Note: this is a cross-post from The Realignment Project. 

Introduction:

In part 1 of this series, I discussed the possibility of creating state economic recovery bonds that the Federal government could buy to lend its ability to deficit-spend in recessions to the state governments to counter-act their natural pro-cyclical tendencies. In part 2, I expanded on how we could adapt state governments to Keynesian economic policies by passing anti-recession budget reform initiatives allowing limited deficits during times of economic recession, establishing state banks to provide borrowing capacity for state governments, and establishing state job insurance programs.

So what remains to be done for Keynesian economic policy to be brought to the benefit of state government?

Investment Function:

Historically speaking, the economists who followed John Maynard Keynes can be grouped into two camps: fiscal Keynesians, who created a synthesis between Keynes and standard neoclassical microeconomics, and emphasized the power of aggregate spending and monetary policy, and social Keynesians, who emphasized the more heterodox elements of Keynes’ thinking, and argued that the government had to be a more dynamic actor in the economy. One of the chief arguments of the social Keynesians was that fiscal Keynesians, in their attempt to fit Keynes’ theories into the free market orthodoxy, had neglected the great man’s denunciation of the market as a tool for investment. Less well known than his arguments about aggregate demand, John Maynard Keynes had argued in the General Theory that the stock, bond, and money markets were terrible ways to distribute capital for investment, likening them to a giant casino, in which people made bets on what they thought other people would think the average man would think. Keynes argued that this process inevitably led to excesses of fear and exaltation that led at various times to over-investment, under-investment, maldistribution of capital, and general inefficiency – the government, he argued, would have to take over the investment function. And so the social Keynesians argued that it was insufficient merely to boost the level of Federal spending in recessions; the government had to use its spending power to invest counter-cyclically in those needed areas (infrastructure, for example) over the long run.

So, what do we need in order to make sure that 50-State Keynesianism can handle both the short-term consumption function (boosting aggregate demand in recessions, dampening things down in bubbles) and the longer-term investment function?

To begin with, as mentioned in part 2, the establishment of state reserve banks are a critical structure for developing a stable and counter-cyclical source of financing during recessions, both to fund the consumption function programs , and to provide the capital to keep necessary public investments running in times when the private credit markets have frozen up. However, it is only once “fractional reserve lending is combined with an agile use of the power to tax (as opposed to the 2/3rds rule in California) and a temporary suspension of balanced budget rules that individual states can muster enough financial muscle to be able to run counter-cyclically.

The second part of establishing a capacity to do long-term investments is to set up mechanisms for state planning. A State Full Employment Budget, modeled after the process outlined in the Full Employment Bill of 1945-6, would require governors to send to the state legislature an economic projection of the labor market for that year, estimating the total number of jobs that will be created by private industry, and recommending public programs to create the necessary shortfall. This would create the necessary political infrastructure for doing Keynesian policy on a regular basis, create a framework for infrastructure development and jobs programs, and incidentally is a major policy accomplishment that any progressive governor could accomplish for free. Similarly, establishing the bureaucratic organization necessary for carrying out a Swedish-style labor market policy is also a way to develop the institutional mechanisms for doing long-range, counter-cyclical investment projects.

Consumption Function:

All of this fiscal capacity to do long-term investment in recessions (in order to keep the pace of job creation, technological improvement, and the like on pace) must also be matched by an equally-strong capacity to use effective and efficient “consumption function” policies to boost incomes and employment in the teeth of a recession. As I have discussed, a Job Insurance system (backed up by state bank lending, a state Full Employment Budget, and a Labor Market Board system) can provide an extremely efficient form of such Keynesian stimulus: a job insurance system, unlike standard Keynesian spending (where money is plugged into spending, and then a multiplier effect is supposed to generate additional employment), adds to aggregate employment in the first place, and then again when the wages generated by that employment create a multiplier effect on the rest of the economy. Similarly, a state-level Unemployment Insurance program that actually covers all workers and provides a decent pension would provide a truly effective “automatic stabilizer,” rather than the sad, crippled thing we have today.

Moreover, the expansion of state EITCs (earned income tax credits) into a system of guaranteed minimum income for workers can serve as a third line of defense. In addition to re-distributing wealth to the working poor (and thus, abolish working poverty), such a system could be made into a counter-cyclical program by providing temporary boosts in recessions and then freezing the EITC during “overheats.”

Sadly, if one looks at the state of California, where the state has dramatically accelerated withholding to counter-act falling tax receipts and fill up the deficit, one sees the illogic of states following balanced-budget policies in a recession. By increasing withholding, the state partially recoups some of its lost revenue, but directly reduces the monthly take-home pay of workers, further depressing consumer purchasing power, which in turn hammers retailers, manufacturers, transport, and so on, who in turn reduce employment and order, which further reduces spending. Alternatively, with a sufficient financing system (as outlined in the previous section), one could counter-cyclically adjust state income tax withholding to boost or lower monthly income.

Fitting The Pieces Together:

With the potent array of economic policy tools outlined above, state governments should have the “state capacity” to do Keynesian economic policy in recessions. However, as critics of Keynesian policy used to point out (and it’s the rare “honest cop, guvna”), Keynesian policy is supposed to be applied in economic boom-times as well as recessions: governments are supposed to raise taxes and slash spending when overly rapid economic growth pushes inflation too high.

Naturally, this tends to be somewhat politically unpopular. However, as I’ve argued in “Linking Taxation and Spending,” I don’t think it’s automatically the case that increasing taxes and freezing spending has to be a political killer, as long as it’s done in the right way. By linking tax increases to specific policy areas – boosting the “education tax” or the “transportation tax” – and thus framed as making investments for the future, I think we can short-circuit anti-tax politics by shifting the debate towards public priorities. Similarly, freezing spending can also be reframed as saving for future initiatives, such that the public knows that spending on popular programs is not being miserly forgone, but rather delayed, can also have a positive effect.

The same institutions that could make Keynesian policy easier and more successful in recessions can also have the same effect in boom-times. For example, the Swedish Labor Market Policy system involves rebating taxes on profits if companies agree to sequester the money in restricted accounts in the state bank that are set aside for infrastructure investments (and released during recessions). When investment is running too high, these accounts can be re-frozen and the tax rate on profits can be boosted – again, reframing the issue from taxing business to laying aside money for the future (since the businesses aren’t actually losing the money, just having it sequestered, it’s not even really a tax).

Conclusion:

As the thrust of this series has pointed out, the question of whether states can pursue Keynesian policy is not ultimately a question of ability. There are many different, tried-and-tested methods for conducting Keynesian economic policies that states can make use of (especially if states can get themselves out of the crippling legacies of supermajority and balanced budget rules). Ultimately, it is a question of political will, whether progressive  politicians at the local and state-wide level are willing to take up the banner of activist governance and challenge the orthodoxies of modern statecraft, and whether the voters who decry the mass firing of teachers and the closure of state parks – to say nothing of double-digit unemployment, millions of foreclosures, and falling levels of health coverage – are willing to take control of their economic destinies.