000025 percent of our population, determines how one-quarter of our national output is allocated. They tax approximately one-fifth of our national income away from earners and allocate it to nonearners. They set the dollar value of the social security benefits received by thirty-six million Americans. The regulatory power under the jurisdiction of the 536 individuals holds a life or death grip on the economic health of literally millions of businesses. In contrast with private owners, members of Congress have the power to take property, a portion of your earnings for example, without your consent. One could go on and on, but the point is clear. When government ownership is substituted for private property, enormous power over the lives of others is bestowed upon a small handful of political figures. One of the major virtues of private property is its ability to check the excessive concentration of economic power in the hands of the few. Widespread ownership of property is the enemy of tyranny and abusive use of power. This proposition is just as true today as it was a couple of hundred years ago. - James Gwartney, Private Property, Freedom and the West
Back on the topic of frozen oranges...
Farming is inherently risky. Weather, insects and disease, over which you have limited control or none at all, can wipe you out. One of the ways farmers manage risk is to plant variety. Okay, powdery mildew got your strawberries, but the broccoli’s going gangbusters. For farmers, crops that are given guaranteed protection from both losses and price drops are lower-risk propositions. - Brian Stauffer, Farm bill: Why don’t taxpayers subsidize the foods that are better for us?
Back to Adam Smith...
When a great company, or even a great merchant, has twenty or thirty ships at sea, they may, as it were, insure one another. The premium saved upon them all, may more than compensate such losses as they are likely to meet with in the common course of chances. - Adam Smith, Wealth of Nations
Yeah, we're going to need a larger megaphone.
Let's review...
Sumner is saying that fiscal stimulus is necessary because some countries aren't diversified. I'm saying that if fiscal stimulus is ever necessary... then the solution really isn't fiscal stimulus. The solution is to decrease government centralization/control. This will allow inherent diversity to naturally flourish... which will eternally eliminate the need for fiscal stimulus.
Pragmatarianism is the best way to decrease government centralization. Taxes will still be there... the difference is that a much greater diversity of people will choose where they go. Hedging bets is just as important in the public sector as it is in the private sector.
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