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Structural Shifts and Bailouts

Richard Florida, sounding a skeptical note about bailouts, says we need to look to structural shifts:

The bailouts and stimulus, while they may help at the margins, also pose an enormous opportunity costs. On the one hand, they impede necessary and long-deferred economic adjustments. The auto and auto-related industries suffer from massive over-capacity and must shrink. The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy — and consumer demand — for a new round of growth. The financial and banking sector grew massively bloated — in terms of employment, share of GDP and wages, as the detailed research of NYU’s Thomas Phillipon has shown — and likewise have to come back to earth.

I think we need to distinguish between the bailouts and the stimulus here. And then within bailouts, we need to distinguish between the auto bailout and the financial sector bailouts.

So, starting with bailouts. The problem comparing the two bailouts is that social justice considerations and economic considerations point in different directions here. The auto workers are sympathetic claimants in a way that nobody in the financial sector is. But Florida’s point about the need for structural shifts has a lot more force in the auto case. In principle, the funds spent (and to be spent in the future) on the auto bailout could have been put directly into auto workers’ pockets while Chrysler and GM were put into government-sponsored debtor-in-possession financing. That would have achieved similar social justice ends without retarding necessary sectoral adjustments toward a world in which somewhat fewer automobiles are made. That said, the total quantity of funds involved in the auto bailout has been relatively small compared to the financial bailouts.

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On the financial bailouts, it’s true that the size of the financial sector needs to shrink. But the bailouts are not preventing that from occurring — it is shrinking. And hopefully it will continue to shrink, in relative terms, as we move into recovery. But the point I would make here is that it’s extremely difficult for the needed sectoral shifts to happen absent a functioning financial system. The point isn’t that we need looser credit card rules so that people can go back to spending money they don’t have on short-term consumption. But if we want there to be more employment in the future, people are going to need to start some new businesses. And some existing businesses that aren’t auto companies, banks, or homebuilders are going to have to expand. And it’s very hard to expand without the ability to access credit markets. When people say that we need to “get credit flowing again” I sometimes worry that they’re talking about re-inflating the housing bubble, or getting us back to households having negative savings. That’s credit. But credit that’s used to finance productive business activities is necessary for sustainable economic growth.

On stimulus, I think that how well this turns out will ultimately hinge to some extent on the success of the programs. In principle, the stimulus spending — which largely goes to infrastructure, to education, and to health care — ought to greatly facilitate economic transition to the kind of “creative” economy Florida’s envisioning. To the extent that that money winds up wasted on programs that are ineffective we will have bought short-term demand at the price of stalling on long-term adjustments. I’d still say that’s a price worth paying, all things considered, but obviously it’s a good deal worse than a scenario in which these investments turn out to pay off in the long-run in the form of a healthier, better educated population able to move on better transportation and take advantage of faster broadband.