Tag: growth

The Consumer Spending Fallacy behind Keynesian Economics

I’m understandably fond of my video exposing the flaws of Keynesian stimulus theory, but I think my former intern has an excellent contribution to the debate with this new 5-minute mini-documentary.

The main insight of the mini-documentary is that Gross Domestic Product (GDP) only measures how national output is allocated between consumption, investment, and government. That’s useful information in many ways, but if we want more output, we should focus on Gross Domestic Income (GDI), which measures how national income is earned.

Focusing on GDI hopefully would lead lawmakers to consider ways of boosting employee compensation, corporate profits, small business income, and other components of national income. Focusing on GDP, by contrast, is misguided since any effort to boost consumption generally leads to less investment. This is why Keynesian policies only redistribute national income, but don’t boost overall output.

You may recognize Hiwa. She narrated a very popular video earlier this year on the nightmare of income-tax complexity.

Obama’s Job-Killing Policies: A Picture Says a Thousand Words

The new unemployment data have been released and they don’t paint a pretty picture – literally and figuratively.

The figure below is all we need to know about the success of President Obama’s big-government policies. The lower, solid line is from a White House report in early 2009 and it shows the level of unemployment the Administration said we would experience if the so-called stimulus was adopted. The darker dots show the actual monthly unemployment rate. At what point will the beltway politicians concede that making government bigger is not a recipe for prosperity?

They say the definition of insanity is doing the same thing over and over again while expecting a different result. The Obama White House imposed an $800-billion plus faux stimulus on the economy (actually more than $1 trillion if additional interest costs are included). They’ve also passed all sorts of additional legislation, most of which have been referred to as jobs bills. Yet the unemployment situation is stagnant and the economy is far weaker than is normally the case when pulling out of a downturn.

But don’t worry, Nancy Pelosi said that unemployment benefits are stimulative!

China Bill All about Saving Lawmakers’ Jobs

The House is expected to vote today on a bill that would allow U.S. companies to petition the Commerce Department for protective tariffs against imports from countries with “misaligned currencies.” Everybody knows the bill is aimed squarely at China.

Advocates of the legislation say it is about jobs, and they are partly right. The bill is about saving the jobs of incumbent lawmakers who are desperate to appear tough on China trade, which they blame for the loss of U.S. manufacturing jobs.

As my colleague Dan Ikenson and I have argued at length, in blog posts, op-eds, and longer studies,

Let’s hope cooler, wiser heads in the Senate and the White House save us from this election-season folly.

Trade Can Help the Poor Escape Poverty

Professor William Easterly, the economic development expert from New York University, has written an excellent comment for the Financial Times online. He writes, “The Millennium Development Goals [summit that wraps up in NY today] tragically misused the world’s goodwill to support failed official aid approaches to global poverty and gave virtually no support to proven approaches. … But current experience and history both speak loudly that the only real engine of growth out of poverty is private business, and there is no evidence that aid fuels such growth.”

At the Center for Global Liberty and Prosperity, we have continuously emphasized the power of trade to help the poor escape poverty. Unfortunately, politicians in rich countries find it easier to waste billions of taxpayers’ dollars in the form of foreign aid than to take on special interests that thrive on trade protectionism; hence European and American agricultural tariffs and subsidies.

However, the impact of rich countries’ protectionism should not be exaggerated. African countries are typically more protectionist than rich countries. In fact, they are more protectionist against one another than against rich countries. The sad truth is that poor countries are perfectly able to shoot themselves in the foot by following growth-killing economic policies – irrespective of what the rich countries do.

Foreign aid, incidentally, has been ineffective at promoting liberalization.

New York State Should Cut Property Taxes

The New York Times editorialists are at it again.  June 12th’s lead editorial, “The Latest Work Dodge: A Shutdown,” frets over the specter of the New York state government being shut down because Albany’s legislators can’t agree on a budget.  Well, the Times must have breathed a collective sigh of relief late Monday (June 14th).  That’s when the State Senate passed Governor Paterson’s 11th temporary budget extender, which allowed state offices to hang out “open for business” signs on Tuesday.

But, the Times wants a final state budget and claims that more taxing and borrowing and maybe some cuts in school aid will do the trick.  One item that the Times wants off the table in Albany is property taxes.  According to the Times, Democratic state senators outside New York City should stop pushing for restrictions on the rate of growth of property taxes.  I agree.  Instead, the legislators should start pushing for sharp cuts in New York’s oppressive property taxes.  When every U.S. county is ranked according to its average property-tax bill, as a percent of home values, 14 of the highest 15 are in New York state.

