The Fed Can’t Do It Alone

By John O. Whitney
This article appeared on on January 14, 2008.

January 29 is D-Day — the day that the Fed sallies forth to slay two economic dragons: unemployment and inflation. Good luck, Ben! Unfortunately, Congress, the executive branch and the business community routinely trump monetary policy with punishing fiscal policy, excessive regulation, protectionist legislation, corporate welfare and other non-monetary policies. These factors have more influence on jobs and prices than Fed action, important as it is.

What is lost in this political shuffle is the importance of productivity, the only constant in creating jobs while keeping prices stable. How so?

One cause of inflation is too much money chasing too few goods; ergo, reduce the money supply. That’s fine and usually necessary. But what about keeping the money supply constant and producing more goods and services? And doing so without an increase in gross economic inputs but with a reallocation of those inputs! By moving resources away from government, unproductive by its very nature, to individuals and businesses, we would experience a significant increase in living standards, not just for the rich, as class warriors suggest, but for everyone. Those who believe that productivity benefits the rich and destroys middle class jobs have been living in caves or have self-serving political agendas. Despite the best efforts of modern Luddites, the United States has been the most productive and has the highest universal living standards of any country in the world. Our current unemployment rate of 5% is well under most European countries and a fraction of emerging countries or those with authoritarian central governments.

Here are the threats we must overcome if we are to help the Federal Reserve meet their mandate of assuring stable prices and full employment.

Excessive Regulation

The Mercatus Center at George Mason University estimated that, in the year 2000, the cost of regulation was $843 billion or around $9000 per household. Sarbanes-Oxley, 9/11, an activist Congress and executive branch surely have escalated today’s cost to well over $1 trillion. Of course, some regulation is salutary, particularly the regulation that protects free speech, property rights, the sanctity of contracts, free trade, pure food and water, and driving on the right side of the road. But the infamous “no flush” toilets, front loading washing machines, spotted owls, and kangaroo rats now augmented by section 404 of Sarbanes-Oxley, the SEC’s peek-a-boo board, unrealistic carbon emission targets and about 30% of OSHA-mandated paperwork are nonsense.

If regulation costs us $1 trillion, that’s 8% of GDP. If we could bring that down to 6% we could look for $260 billion more in products and services and our now anemic GDP growth would be robust again.

Tax Policy

United States tax policy is a shameful destroyer of productivity. The tax code in 1913 had 400 pages, 19,500 pages in 1974, 54,846 pages in 2003 and 66,000 pages in 2006. The OMB estimated that Americans spent 64 billion hours and $265 billion to prepare their tax returns in 2005. (These numbers do not include the cost of preparing state and local tax returns.) It requires no stretch of the imagination to estimate that another 1% or 2% would be added to our productivity if these resources had been dedicated to designing and delivering useful products or services! Indeed, the gain could be greater considering that some of our best educated citizens — lawyers, accountants and financial consultants — are engaged in this shameful pursuit.

Bastions of “capitalism” like Russia, Mongolia, Lithuania, Latvia, Estonia, Kazakhstan and a dozen others are laughing at us all the way to the bank. It seems that the flat tax system is serving them well.

Corporate Tax Rate

Corporate tax rates in the United States are among the highest in the world’s developed economies. Not only should they be lowered, they should be abolished. The reason is simple. Corporate taxes shift resource allocation away from the most productive sector of our economy. To stay in business, a company must produce more than it consumes. The $300 billion dollars in revenue from corporate taxes, when applied to more productive uses, will have a salutary effect on GDP. My students were required to write an article titled, “Workers of the World, Unite. Help Eliminate Corporate Taxes.” The objective was to trace alternate revenue streams. Neither I nor my students — nor anyone else, for that matter — has the information, prescience or skill to trace those streams precisely. Nonetheless, the students’ directional indicators were consistent: tax revenues at least neutral, higher CAPEX leading to higher productivity, higher revenue and faster profit growth, more dividends, higher wages, continued low unemployment, lower prices and increased global competitiveness.


