The number of economically damaging policy ideas imposed on the United States has greatly increased in the last few months. However from the statements of the Presidential candidates, the next few years may turn this storm of bad ideas into a blizzard. Those with an emotional attachment to the US economy should brace themselves for trauma.
The new salience of bad economic ideas is not particularly surprising. The US economy is heading into an economic downturn that promises to be at least as severe as those of 1974 and 1980-82, whose memory is already fading a generation into the past. Additionally, the 2000-07 period was one in which US voters made very small if any income gains, with such gains arising only through refinancing of ever more gigantic home mortgages. Meanwhile the distant and dislikeable titans of Wall Street apparently scooped up all the money generated by the economy.
Now the housing bubble has burst, the average jaundiced voter naturally sees the free market system and the George W. Bush administration as responsible for the recent not-particularly-pleasant years and the economic horror that has followed. Claims by Republican politicians that the debacle was all the fault of the housing finance agencies Fannie Mae and Freddie Mac, while partly true are wholly unconvincing.
With voters miserable and facing a disastrous economic position that they believe was caused by free market excesses, it is not surprising that they are looking favorably on statist nostrums. Both political candidates have propounded bad ideas; Obama more than McCain largely because he has more ideas in general. In addition, there are a few bad ideas that have embedded themselves into the system, accepted by both political candidates and the political class as a whole.
McCain’s bad economic ideas are few in number, but in terms of economic ineptitude they’re doozies. Typical of them was the proposal for a gas tax holiday over the summer, which since supplies were tight would have driven up consumption, transferring wealth from the US government to the Saudis. In his urge to connect with populist-minded voters McCain appears either not to have consulted any economists on this bizarre scheme or to have ignored their advice when presented.
Then there’s his proposed $300 billion bailout of subprime mortgage borrowers who cannot make their payments. Like the Troubled Assets Relief Program, this appears principally to be a vehicle for relieving taxpayers of their money. By providing benefits only to those mortgage payers who are not paying their mortgages on time, it rewards the most over-optimistic borrowers and the most feckless lenders at the expense of those who restricted themselves to more manageable mortgages or who maintained careful credit standards over their mortgage lending (not that there appear to have been many of the latter.) Even if the $300 billion was dropped from helicopters (no thanks, Mr. Bernanke, we’ll call you if we need you) it would reduce the value of mortgage loans outstanding, probably by more than its nominal amount, by increasing the chance that borrowers would fall into arrears in order to qualify for a bailout..
McCain’s third major bad idea is the design of his “cap and trade” carbon emissions program. Global warming may or may not be real. It seems likely that the most effective approach to combating it would combine programs of population control (to reduce the number of future carbon emitters) with mitigation efforts such as higher seawalls and heat-resistant crops. Even if restricting carbon emissions were attractive, a carbon tax would be a more efficient way to achieve it than a “cap and trade” system. Finally, at the fourth layer of economic inefficiency (although to be fair, the first three layers seem to be common to almost all politicians) McCain adds an additional nonsense by giving away emission permits. That turns a more or less market-oriented system for achieving something probably pointless into a government handout system. Permits under McCain’s system will be allocated by bureaucrats, either according to some faceless and doubtless erroneous formula or according to the amount of campaign contributions they had given. The arena of government favoritism would thus be considerably enlarged, that of the free market correspondingly diminished.
Turning now to Barack Obama, some of his proposals are well designed and appear likely to achieve their objectives without creating gross economic distortion. It is for example likely that a capital gains tax increase from 15% to 20% will indeed yield additional revenue over the long term, although a further increase beyond 20% might not – wherever the Laffer optimum for capital gains taxes lies, it is almost certainly above a 20% marginal rate. Likewise Obama’s healthcare proposals mix increased government subsidy with considerable reliance on free-market cost reduction measures; they appear well designed if you like that sort of thing.
The principal problem with Obama is his deliberate failure to define himself. The moderate Obama, with a University of Chicago economic advisor and a keen brain attuned to the free market system, would probably be a pretty good President, at least in the economic sphere. However there is also another Obama, possessor of the most liberal voting record in the US Senate and supporter of many of the more damaging schemes beloved by House Speaker Nancy Pelosi and the barons of the Congressional Democrat left. Finally there is the shadow of a third Obama, born and bred a street radical, friend of ex-Weatherman terrorist William Ayres and supportive parishioner of the highly anti-capitalist parson Jeremiah Wright. It is an interesting question whether Ayres-Obama or Pelosi-Obama would be more economically damaging – their prescriptions would clearly be very different – but there is no doubt that by relying on Moderate-Obama being fully in control throughout, we are taking a considerable chance.
Obama’s tax proposals come in several versions, reflecting his multi-facetedness. One version would simply reverse most of the Bush tax cuts, plus add a moderate social security surcharge for high incomes, taking the top marginal rate of Federal tax up from 35% to 42% or so. The other, produced by Pelosi-Obama, would sock top incomes with the full social security charge and add a further tax increase, taking the top marginal Federal rate well up into the mid-50s (and adding state tax on top of that.) Pelosi-Obama’s tax proposal would be highly economically damaging; Moderate-Obama’s would not.
On trade there is a similar dichotomy. Renegotiating NAFTA and using trade agreements to enforce labor and environmental standards is a Pelosi-Obama approach that could potentially have the same effect on world trade as the infamous 1930 Smoot-Hawley tariff. Moderate-Obama’s advisors say he doesn’t really mean it. We’ll have to see.