As Prof. Steve Walters and I concluded in “A Property Tax Cut Could Help Save Buffalo” (Wall Street Journal, December 6, 2008),  New York should follow California and Massachusetts and cut property taxes.  Voters capped property taxes in California at 1% of market value with Proposition 13 in 1978. That forced San Francisco to cut its rate by 57% overnight and brought forth a tidal wave of investment, even amidst a recession. By 1982, inflation-adjusted city revenues were two-thirds higher than they had been before Prop. 13. Massachusetts voters passed Prop 2 ½ in 1980, forcing Boston’s property tax rate down by an estimated 75% within two years. Massive reinvestment, repopulation and urban renewal followed.

Prof. Krugman Is Wrong, Again

Prof. Paul Krugman asserts in his New York Times column of May 31st that “Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea – not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts.”

While Prof. Krugman and most other fiscalists believe this to be self-evident, it is not.  Indeed, this fiscalist dogma fails to withstand the indignity of empirical verification.  Prof. Paul Krugman’s formulation fails to mention the state of confidence.  This is an important oversight.  As Keynes himself put it: “The state of confidence, as they term it, is a matter to which practical men pay the closest and most anxious attention.”

By ignoring the confidence factor, economic theory can lead to wildly incorrect conclusions and misguided policies.  Just consider naive Keynesian fiscal theory – the type presented (as Prof. Krugman notes) in textbooks and embraced by most policymakers and the general public.  According to Keynesian theory, an expansionary fiscal policy (an increase in government spending and/or a decrease in taxes) stimulates the economy, at least for a year or two after the fiscal stimulus.  To put the brakes on the economy, Keynesians counsel a fiscal contraction.

A positive fiscal multiplier is the keystone for Keynesian fiscal theory because it is through the multiplier that changes in the budget balance are transmitted to the economy.  With a positive multiplier, there is a positive relationship between changes in the fiscal deficit and economic growth: larger deficits stimulate growth and smaller ones slow things down.

So much for theory.  What about the real world?  Suppose a country has a very large budget deficit.  As a result, market participants might be worried that a further loosening of fiscal conditions would result in more inflation, higher risk premiums and much higher interest rates.  In such a situation, the fiscal multipliers may be negative.  Fiscal expansion would then dampen economic activity and a fiscal contraction would increase economic activity.  These results would be just the opposite of those predicted by naive Keynesian fiscal theory.

The possibility of a negative fiscal multiplier rests on the central role played by confidence and expectations about the course of future policy.  If, for example, a country with a very large budget deficit and high level of debt (estimated U.S. deficit and debt levels as a percentage of GDP for 2010 are 10.3% and 63.2%, respectively) makes a credible commitment to significantly reduce the deficit, a confidence shock will ensue and the economy will boom, as inflation expectations, risk premiums and long-term interest rates decline.

There have been many cases in which negative fiscal multipliers have been observed.  The Danish fiscal squeeze of 1983-86 and the Irish stabilization of 1987-89 are notable.  The fiscal deficits that preceded the Danish and Irish fiscal squeezes were clearly unsustainable, and risk premiums and interest rates were extremely high.  Confidence shocks accompanied the fiscal squeezes, and with negative multipliers in play, the Danish and Irish economies took off.  (Evidence from the U.S. is presented in an article by Professors Jason E. Taylor and Richard K. Vedder which appears in the current May/June 2010 issue of the Cato Policy Report.)

Margaret Thatcher also made a dash for confidence and growth via a fiscal squeeze.  To restart the economy in 1981, Thatcher instituted a fierce attack on the British deficit, coupled with an expansionary monetary policy.  Her moves were immediately condemned by 364 distinguished economists.  In a letter to the Times of London, they wrote a knee-jerk Keynesian (Prof. Krugman-type) response: “Present policies will deepen the depression, erode the industrial base of our economy and threaten its social and political stability.”  Thatcher was quickly vindicated.  No sooner had the 364 affixed their signatures than the economy boomed.  People had confidence in Britain again, and Thatcher was able to introduce a long series of deep free-market reforms.

While Prof. Krugman’s authority is weighty, his arguments and evidence are slender.

Beware of Americans Proselytizing the Chinese Economic Model

In a Cato paper released earlier this month, I argued that the glacial pace of America’s economic recovery and its growing public debt juxtaposed against China’s almost uninterrupted double-digit annual economic growth and its role as Congress’s sugar daddy have bred insecurity among U.S. opinion leaders, many of whom now advocate a more strident approach to China, or emulation of its top-down approach.

I cite, among others, Thomas Friedman of the New York Times, who is enamored of autocracy’s capacity to facilitate China’s singularity of purpose to dominate the industries of the future:

One-party autocracy certainly has its drawbacks. But when it is led by a reasonably enlightened group of people, as China is today, it can also have great advantages. That one party can just impose the politically difficult but critically important policies needed to move a society forward in the 21st century. It is not an accident that China is committed to overtaking us in electric cars, solar power, energy efficiency, batteries, nuclear power, and wind power. China’s leaders understand that in a world of exploding populations and rising emerging-market middle classes, demand for clean power and energy efficiency is going to soar. Beijing wants to make sure that it owns that industry and is ordering the policies to do that, including boosting gasoline prices, from the top down.

