Neither party has been exactly forthcoming about its potential economic policy after Tuesday’s Congressional elections. However, since the Democrats seem likely to control at least the House of Representatives, I thought it worthwhile to look at where their policies might differ from those in place. A “Back to the Economy” seminar October 30 hosted by the New America Foundation gave some interesting clues to Democrat thinking.
Raising taxes doesn’t seem to be a priority. Of course, it doesn’t need to be; if Congress does absolutely nothing, the 2001 and 2003 tax cuts reverse themselves in 2010, including the indexation of exemptions that took account of past and future inflation. This would raise marginal tax rates at the top level, subject the entire professional class to the rigors of the Alternative Minimum Tax, and make owners of even quite modest homes on the two coasts subject to Estate Duty at a marginal rate of 55%. Armed with this threat, a Democrat majority wishing to raise government revenues will be able to pass moderate tax increases from their current levels without too much difficulty.
Had this conference taken place in Europe, there is no doubt that revenue raising by means of “green taxes” would have been high on the agenda. Tony Blair’s Labor government in Britain has announced its intention to impose such taxes, and the opposition Conservatives seem distinguished these days only by their enthusiasm for some such scheme. In the United States, however the case for draconian action against global warming is much less well established, even on the center-left. Enthusiasm at the seminar was thus focused on ethanol production, which can replace up to 25% of U.S. gasoline consumption and has the additional benefit of providing endless subsidies to heartland farmers in key Midwestern and Plains states which the Democrats have hopes of capturing. There was no discussion whatever of the advantages of producing ethanol from tropical sugar-cane, a much cheaper alternative.
Heartland economic development was another theme of the conference, and we were regaled with stories of community regeneration in small and medium sized cities in “flyover” territory. Of course it’s not surprising they’re regenerating; the biggest economic boost to the center of the United States since 2000 has been the enormous real estate boom on the coasts, which has made coastal housing costs intolerable for vast numbers of moderate income people. This has allowed a number of large employers to reduce their wage costs significantly by relocating to lower-cost communities in the heartland, to the benefit of all concerned. I’m not sure how much credit any political party can or should take for this development; it is nevertheless on balance a positive one.
On the economy as a whole, it was refreshing for once not to be listening to either the George W. Bush administration or Wall Street economists, both of which have a vested interest in puffing up the current state of the economy, whatever it may be at any particular time. Nobody at the conference, not even Paul Krugman, was as bearish as the Bear, even though Democrats’ vested interest currently lies in denigrating the economy’s current performance. Nevertheless there was a consensus that the U.S. housing market has moved into a serious downturn. The effects of that downturn, combined with the economic restructuring needed to reduce the U.S. trade deficit to manageable levels, are likely to cause either a modest recession in 2007 or a prolonged period of very slow economic growth, which could even last as long as 5 years. There was also consensus that the productivity boom of 1996-2005 had ended, and that Americans would have to accustom themselves to a lower trend rate of growth. The Bear’s view is of course that the productivity boom never happened in the first place, but if the consensus is now that it’s ended, we’re debating mere history.
Probably the greatest emotional agreement of the conference was behind the idea of increasing the minimum wage. In the traditional Whiggish free market view of economics, this is thought to be an unalloyed bad idea. Innumerable economists have obtained PhD’s through attempting to prove that raising the minimum wage simply increases unemployment and reduces output, thus having only a negative effect on the living standards of the poor.
As usual, the Whiggish view of economics makes a number of assumptions, which on inspection turn out to be false. It assumes that if there is no minimum wage, or the minimum wage is set below the level at which the domestic labor force would experience full employment, then wage offers below the market level fail to attract workers, so employers are forced to raise their wage offerings to reflect a level that is attractive to domestic workers. In the modern economy, this isn’t true. Wage offers below those acceptable for the domestic market (which level is generally determined by the menu of welfare benefits available at that location) simply attract illegal immigrants, since even a wage considered insufficient for domestic workers is considered good money for those whose home economy is Ecuador or southern Mexico.
With this essentially infinite pool of very cheap labor available, albeit illegally, employers can and do drive low skill wage rates down as far as they like, while domestic workers have the option of accepting lower and lower wages or subsisting on welfare. Since the laws against employment of illegal aliens are enforced spottily at best, the result is immiseration of the low-skill domestic workforce.
An increase in the minimum wage, provided it is not too great, can thus provide large benefits to the domestic poor. Unlike employment laws, minimum wage laws are enthusiastically enforced, so employers are compelled to pay the new higher minimum wage. Their incentive to employ illegal aliens is correspondingly reduced (since they daren’t employ them at below minimum wage levels) and so employment is diverted to domestic workers, and the job losses from higher minimum wages are concentrated on illegal immigrants, who presumably mostly get discouraged and return home.
Former presidential candidate Michael Dukakis last July took this further, and suggested a strictly enforced minimum wage of $12 per hour, which would hugely reduce the illegal immigration problem, while raising domestic low-skill wages close to their peak 1973 levels. While Dukakis’s proposed change is extreme enough to produce a sharp increase in unemployment, by imposing unbearable costs on low-wage employers, the howls of derision from the right were misguided. Today a substantial increase in the minimum wage, to at least the $7-8 per hour level from the current $5.15, possibly with a differential between the coasts and the heartland, is not only good politics but good policy.
In terms of public spending, the conference was more or less agreed on three priorities: research and development, education and infrastructure. There was however little recognition that funding such investments through the public sector increased their cost and reduced their benefits. There was for example no discussion of how education might be reformed and competition introduced, so that education expenditure would not be wasted on bureaucracy.
There appeared to be a general belief that more college education could increase U.S. competitiveness and solve the problem of the underclass. This idea may however be fallacious. Given even modest competence at the K-12 level, there can be no significant pool of geniuses left untapped in the United States. Thus driving college attendance rates above 50% of the population simply extends college education to the below-average student, who, given the distractions of popular culture, may benefit very little from it. Increasing the intensity and quality of K-12 education and curbing the anti-intellectualism of popular culture would both help considerably more, but nobody has discovered how to do either of those things.
There was much lamenting about the lack of a huge infrastructure project such as the Tennessee Valley Authority or the Interstate Highway System, which revealed a certain insensitivity to cost/benefit analysis. One participant, for example denounced the decision to extend the Washington Metro to Tysons Corner above ground rather than underground, even though the underground route would cost an additional $500 million, and the amenity being protected is Route 7, a particularly unprepossessing section of suburban drag-strip, lined largely by automobile dealers. As one would expect, the debate on the tunneling alternative has now itself delayed the project by a year and probably increased its cost more than the tunnel would have done.
Overall, the proposals favored by the New America Foundation conference are un-threatening, and some of them might well do some good. The problem of course is that the NAF represents the super-ego of the Democrat party, proposing elegant and innovative policy ideas, only some of which see the light of day.
Countering the high-minded super-ego in the Democrat corridors of power, there is an id, not represented at the conference, consisting largely of lobbyists, protectionists and trial lawyers. Id schemes (they aren’t worthy of the name of “proposals”) are mostly economically damaging and always expensive. As the last few years have demonstrated, however, the Republicans are also not without their id, and a change of ids may be in itself beneficial to the United States as a whole.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)