Missing the Point on the Economy

As Congress and the Administration debate how to spark an economic recovery—a goal that seems to be receding every month—none of the discussion addresses  the one policy that could actually get adopted with bipartisan support and make a difference:  expanded reliance on energy efficiency. This is a critical mistake.

Paul Krugman warns in his New York Times column that policymakers in Washington and Brussels are making critical errors in their handling of the current economic slump, which he calls the Lesser Depression. On the same day, Matt Miller chastises S&P for its single-issue focus on the federal deficit as a threat to the security of U.S. debt obligations. Both writers are concerned that too much attention is focused on government deficits; both agree that reducing the deficits both at home and in Europe is important, but cite other problems with the economy that they assert are equally important.

Lest we forget about them in the midst of the partisan posturing on deficits, the other problems are ones that economists from all points on the political spectrum would agree with (as well as accepting the proposition that deficits are a problem, even while disagreeing on how to solve it).

The other causes are:

• The mortgage meltdown
• The risk of inflation
• The large trade deficit
• The low savings rate
• Weak consumer/business spending
• Too few jobs

As long as we do not address all of these causes of economic decline, we are unlikely to emerge from economic stagnation.

“Prosperity is just around the corner”

Economists seem to think that the economy will recover naturally, as water flows naturally downhill, without providing any objective reason things should get better. As the months go by, they are surprised that the recovery, such as it is, is weaker than their models predict, and readjust the models so that they predict that things will get better in six months. “Prosperity is just around the corner,” say the models.

(For those of you who do not recognize the quote, it is from President Hoover in 1932. Prosperity turned out to be over a decade away, even with vast economic recovery efforts by his successor. And balancing the federal budget was a major goal of economic policy though 1932, supported at the time by both parties.)

The Importance of Energy Efficiency

These seven elements are widely accepted as important by economists on the left, the right, and the center. And what do they have in common? The answer, which most policy makers are unaware of, is that all of them are the consequences of weak policies on energy efficiency.

The reasons are explained in detail in Invisible Energy, and more simply in my previous blogs:

The mortgage meltdown was caused by many factors, most of which are well understood but one of which is ignored or forgotten: the fact that lenders considering whether a family could afford to pay back a $200,000, 30-year loan ignored the effect that transportation expenses (more than $300,000 over the same 30 years for a house in urban sprawl) and energy ($75,000) would have on their ability to make their payments. As a result, defaults are roughly 1/3 higher in sprawl than in more compact suburbs, controlling for all other factors.

And this hasn’t changed since we first realized that America was facing a mortgage default problem. The banks have tightened traditional lending criteria, making it harder for most families to buy a house and depressing the construction market, but by ignoring transportation and location expenses, they may not be doing much to solve the default problem. In fact, with gas approaching $4 a gallon, the cost of transportation is now likely to exceed $350,000.

The problem of low consumer demand could perhaps be solved by pumping up the economy, but this would increase the deficit and hurt savings, and could eventually lead to inflation. Similarly, the problem of too few jobs could be helped by a public works program like WPA, but this would exacerbate the deficit problem. The fed could print money, which would depress the dollar and raise inflation, but this might increase spending and help the trade deficit. Note that the trade deficit is dominated by energy imports and the high oil prices that are the consequence of excessive demand.

Tackling All Seven Problems at Once

Thus we see that by trying to solve one of these seven problems in isolation, we can make the others worse. That is the risk of an obsessive focus on federal deficits. If we cut federal spending, we will worsen the job situation and exacerbate the weaknesses of consumer and business spending.

The only policy option that can address all seven problems at once is a greatly expanded program for energy efficiency. If we encouraged demand for energy- efficiency investments — and there are hundreds of billions of dollars a year that could be spent — the returns on investment from energy we would no longer need to buy are so large that the borrowing would all be paid back in 3 years or so.  The jobs produced would be almost entirely local, rather than abroad. Less demand for energy would undermine the main basis for inflation.

This may not be enough all of itself to make the economy recover next year, but it relies on policies that are compatible with both conservative and progressive ideologies, and thus could actually be agreed to and enacted. Some amount of recovery that wouldn’t have happened anyway is a lot better than none.

While efficiency policy alone may not be enough to restore prosperity quickly, then again it may. We should at least try it and find out.