Sunday, July 3, 2011

America's Deficit Hysteria is Taking a Toll on State Governments

To follow economic news these days is painful.  It seems that each thing you read is worst than the last.  So in an effort to keep my sanity I have watched quietly as the eurozone dismantles itself.  Perhaps a combination of fatigue and an insular Atlantic has me pacified.  But as whatever mental disease that compels the leadership of Europe these days spreads across the pond, I'm once again obliged to pen a few words in protest.

The State of Minnesota shut its doors last Thursday as a result of an impasse over its $5 billion budget gap.  Minnesota is not alone as most states in the union, in varying degrees, currently face budget crises.  According to  the Center on Budget and Policy Priorities 42 states project budget shortfalls for FY 2012.  These gaps range from 2.4% to 37.40% of their respective general fund budgets, with most states hovering around a median of 11.5%.  States with budget deficits are projected to total over $100 billion in FY2012.  While that sum is better than the current fiscal year deficit of $131 billion, states expect to be in the red for the foreseeable future.

To deal with this issue states are faced with the choice of raising taxes, cutting spending, or a combination of both.  Unlike the federal government, states cannot generally run deficits in perpetuity.  They must balance their budgets or run surpluses.  Usually tax increases are ruled out immediately and for good reason.  We are in the midst of a recession and raising taxes drains spending power from the economy, which only serves to prolong the misery.  Of course, there are other ways to raise taxes that don't have that effect - like increasing marginal tax rates on income and capital gains - but those are often immediately discarded from debate as "socialist" and "unamerican."  They are not, but that is a subject for another post.  So any kind of tax increase is off the table, leaving only spending cuts.

While it seems to be the weapon of choice for governments, spending cuts are often worse than tax increases, especially at the state level.  Typically there is not much fat to trim from state budgets before you cut into the meat.  Take for instance Nevada who ranks the highest in terms of deficit as a proportion of its overall budget.  Below is a snapshot of how Nevada divides its spending pie.  Notice the two largest pieces of the pie are expenditures on education and human services (health care, elderly assistance, employment services, mental health services and programs for families and children).  Now since Nevada has a large budget gap to close - more than 37% of its budget - it has no choice but to look for opportunities to cut spending on education and human services, as they account for 60% of the state's total spending.  You won't find those savings by streamlining the finance / administration sector.

Source:  Nevada Open Government
Cuts to education and health services not only have an immediate, negative impact on the economy, as layoffs and furloughs translate into less demand, but they also limit the ability of the state to meet its long-term social and economic goals: mainting a healthy and well-educated workforce.  What is most appalling is the fact that states are being forced to hollow themselves out to deal with temporary, cyclical budget shortfalls.  These deficits, in large part, are a consequence of the Great Recession.  They have nothing to do with the normal function of each states' budgets and priorities, but rather the reduction in tax revenues and increase in unemployment benefits as jobs disappear from a contracting economy.  As unemployment remains high and federal support to states runs dry, these states are resorting to drastic measures to remain solvent in the short-term.

The massive layoffs, government shutdowns and liquidation of entire "right-sizing" of school districts around the country is completely avoidable.  That is the great tragedy.  The farce is that Washington believes it needs to behave like individual states, member countries to the EU (read:  Greece), or even individual households.  The rhetoric these days is all about balancing the budget or running surpluses, rather than providing liquidity to states to keep them in the black during the recession.  Absolute madness!  Worse, the POTUS is so committed to convincing us that he's just as austere as the next guy that he keeps playing the same old "fallacy of composition" record, hoping that this time it will sell:

"Government has to start living within its means, just like families do.  We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs." ~ Barack Obama, July 2nd 2011 Radio Address (h/t Krugman)

The president is wrong.  The federal government does not face the sort of funding constraints that individual states, businesses or households do.  Nope, they are the issuers of the currency in use by those entities, and as such can never run out of dollars.*  Federal spending is only limited by political will and the sort of inflation an economy experiences as it nears full employment.  With this in mind, the president should instead spend his political capital reminding the polity that incumbent upon the federal government is a responsibility to the states, that during periods of cyclical budget crises they will be extended the liquidity necessary to keep the doors open and resume their long term development strategies.  

* For those unacquainted with the operational facts of modern US finance this claim may come as a shock.  If so, please see this primer on Modern Monetary Theory (MMT)

Tuesday, February 1, 2011

Network Science, Facebook and Economics

In their critique of orthodox method, heterodox economists are faced with the burden of offering alternatives.  By stressing the importance of tradition, consequence and interconnectedness, we agree to the task of accounting for them.  One quest that emerges from this seeks to identify the network of social connections that constitute our environment.  To whom are we connected?  How do we affect the decisions of others?  What goods flow between which connections, and why did they do so at all?

In order to find appropriate methods for addressing these questions I've spent a deal of time lately reading the literature on network analysis. The idea is that if you have a list of nodes - e.g. friends, colleagues, etc. - and a list of their connections, you can begin to see the structure of the network.  For instance, two friends may have a set of common friends, who in turn may have common friends, and so on.  When we think of the degrees of separation, we are referring to the structure of the network.

Out of curiosity I decided to analyze my facebook friends network.  Using netvizz I extracted a graph file that contains my lists of nodes and edges (connections).  Then I imported that into Gephi and ran a few tests on the data.  First, I ran an algorithm that determined the degree of connectedness of each node.  The degree measure is simply the number of connections to other nodes per node.  Next, I sized each node relative to its degree, making larger nodes visible as the most connected.  Then, I ran the force atlas algorithm to distribute the nodes in a manner that makes the network visually meaningful.  Finally, I ran a modularity test.  This detects distinct communities in the network, based upon a neighborhood of mutual connections.  Oh, and I got rid of the names for the sake of anonymity.  Here's what I discovered:

Immediately you'll notice that there about 9 main color groups.  These are the communities that were discovered in the modularity test.  I was pretty amazed at how accurately it identified the communities in my actual friendship network.  For instance, all purple, red, yellow and peach nodes went to my high school.  But, only the purple nodes graduated in 2002, while the red group was in my class of 2000.  Further still, the yellow group singles out the people I knew in high school since middle school.

Overall my facebook network is well connected.  With exception of a few "islands" of friends most of my friends have direct friendships with other friends of mine.  In particular, this network has an average path length of 2.087:  on average people in my network are within 2 degrees of separation.  Each friend is connected to 11 of my other friends on average.

There are four friends in particular that stand out as being much more connected than the group as a whole:  the largest of green, purplish-blue, dark blue and peach.  Their respective degrees are  58, 42, 50, 53.  This isn't terribly surprising given that each of these are my closest friends.  What this graph infers and my experience confirms, is that each of these well connected nodes is my connection to its respective color group.  My large green friend is well connected to my friends from Western, and indeed is responsible for our introduction.  Similarly, my large purple friend is connected to 42 of my high school and family friends.  And the large blue and peach friends are brothers.

The islands of friends share in common no connection to the larger group of high school, family and WWU friends.  They are entirely representative of discontinuous breaks in my past experience.  For instance, the small turquoise pair of friends is drawn from a set of friends I know from my days in the army.  Similarly, that rather lonely set of friends to the right are from Kansas City.  This is not to say that these friends are friendless; they aren't in their respective networks!  They simply don't share too many common friends from previous stages of my life.

This little exercise is exploratory and does not make any substantial claims.  However, some observations may be drawn from these results.  Primarily that distribution matters when we theorize about the structure of the social systems.  In economics, how individuals are connected in social networks plays a part in the flow of resources through the network.

The much more difficult task of identifying and parsing the data from which to develop structural models of the economy remains.