Elections are not a time for considered economic analysis, but then few times are. Opponents of the free market are able to point out obvious flaws in recent economic trends, but are met with mere cheerleading by free-marketers. The appearance of an Obamaist policy document “Prosperity for All” written by Yale professor Jacob Hacker and Nathaniel Loewentheil is thus a useful opportunity to check out the opposition thinking, spot its flaws and ideological blind spots, but more important, determine where it indeed makes good points, and what the answer to them should be.
Perhaps the most powerful current argument against the relatively free market policies of 1980-2006 is that of recent U.S. trends in inequality. In economic principle, there should be no great preference for one income distribution over another, but in practice observation has found that both extremes are bad. Very flat distributions of income and wealth, especially if caused by government fiat, destroy wealth creation and suppress economic growth (and give too much power to government bureaucrats – more on that later.) Equally however very skewed distributions of income and wealth, if accompanied by democracy, produce economic stagnation at the bottom and therefore appallingly bad governments since the poor majority sees no way out of its impoverishment and votes for nut-job populists.
The main problem with the increase in inequality since 1973 (as it has not taken the U.S. particularly far out into the Latin American part of the curve) is the stagnation of income for the working class, in spite of 40 years of technological progress and productivity increase. In this diagnosis, “Prosperity for All” is correct; its explanation of why it happened and its suggested cures are however mostly misguided.
There are other areas of agreement. “Prosperity for All” decries the bad behavior on Wall Street and the “crony capitalism” of government handouts to favored industries. We can all agree on that, although when it comes to solutions the document proposes several that are equally crony capitalist. It proposes that Wall Street houses should be split between commercial banking and trading operations – again we can agree; it’s not a free-market solution, but with deposit insurance and an over-powerful Fed it may be the least bad second-best approach. It wants a Tobin tax on trading to reduce its profitability – again I agree, though I want a much smaller one that attacks primarily automated “fast trading” which essentially uses insider information on market activity.
“Prosperity for All” decries the lack of investment in infrastructure. Here I agree to an extent, but the problem is nothing to do with the free market; most infrastructure is provided by governments, which have incentives to build flashy new ziggurats like California’s high speed train and neglect maintenance. More seriously, infrastructure costs have been grotesquely inflated by union featherbedding, environmentalist nonsense and excessive regulation. The Holland Tunnel under the Hudson River, completed in 1927, cost $48 million, equivalent to $700 million today. New Jersey Governor Christie’s zapping last year of a duplicate tunnel, expected to cost $8.7 billion, indicates just how out of control infrastructure costs have become.
Finally, “Prosperity for All” decries the insecurity of the current economy, especially for those without great resources. Social security and Medicare programs are both endangered, and likely to cover fewer of the old-age costs of those now approaching retirement, especially with the rapid escalation in medical costs. The collapse in house prices has removed what many people saw as a net worth cushion that could be tapped in time of difficulty. College costs have soared, and the employability of college graduates has increasingly come into question. Here the effect of prolonged recession has merged with relentless cost escalation in education and medicine, the actuarial problem of baby boomer retirement and the effects of excessive leverage to produce a toxic increase in insecurity beyond that inevitable in a free economy.
Having given “Prosperity for All” credit for its successful diagnoses of many of our current ills, it is nevertheless impossible to be so complimentary about its proposed treatments. Its most egregious error is a refusal to accept that governments, unions and NGOs have incentives too, just like corporations. Consequently, however easy it may be for an optimal analyst in a comfortable armchair to propose government-directed solutions to economic problems, governments are no more likely to behave in a “socially optimal” way than are corporations.
This is the central fallacy of Keynesianism. Keynes himself was so convinced of the quality of his analysis that he negotiated an overvalued fixed exchange rate for post-war Britain that killed stone dead the surge of automobile exports planned by the brilliant William Morris, Lord Nuffield. Morris, who left school at 15 to work in a bicycle repair shop but was Britain’s most successful industrialist, was not someone Keynes was accustomed to consulting about the economy’s needs. The Keynesian Bureaucrat Fallacy, that bureaucrats of immense intelligence and complete incorruptibility can arrange the workings of the economy, is probably the most damaging economic belief of all time, even worse than Marxism.
Apart from its inability to invest efficiently, the most important failing of incentive-ridden government is in regulation. Agencies such as the Environmental Protection Agency and the Consumer Product Safety Commission exist simply to propagate and enforce regulations, and the more regulations they propagate and enforce, the more benefits in terms of remuneration, power and staff their senior officials obtain. Accordingly, we get nonsenses like the EPA regulation of carbon emissions, which may well shut down much of the U.S. power sector, thereby causing economic damage far beyond that sector.
