Shadow Government

The ongoing problems of "stimulust"

By Phil Levy

It was not hard to predict that an Obama administration's skeptical approach to trade could cause international tension. But who ever would have thought we'd be berating Europe over insufficient enthusiasm for domestic spending?

And yet that was at the heart of last week's less-than-diplomatic lead up to the weekend meeting of G-20 finance ministers in the United Kingdom. White House aide Larry Summers, in a reprise of his past role as Treasury Secretary, called for further European stimulus. The European reaction ranged from "significant bewilderment" to outright rejection.

The U.S. theory is that we're in a Keynesian world in which any federal spending is worth its weight in economic activity and then some. There are at least two big problems with this. First, there's the most basic question: what is fiscal stimulus? The answer might seem obvious: it's an increase in government deficit spending. That, though, would be the European answer. The U.S. answer seems to be: fiscal stimulus is a new package that goes above and beyond what you were planning to do anyway.

The difference is pretty big, as a recent IMF paper showed. Countries with extensive social safety nets and high taxes see greater automatic deficit increases as welfare payments rise and taxed activity falls. That reduces the need for new legislative packages; the response is largely built-in. To take the most extreme example, Britain's stimulus package for 2010 actually shows a 0.1 percent decrease in net government spending relative to GDP under a narrow definition. But Britain's overall increase in deficit spending for 2010 is predicted to be 5.4 percent of GDP, second only to that of the United States among major nations. The difference is in the automatic stabilizers.

Why should it matter if a stimulus was built-in or delivered in a shiny new package? One might argue that gloomy consumers already knew about the built-in spending, whereas the shiny new package might surprise and stimulate them. Here we come to the second big problem with the idea of fiscal stimulus as a panacea. A big reason that fiscal stimulus had fallen out of favor in economics was that it's hard to tell a consistent story about how it will work. This problem is particularly acute when we start worrying about people's expectations.

The intellectual foundation for the administration's claim that its fiscal stimulus will create or save up to 3.5 million jobs is a short paper by Christina Romer and Jared Bernstein. It is based on old-school theorizing (i.e. don't worry about expectations). It relies critically on assumptions such as a zero interest rate in perpetuity. What if we revisit that assumption and apply some of the macroeconomics learned over the last few decades? A recent paper by former top Treasury official and Stanford economist John Taylor and colleagues does just that. It finds that the U.S. stimulus package is likely to create or save a total of about 500,000 jobs -- roughly the level of recent monthly job losses.

While the Obama administration deals with its fiscal stimulus fixation, the financial sector lurks. Without a banking fix, even beguiling new fiscal packages are unlikely to save the economy. The problem is that a financial sector fix may cost dramatically more than the administration has acknowledged. Holes in bank balance sheets have been estimated to be in the trillions. The U.S. Treasury has decided to check how bad this problem really is by putting major banks through "stress tests." In Western Europe, they're already stressed as they grapple with weakened banks with major exposure to a faltering Eastern Europe.

One European argument is that they don't want to exhaust their credit lines with this potential trouble on the horizon. The Obama administration has no such worries, planning trillions of deficits for years to come in its new budget. Perhaps it should listen to its creditor, though. Chinese Premier Wen Jiabao is worried. He just called on the the United States to guarantee the security of Chinese assets, a guarantee the United States can certainly not provide (it would require perpetual low interest rates, a fixed exchange rate, price stability, and fiscal responsibility).

While the Europeans may be more mature on fiscal discipline, they have their own obsessions. In their view, the world will be set aright if only we could all get together and regulate. The last great effort at global financial regulation was to set standards to make sure banks had enough capital to avoid a financial breakdown (the Basel II negotiations). Years of technical talks wrapped up in 2004, but the approach has not worked so well. Nor is it clear that tighter financial regulation needs to be globally coordinated to be effective.

All of this should make for a fun set of G20 talks over the next few weeks.

Shadow Government

Is Obama losing public support for Afghanistan?

By Peter Feaver

Will the American public turn on Afghanistan in 2009 the way they turned on Iraq in 2006? I have a new academic book out, co-written by my Duke colleagues Christopher Gelpi and Jason Reifler, which explains how the mounting costs of any particular war affect public support for continuing that war. Our bottom line: support for war is a function of two attitudes: the retrospective attitude of whether the war was the right thing in the first place, and the prospective attitude of whether the war will be won. Both affect public willingness to continue the war, but the prospective attitude has a bigger impact. In other words, the long pole in the tent is the public's belief that the war can and will be won.  

Many other factors affect public support -- including partisanship, general support for the president, estimations of the president's resolve, the extent of elite consensus in support of the war, and so on. But the largest is this expectation of success. When the public believes the war can be won, then they will stomach mounting costs. When the public doesn't, then mounting casualties cause public support to erode fairly quickly. Senator Kerry famously suggested that no one wants to be the last person to die for a mistake.  He misunderstood the situation. No one wants to be the last person to die for a lost cause.