On housing, Moderate-Obama opposed a 3-month foreclosure moratorium. Pelosi-Obama favors it and appears to be dominant here. Moderate-Obama was right; such a moratorium, like McCain’s foreclosure subsidy, would be highly damaging to the value of outstanding mortgage debt, worsening the banking system’s balance sheet problems.
On Wall Street, Pelosi-Obama is largely dominant, denouncing greed and calling for much tighter regulation. (Of course, the crisis also brought out a hitherto unexpected streak of Pelosi-McCain.) Pelosi-Obama also governs Obama’s co-sponsorship of “card check” legislation, by which the unions would no longer have to win a secret ballot to gain representation at a workplace, but would only need to strong-arm the weaker members of the workforce into signing a representation card. While failing to address the problems of the poor, who generally do not have unionizable jobs, that legislation would drive the US workspace sharply back towards the French model of union dominance of key industries, with consequent decrease in US economic efficiency and competitiveness.
Some of Obama’s other economic ideas seem to derive from Ayres-Obama. His attempt to tie student funding to hours of community service worked derives less from the unionized Pelosi Democrats than from a street-radical’s urge to make snotty middle class kids experience the “real world” of the streets. Likewise, his 2001 regret that the Supreme Court “never ventured into the issues of redistribution of wealth” and “didn’t break free from the essential constraints that were placed by the Founding Fathers in the Constitution” was pure Ayres-Obama. Lovers of the rule of law and well-established property rights must hope that at least on this front Ayres-Obama will remain dormant through an Obama administration.
Finally, there is Obama’s Clean Technologies Venture Capital Fund, deploying $50 billion of taxpayer money over 5 years. The nature of this venture depends on whether Pelosi-Obama or Ayres-Obama is dominant in its creation and design. A Pelosi-Obama fund would promote unprofitable ventures by large unionized companies with proven but uneconomic technologies in politically important regions – similar to the Bush administration’s ethanol boondoggle. An Ayres-Obama fund would promote street-environmentalism, devoting its resources to wholly unproven back-of-an-envelope ideas with no obvious profit motivation that were promoted by urban hustler groups. Neither would be economically or environmentally useful – a carbon tax, tilting the playing field towards environmental technologies, would be much more likely to produce useful enviro-tech advances.
In many ways more frightening than the bad ideas supported by one or other candidate are those for which there is a consensus. For example, both parties now appear to believe in larger government. The Democrats welcome it explicitly, whereas according to OECD statistics US public expenditure bottomed out in 2000 at 34.2% of GDP and has now increased under Republican government to 38.3% of GDP in 2008. Given the enthusiasm of both parties for increasing it further, this trend is likely to continue. As I have discussed previously, OECD data since 1960 shows that high levels of public expenditure and rises therein have marked depressing effects on economic growth, being together responsible for over 50% of the differences between countries and periods in growth rates. Little wonder therefore that US growth over the last few years has been sluggish; it is likely to get more so.
A second idea on which there has been general consensus between Presidential candidates, although a modest rebellion in Congress, has been the TARP. The original idea of devoting $700 billion of taxpayers’ money to buying the economy’s least valuable assets, surplus securitized mortgage bonds, has now apparently been abandoned. At least one can hope so – by diverting scarce capital from more productive uses it would have depressed economic growth markedly.
However, instead of breathing a sigh of relief and letting taxpayers off the hook, Treasury Secretary Hank Paulson has taken to using the TARP as an all-purpose slush fund, bailing out the banks, and apparently in future providing subsidies to the automobile industry, local governments and anyone else with political connections who needs it. The result is that Treasury borrowing in the year to September 2009 is now estimated to be $2 trillion, around double last year’s level. Needless to say that too will damage the economy. TARP was a terrible and poorly implemented idea; no doubt that is why it is so popular with the political class.
However the bad economic idea for which support in the political class is most whole-hearted is that of excessively low interest rates, far below the rate of inflation. The financial crisis has been caused not by high interest rates, but by excessive leverage. The 3-month interbank dollar LIBOR peaked at 4.82% and overnight LIBOR at 6.87%, neither representing “tight money” in a currency whose inflation is still running at more than 5%. Even those who decry over-loose monetary policy as responsible for the 2002-06 housing bubble fail to identify its responsibility for the stock bubble that preceded it in 1995-2000. As for Fed Chairmen Alan Greenspan and Ben Bernanke, they are wholly unrepentant of their monetary profligacy, and to a large extent remain the heroes of the political class, in spite of the devastation they have caused.
It is this item of public education that must be stressed repeatedly by those who seek the welfare of the US economy. Deregulation was only a minor cause of the housing bubble and subsequent debacle; the true cause was excessive money supply creation by the Fed, which is not a private sector free-market entity but an agency of government. It is these lessons, that over-easy money will bring long-term disaster and that government has been primarily responsible for this as for so many previous crises, which must be taught to the American people. Only when voters have learned their lessons can we hope that politicians will no longer find political traction for cockamamie and damaging economic nostrums. The campaign against Greenspan and Bernanke, to get Bernanke fired and Greenspan de-deified is not an optional meddling in ancient history, it is the most crucial economic struggle of our time.
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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.)