Will we never learn? Protectionism is again rearing its ugly head in Congress and, if not stopped, will have the same destructive effects as it did in the two decades following 1929. There are two aspects of this deadly economic disease: trade policy and corporate welfare.

Trade Policy

The Smoot-Hawley Tariff Act of l930 was one of the great economic disasters of all time. Not only did it deepen and prolong the depression but many believe it was one of the causes of World War II. Tariffs were imposed on 20,000 items. Our trading partners retaliated. Goods became more expensive and the United States became more and more isolated. We were the enemy, no longer a partner. Our sacrifices in WWI were forgotten. Yet there was plenty of evidence that tariffs did not work.

Although David Ricardo was not the first to articulate the Law of Comparative Advantage, his 1817 book clearly spells out why trade is good for all parties, even when one party does not have absolute advantage over another. Here’s one way to think about it. What if each of our 50 states had tariffs, quotas and subsidies to “protect” workers and citizens in each state? We would be a third world country. Food in manufacturing states would be more expensive and, ironically, also would be more expensive in agricultural states because farm equipment would be more expensive. Another way to look at it is the relative improvement in EU living standards since country barriers were eliminated. Yet many of our politicians are cynically and mistakenly pandering to special interest groups which have been hurt by foreign competition. Yes, we have fewer manufacturing jobs but so does the entire world, thanks to technology. And, what if, in 1900, we had legislated against farm equipment manufacturers in order to preserve farm jobs which employed 37% of our population? Today less than 1% of our population is hired farm workers and we feed ourselves as well as much of the world. Cavalier as this might sound, if you were a hunter-gatherer and the Wildebeests moved south, would you move south or would you petition the animal gods to move the Wildebeests back north again. You might do both but only one of these actions would solve the problem.

I would reluctantly concede that we can provide temporary relief for those who are severely damaged by economic forces beyond their control; but history shows that precious few of such measures are temporary.

Corporate Welfare

Lobbyists are a useful adjunct to the legislative process. It is difficult for a congressman to know enough to make good decisions about every issue. But lobbyists are destructive when their clients send them out to seek advantage using political rather than economic means.

As a result of the 2001 steel tariffs, more jobs were lost by US steel fabricators than were “saved” in the steel companies. And prices certainly were raised. Our most important trading partner, Canada, was understandably angered by our recent tariffs on their lumber. Textile and apparel quotas might save some jobs in the United States but raise prices for consumers. Does Congress, the executive branch and the textile industry believe it is fair to punish the rest of the country to save some jobs in textile states? Apparently, they do.

A particularly egregious example is the unholy alliance among Congress, the sugar, and corn lobbies that keeps cheaper, more efficient sugar-based ethanol out of our gas tanks. Corn ethanol is protected by a 51cent per gallon tax credit and both sugar and corn interests are protected by a 54 cent per gallon tariff on Brazilian ethanol. Given the drag on our employment along with the inflation effect of $100 oil along with the nation’s quest for energy independence, it is almost seditious that Congress diverts attention from its malfeasance by holding kangaroo courts for “Big Oil”.

If we can import oil from Venezuela but cannot import sugar-based ethanol from our friends in Brazil, Chairman Bernake might be excused for wondering how he, alone, can assure price stability and full employment.

Humphrey-Hawkins Day at the Fed

It would be a wonderful irony if the Federal Reserve Governors could summon Congress, the executive branch and corporate welfare recipients to learn what they are doing to promote full employment and a stable currency. The decorum in the Fed chambers would be classier and the courtesy not as cloying or insincere. Moreover, the speeches leading to the Governors’ questions would not be as tediously long, nor would they be as ill-informed. The spectacle, however, would be instructive as well as entertaining. Let’s keep this role reversal in mind as the media frenzy builds toward the end of the month. The Fed can’t do it alone.

John O. Whitney is Professor Emeritus in the Practice of Management at Columbia University in New York City.