Regulatory government is essentially irrational, and in practice pays little or no attention to the cost of the regulations it enforces – for example, a recent regulation banning “buckyball” products on the grounds children might swallow them, which bids fair to put a $50 million company out of business. As I have written previously in this column, it seems likely that the EPA’s advent was responsible for much of the decline in U.S. productivity growth after 1973, and that the current lethargy in the U.S. economy is at least partly due to the tsunami of new and expensive regulations under President Obama.
The cost of government favoritism is probably less than the cost of regulation, simply because the latter costs are so easy to hide. Nevertheless the entire clean energy program, based as it has been on science which increasingly looks chimerical, has been a bonanza of opportunity for the world’s least scrupulous businessmen. Not that “global warming” should be held entirely to blame; the corn-based ethanol boondoggle, pointless environmentally even if global warming were a problem, is a simple outgrowth of U.S. agriculture subsidies dating back to the 1930s. Needless to say, such programs almost never disappear, because the lobbies depending on them become so powerful; they only multiply.
A further fallacy perpetrated by “Prosperity for All” is the beneficial nature of unions and non-governmental organizations. Such entities, like governments, operate according to their own incentives dictating growth and the search for power. The best conditions for skilled and unskilled workers exist and have always existed in the most prosperous and fastest growing industries. Henry Ford’s $5 day, for example, the greatest single leap forward in unskilled-worker welfare of the twentieth century, was instituted in his entirely non-unionized plant in 1914, after the incredible success of the Model T. Automobile unionization happened only twenty years later, during the Great Depression and in the long run resulted in the U.S. automobile industry becoming hopelessly vulnerable to foreign competition. As for NGOs, their goals are political and their proliferation is entirely the result of the indefensible tax benefits given the “charitable” organizations. Remove those benefits, and NGOs would mostly wither away, leaving national prosperity very much greater for their absence.
Finally, “Prosperity for All” demands immediate legalization of the 10-12 million undocumented immigrants in the United States. Far from improving living standards, this would produce a further flood of unskilled undocumented immigrants, as did the 1986 amnesty. The result would be profits for Big Agribusiness but further immiseration of the less skilled half of the U.S. population. An economically successful society needs to be governed by the rule of law, and to ensure that its less productive citizens are able to get adequately paying employment without being subjected to wage-destroying competition from a flood of outsiders.
Since the problems identified by “Prosperity for All” are mostly genuine, and the solutions mostly chimerical, it behooves us to propose solutions that might actually work. Far from chivvying the Fed to satisfy its “full employment” mandate under the 1978 Humphrey-Hawkins Act, we need to reduce its remit to the single mandate of preventing inflation, and pass further rules so that its operations become “Volckerized” ensuring that henceforth it keeps interest rates high. With high interest rates, capital formation will be encouraged, and the United States’ traditional capital advantage over emerging markets will thereby be rebuilt, allowing its living standards and employment to remain at a satisfactorily high level because of its high ratio of capital to labor.
Tax reform is another essential. The current loopholes for home mortgage interest, state and local taxes, healthcare premiums and above all charitable contributions need to be removed, and the system pushed as far as possible towards taxing consumption rather than production. That way, the U.S. economy’s excessive dependence on mindless consumer spending will be removed, and it will become a high capital formation powerhouse like Germany and the best economies of Asia.
Markets in education and medicine must be reformed, by removing government subsidies and excessive regulation. That will make the reform of Medicare and Social Security very much easier, so that a Paul Ryan-style plan of limited targeted subsidy to those in need can be implemented, while costs are brought back under actuarial control. In these areas, foreign examples such as those of Germany and Japan are extremely useful, showing that quality can be improved and costs reduced without condemning America’s less fortunate citizens to sickness or illiteracy.
Finally, a bonfire of regulations must accompany a massacre of corporate welfare schemes. By these means, the economy will become more efficient and government costs will be greatly reduced, enabling proper provision to be made for the unfortunate while taxes are kept moderate, economic growth rebounds and full employment is restored in a natural unforced manner.
Looking at the detailed plans of political opponents is highly beneficial. Their diagnosis of society’s ills is often correct, and even if their solutions are misguided, one can at least ensure that one’s own plans address the ills they have identified. Nobody ever learned much through dialogue only with the like-minded.
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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.)