Friedman’s theme—but less googoo eyed and more all-hands-on-deck!—is echoed in an op-ed by China-expert James McGregor, which ran in yesterday’s Washington Post.  McGregor conveys what he describes as an emerging sentiment within the U.S. business community in China.  That is: the Chinese government is hell bent on creating national economic champions; is using its increasing leverage (as global financier and fastest-growing market) to impose its own interpretations of the global rules of economic engagement in support of its comprehensive industrial policy, and, ultimately; the United States must wake up and rise to the challenge by crafting some top-down industrial policy of its own.

I don’t dispute some of McGregor’s premises.  China’s long process of market liberalization has slowed down, halted, and even reversed in some areas.  Policies are proliferating that favor local companies (particularly state-owned enterprises), hamper the operations of foreign-owned firms, and impede market access for imports.  Indeed, many of these policies are likely the product of industrial planning. 

But McGregor’s conclusion is extreme:

The time has come for a White House-led, public-private, comprehensive examination of American competitiveness against a clear-eyed view of China’s very smart and comprehensive industrial development policies and plans…What technology do we protect? What do we share? What are our commercial strategic imperatives as a nation? How do we retool the U.S. government’s inadequate and outdated trade bureaucracy to provide thoughtful strategic focus and interagency coordination? How do we overcome the fundamental disconnect between our system of scattered bureaucratic responsibilities and almost no national economic planning vs. China’s top-down, disciplined and aggressive national economic development planning machine?

Central planning may be more en vogue in Washington than usual nowadays, but to even come close to reaching his conclusion requires disregarding many facts, which is how McGregor gets there sans tongue in cheek.

First, in an effort to preempt any suggestion that China’s protectionism is nothing exceptional and can be remedied through the World Trade Organization and other channels, McGregor offers this blanket statement: “Chinese policymakers are masters of creative initiatives that slide through the loopholes of WTO and other international trade rules.”  I realize that op-ed writing forces one to economize on words, but that statement, which serves as McGregor’s springboard to socialism, cannot suffice for an analysis of the facts.  One of those facts is that the United States has been successful in compelling changes in China’s protectionist practices in all of the formal WTO disputes it has lodged that have been resolved thus far (6 of 8 formal cases have been resolved).  If China violates the agreed rules of trade, and its actions impair benefits or impose costs on U.S. interests that are too large to ignore, pursuing a WTO case is a legitimate and proven channel of resolution. Chinese protectionism can be addressed without the radical changes McGregor counsels. 

But I think McGregor—sharing the tactics of other in the media and politics—exploits public angst over a rising China to promote his idea as the obvious and only solution to what he sells as a rapidly-metastasizing problem.  McGregor argues that China is aiming to create national champions through subsidies and other preferential policies, while charging foreign companies admission to its market in the form of technology transfer, joint-venturing requirements, and local content rules.  McGregor claims, that this appropriation of foreign technology will be used to “create Chinese ‘indigenous innovations’ that will come back at us globally.”  Ultimately, McGregor fears that “American technology companies could be coerced to plant the seeds of their destruction in the fertile China market.”

It is telling that McGregor doesn’t consider U.S. government expropriation of those companies’ technology assets as planting the seeds of their own destruction.  Indeed, it is nothing short of expropriation when technology that is owned by individual companies in the private sector, making unique decisions to improve their own bottom-lines on behalf of their own shareholders is suddenly subject to the questions McGregor wants answered: What technology do we protect? What do we share? What are our commercial strategic imperatives as a nation?  Those questions, let alone the answers, imply that the U.S. government should have at least de facto ownership and control over these privately-held technology assets.

What is wrong with allowing each of these companies to decide for themselves whether they want to license or transfer some of their technology to Chinese companies, as the price of doing business in China?  Some will, some won’t, but the presupposition that those who do are selling the golden goose is not based on fact.  Let companies decide for themselves how to use their resources, and don’t treat industry as a monolith, as in “What are our commercial strategic imperatives as a nation?” 

Had we tried to answer and implement the answer to that question in the face the Japanese “threat” two decade ago, we’d be bereft of some of the most ingenious technological breakthroughs and the hundreds of industries and thousands of products that “our system of almost no national economic planning” has yielded.

When we peel away the chicken-little rhetoric, when we dispense with neo-Rahm Emanualism (“Never manufacture a good crisis and then let it go to waste”), when cooler heads and analytical minds prevail, the economic question boils down to this: What has been more successful at creating growth, central planning or decentralized dynamism?  For both China and the United States, it has been the latter. 

My bet is that China’s re-embrace of greater central planning will be brief, as it wastes resources, yields few -if any- national champions, and limits innovation.  For similar reasons, U.S. opinion leaders will eschew central planning, as well.