A War Economy

By Galbraith, James K. | The American Prospect, October 22, 2001 | Go to article overview

A War Economy


Galbraith, James K., The American Prospect


... But without the Usual Wartime Stimulus?

IN A WAR ECONOMY, THE PUBLIC obligation is to do what is necessary: to support the military effort, to protect and defend the home territory, to stabilize the economy itself, and, especially, to maintain the physical well-being, solidarity, and morale of the people. These may not be easy tasks in the months ahead.

We are facing an economic war--but not exactly a war economy. That means we get the dislocation without the usual growth. The impact of the September 11 attacks now includes a 14.4 percent drop in stock prices in the first week and collapse in sectors related to travel and leisure, notably airlines, hotels, and resorts. As these events cascade through the economy, they will weaken fragile household balance sheets and precipitate steep cuts in consumer spending. This, in turn, will deepen layoffs and depress economic activity. The ensuing recession could be severe.

This is not merely a shock to a healthy system, requiring only limited measures to restore confidence and stimulate spending. Since 1997 consumers have been financing consumption in excess of income. Those who had stock-market winnings borrowed against them. Those who did not borrowed anyway. But capital gains turned negative 16 months ago, and consumers are in no position to borrow more. What has happened since September 11 consolidates and accelerates a pullback that was already well under way.

Estimates last summer by my Levy Institute colleague Wynne Godley were that unemployment would have to rise to 7.4 percent just to bring household expenditures into line with income. Unemployment would rise as high as 9.0 percent, Godley estimated, if households returned to normal post-World War II saving levels. That was before the recent events.

There is thus no chance that events will right themselves in a few weeks or that we will be saved by productivity growth, as Federal Reserve Chairman Alan Greenspan professes to believe; nor will the economy be rescued by lower interest rates or the provisions of the recent tax act, most of which take effect after 2004. Rather, we are in for a crisis; the sooner this is recognized and acted upon, the better.

NORMALLY IN WARTIME, LARGE-scale support to the domestic economy is not needed, because of vast increases in military expenditure. But what we face so far is a veneer of military action over a worldwide diplomatic and police offensive. In a $10-trillion economy, the $40 billion already appropriated for the military and for relief is minor.

Including the airline bailout, further programs exceeding $100 billion may soon appear, including unemployment insurance, extended tax rebates, and payroll-tax relief. But all of this is not likely to be sufficient. Indeed, the concept of "stimulus" should be discarded in favor of the objective of economic stabilization--implying a sustained effort commensurate with the crisis as it unfolds.

Business and capital-gains tax cuts are useless here. Without profits, reduced taxes on profits have no effect. And without sales, investment is riot likely even if the tax regime favors it. The logic and also the motives of those proposing such measures are to be suspected. All wars attract profiteers.

Personal tax cuts pose another problem, even if aimed properly at working households: They may not be sufficient if anxious consumers are in a mood to increase their reserves. Of the available tax-cutting options, temporary cuts in payroll taxes are the best, since they will immediately boost take-home pay. Shibboleths about the Social Security trust funds should not stand in the way of this simple and progressive measure. And if Social Security reserves contribute to relief of the present national crisis, then we have a solemn moral obligation not to use that contribution as an excuse to cut benefits later. To repair the long-term damage to federal finances, Congress should repeal the tax cuts scheduled to take effect after 2004. …

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