Thus, the public turned on the Iraq war over the course of 2006 not because the rationale for the war eroded (the public had long since realized that Iraq's WMD programs were not as far advanced as the Bush administration had claimed), but because the war looked increasingly unwinnable. The erosion in support stabilized in 2008, when the fortunes in Iraq reversed.

This puts President Obama's Dover decision in a different light. While much of the commentary about this decision to allow the media to film and photograph the returning caskets of Americans killed in action was framed by the question of whether this would mobilize public opposition to the war (with some fearing that it might and others hoping that it would), our research suggests that it would only intensify previous attitudes - attitudes that are moving up or down on the war for deeper reasons having to do with the likely success of the war.

But this means, as my co-authors and I have argued, that Obama is living on borrowed time in Afghanistan because the public is fairly pessimistic about the situation there. According to one recent poll, they are split roughly evenly between optimists and pessimists, and as many as 60 percent in a December poll claimed the United States was not winning in Afghanistan. By way of comparison, on the eve of the midterm elections in 2006, a little over half of the American public thought we were losing in Iraq.

I have yet to find a pollster who has asked the proper prospective question -- the crucial attitude is not how things are going right now but whether you believe things will eventually go well. (By analogy, what matters is not how the cancer patient feels about the chemo treatments right now, but whether the patient believes he will eventually beat the cancer). But I suspect prospective attitudes on Afghanistan are trending negative as well.

I see little reason for public optimism to improve in the short run. For starters, the Obama Administration has not yet made a credible effort to shore up public support for the war there (or in Iraq, for that matter). The White House is understandably focused on economic issues, but they have done a fair bit of messaging on Afghanistan. This messaging has addressed the expectations issue, and it is clear that the Obama team would like to define down success to make it easier to achieve.

However, I suspect that this effort could backfire, at least insofar as public opinion goes. The message involves first acknowledging that previous goals are unattainable ("success as you previously understood it is impossible") and then persuading the public that new goals are worthwhile ("here is a better measure of success") and more attainable ("the things that doomed the earlier effort won't doom this"). That is not an impossible hurdle to clear, but it is a very high one.

The job is made more difficult because many of the secondary props of public support may be eroding. For instance, for quite a while now I have worried about the partisan divide on Afghanistan. I was struck by a poll cited by Morton Kondracke from last summer that showed only 55 percent of Democrats viewed the decision to invade Afghanistan as the right one. Republicans and Independents still supported the original decision by the super-majorities that the war had enjoyed from the beginning. In other words, most of the erosion in support had happened among Democrats. 

Fifty-five percent is still a majority, but it is a remarkably low number, given the fact that leaders of both parties have repeatedly emphasized that Afghanistan is a just war, and that Democrats in particular have labeled it the "good war." Perhaps that number has stabilized now that the Democrats "own" the war, what with the White House and both chambers of Congress under the control of the Democratic party. But I suspect that the underlying convictions that soured the Democrats on Afghanistan have not changed that abruptly.  

In light of this, the claim my co-authors and I offered -- that "[w]e suspect the public is likely to continue to believe the war in Afghanistan was right" -- probably warrants a footnote caveat or two. Support even on the retrospective question could erode (albeit more slowly than it did in Iraq) if Democrats do not rally to "their" war, or if President Obama inadvertently knocks down the case for the war by successfully implanting the idea that the terrorists who attacked us are no longer in Afghanistan but in Pakistan, and that Pakistan is the more urgent problem.

Another prop of public support is elite consensus. Right now, the public seems to be mirroring elite confusion on what to do. The most recent poll I have seen has the public equally split between increasing troops, decreasing troops, or keeping the troops in Afghanistan about the same. The military and other experts likewise seem to hold many conflicting opinions on what should be done (contrast this with this). And, for a real blast from 2006, you can't get much more retro than this: Les Gelb arguing for the Baker-Hamilton solution in Afghanistan, while Max Boot and Fred and Kimberley Kagan argue for a surge.

This is a quandary we have seen before -- in Iraq and, before that, in Vietnam. The situation stabilized in Iraq, but only after the Bush administration actually found a winning strategy (the surge) and spent virtually all of its remaining political capital implementing it. The situation never stabilized in Vietnam.  

I am sure it did not please the White House team to see Newsweek label Afghanistan "Obama's Vietnam." But the analogy may be apt in one important respect: Obama may find himself spending far more time trying to mobilize public support to continue this war than he ever expected. And if he does not find a strategy that will reverse the situation on the ground in Afghanistan -- and if he cannot explain this strategy to the American people -- then he may find public support dropping faster than he can prop it up.