a Time for Calm

Let’s take a deep breath and look at where we are, and at what’s the norm. Everybody seems to agree that the current vector of government needs adjustment. That’s where agreement ends.

We are on track for running trillion-dollar deficits ad infinitum, so the track needs changing. The root question is, do we aim for post-World War II norms, or do we wish to set a new norm (and if so, why so). Revenues, spending and unemployment are the three metrics most often held up as points of contention, so let’s look at those. Post-World War II, we have averaged raising ~18% of GDP in taxes, and today we are bringing in ~17% of GDP. Our post-World War II average of government spending has been ~20% of GDP, right now we are spending ~26%. Post-Great-Depression, 4% unemployment has been considered “full employment”, and we have averaged ~5%, post-World War II. Today, that number is at 9.2%.

Taxes first. By far, the most potent factor in raising or lowering revenues is GDP growth or shrinkage. The problem Congress – no matter who is charge – has with sensible tax policy is that they use static scoring. They assume that human behavior doesn’t change in reaction to tax policy. This is why rate increases never raise as much revenue as Congress thinks it will. Another problematic aspect of tax policy is that Congress intentionally misleads voters on what they are doing – they call a one-time-only rebate a “tax cut” (only rate changes are “tax increases” or “tax cuts”); they talk of “millionaires and billionaires” while meaning anyone making over $200,000 or $250,000; our entire tax code is shot-through with exemptions (read: loopholes) for contributors, special interests and corporations that the authors invariably call “evening the playing field”, while they actually unfairly tilt it; on and on. While the code desperately needs simplification, there’s not time to do that before we address the current problems of deficit and debt. I would say that tax increases that would bring us back up to 18% of GDP would be fair (contingent upon spending cuts, below).

Spending. There’s no question that we have embarked on an historic spending binge. The spenders will tell us that it was all necessary to address the crisis within which they found themselves. The credit markets were failing, and that has been saved (that lenders aren’t lending is now voluntary behavior, not one driven by a lack of liquidity, which was the crisis). Zeroing-out bond-holders in General Motors and Chrysler has had a negative affect on bond issues – investors can no longer trust the sanctity of contracts – and this is another hurdle for businesses getting capital, which, in turn, has an artificial depressing effect on interest rates, which invites inflation (especially with a trillion or so in pent-up liquidity in the banks and corporations). All of this begs government spending to “solve” a capital-flow problem that it created. Then there’s the voluntary creation of a vast new entitlement program in the midst of a spending crisis. ObamaCare makes sweeping changes to 17% of the American economy in one, bloated, ill-thought-out program that is permeated with intended and unintended consequences. Our legacy entitlement programs are unsustainable. Again, there isn’t time to address all of this before deficit and debt decisions must be made. I would say that spending cuts to bring us back to spending 20% of GDP would be fair (even though that sustains an historical average of a 2% of GDP annual deficit. Again, contingent upon tax increases, above).

Unemployment. There are two major factors in establishing unemployment norms: GDP growth and technology. GDP growth must at least match population growth in order to keep the ratio of economic activity to workforce stable. Increasing technological norms tend to increase automation and complexity of the workplace, the former requiring fewer people to do the same things; the latter requiring an increasingly sophisticated workforce. These are immutable forces in the American economy, not policy decisions (short of intentionally dumbing-down the economy so that automation ceases and the workplace stays at current or lower levels of complexity). GDP growth answers most of our ills – revenues, employment, research and development, innovation, entrepreneurialism, and so on.

The question is, of course, how do we get anemic GDP growth to accelerate? What are the sectors or sector-segments that can jump-start overall growth? Historically, that has been small business. Not only does small business account for 70% of new hires in this economy, they require less capital for market entry; they are far more agile in reacting to fragile markets and changing conditions; they are quicker to pick up on niche-markets and far better at adapting to fickle public tastes. By far the best way to invigorate both employment and GDP growth is to cater to small business formation.

How do we do that? Define “small business” as those employing less than 500 people, then exempting them from unnecessary regulations and unnecessary taxation. Ease venture capital flow by establishing a government guarantee of up to a million dollars for qualified startup loans (Intel was started with $80,000 of venture capital). This is one place government could actually fulfill the task, but I don’t trust politicians and bureaucrats to objectively evaluate business plans, or to keep their fingers out of the profit pie. Universities could also be of great assistance in this realm – Stanford has established a program that helps their post-grad students start up businesses based on their specialty, provided they do so in the area (can you say “Silicon Valley”?) and that the founders guest-teach classes in their specialty. Stanford also hands graduates any patents they have gained while in class. Most universities keep the patents, and have paltry “business incubators” that are no more than referral services.

All three of these fields have severe structural problems that need to be addressed, but with markets in mind, not politics. To heal the economy, politicians must concern themselves with what the economy needs, not with bottom-feeding for votes.

We simply must expect more from our elected officials than bribing us with our own money.

2 thoughts on “a Time for Calm

  1. I have read this posting three times carefully. I’m sorry to admit that it is much too sophisticated for me to understand. It requires a much greater knowledge of economics than I possess.

    Your use of history and economic conditions and economic theories and how they relate to politics and what to do politically in order to solve the economic crisis…All I can say is you’ve left me in the dust. Sorry.

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