Blue sky thinking

Like this dog Brandy, an American immigrant to Colombia, many are dreaming of a better time. Although a poodle can never really fly, the US economy can and will improve. Let's take a moment to dream about what we could accomplish.

Back when I was young, a new movement was sweeping the West. We thought of a world simpler and freer, with more choice and individual autonomy. A more prosperous world with fewer, more useful restrictions on human action. Most of the energy and coherence has dissipated from the libertarian movement of the 70's and 80's, but let's recall some unfinished business.

Trade reform, tax reform, regulatory reform, government limitation, the end of mining the government, health reform and stable money are all projects that have slipped off track in the last few years.

Back in my business school days, I spent a good deal of effort to try to understand economic policy during the great depression. After grinding through Friedman and Schwarz's "A Monetary History of the United States...." and endless microfilms of the Wall Street Journal from the 20's and 30's, I was struck by how different the policy framework and thinking was at that time. Almost all the world was on some sort of commodity standard, usually the gold standard, that limited any one government's ability to inflate, or fight global deflation. The income tax was new and highly variable, while only one in five (20%) of earners paid income taxes. Little international trade took place. Central banking was new to the United States. Customs duties provided about half of federal revenue.

Yet some things stood out as contractionary. The Smoot-Hawley tariff raised the tax wedge on the importation of hundreds of items. Raising the income tax while the economy was contracting, more than doubling the top rate, invited more contraction and capital flight. As was the huge increase in the death tax and the raising of excise taxes. Cutting federal spending across the board in 1933 didn't help the demand picture either. The Fed misinterpreted the fall in lending as a normal response to falling trade, rather than a reflection of high real interest rates. Endless meetings of the Federal  Reserve Board featured some who wanted to hold off on cutting rates to "keep their powder dry" for the real crisis that was yet to come. Even after successive banking crises, many worried about future inflation of the currency.

 Most of the policy efforts were spent on temporary reacions to repeated crises. Emergency bailouts and mergers, sand-still agreements and moratoria dominated policy headlines. The RFC (Recontruction Finance Corporation) made huge loans or invested in special issues of stock to big business to help the stay liquid, and perhaps expand. Since they had made almost all of their loans in secret, good government types sued and won to reveal the recipients. This made the companies look week when the RFC involvement was published in the papers. A policy that was designed to reassure investors and depositors lead to still more runs on the banks.

Some public works projects were undertaken, trying to boost employment, but higher taxes negated and effect on general demand, which would have been tiny anyway.

A great deal of effort went into suppressing "cut-throat competition" and other efforts to suppress adjustment to the new levels of demand.

In retrospect, much of the policy we see as counter-productive today can be explained by the huge importance of maintaining the gold standard, and the misunderstanding of the source of the fall in demand. Gold flow into the US remained positive through most of the early years of the contraction, and prices throughout the gold standard world had to fall because of the financial crisis in the US banking system. Higher tariffs lead to retaliation, negating the gold hoarding policies of high tariffs, while trade collapsed, leading to competing devaluations around the world.

A list of casualties would be long and various: A third of the banks failed. Trade contracted about 80%, construction collapsed about 80% and by 1933 one in four workers (25%) were unemployed.

What would the libertarian economists of the 70's have done differently? Milton Friedman emphasized stable money and prices. Trying to maintain steady growth in monetary aggregates would be difficult, since they were barely invented yet, and statistics were not reported quickly. In the absence of stats, commodity prices would provide a proxy for the "looseness or tightness" of monetary policy. A policy of steady internal demand would eventually run into a foreign exchange constraint, leading to devaluation or floating the dollar-- a radical departure in policy.

Friedman believed in free or freer trade. Vetoing or repealing the tariff increase would just be a start. Lowering and flattening the tariff schedule would be high on the agenda. Perhaps a Chile style flat 20%. That would have been a huge tax cut, of about half, on foreign trade, inviting a rising instead of a falling trade volume.

Friedman believed in the flat tax.  By '33 the income tax rates ranged between 4 and 63 percent, yet it produced only about 2% of national income. A 5% tax on everyone, unified with a 5% corporate tax above poverty level would have produced about the same revenue, while involving less capital flight and deadweight loss.

Needless to say, there are only a few economists today would think all those anticompetitive efforts were useful. 

Would all these changes produce expansion? I don't know, but I have a hunch.

The 12.1 percent solution?

 

Today, the government collects 12.1 % of what the IRS calls AGI (adjusted gross income). This represents about 8% of GDP.  There is room for reform there. 

The average tariff rate is 1.2 percent, yet many duties are far above that. There is room for reform there.

The trade weighted dollar has fallen dramatically, the risen dramatically, while commodity prices have risen to records, then collapsed, More room to reform.

 

More regulators, more regulations more mind numbing complexity in our dealings with the government. More new taxes and credits and subsidies, especially in energy use and production.

More panicky deals to save this or that institution, while healthy companies are taxed to aid loss making institutions. more reform here too.

What is the reforming market-freeing effort most needed today? What could be simplified,  reduced, rationalized today?

$600 Billion Worth of Payoffs?

It seems that all the spending interest groups are in Ecstasy over the prospect of a huge stimulus package coming out of washington. If $150 billion wasn't enough last spring,  the answer is that it wasn't large enough. Paul Krugman suggests a figure of $600 billion, about 4 percent of GDP. Other commentators have paraded larger piles of cash before the spending interests. "An amount of over a trillion dollars is a minimum needed for the present situation" said one commentator.

It is a tribute to human creativity that the answer to someone's debt problem is for them to spend more-- on the things that will benefit others and calling it "investment". Adding solar panels to government rooftops or insulating old folks houses may sound pleasant, but they are hardly serious answers to heavily indebted people's problems. Added highway spending may relieve congestion, or may not, but it chiefly moves economic activity around from older or unimproved routes, just as the new gas station or fast food joint takes business from the old one in a mature market. Adding a few months to the period of unemployment insurance  will help people in need, helping to feed them while they look for a job (or hold out for a better offer), but those people will not be able to pay their mortgage, since the amount can never going to be large enough.  Nor can bailing out every institution create prosperity, or even much relief, just as the take-over of the railroads and the creation of Conrail and Amtrak did not create a prosperous rail service. Using subsidies to create new "green" energy industries will just create more industries dependent upon subsidies, just as it has since Nixon's "Project Independence" some thirty-odd years ago.

The greenies need other arguments to enact their agenda. While global warming and alternative energy may be superficially popular issues, few are ready and willing to endure the sacrifices and poverty they are really demanding. This year they are envoking the spirits of two of the most corrosive ideas popular in the American political tradition -- Alexander Hamilton's infant industries argument and Keynes pothole argument.

Back when Hamilton was the first secretary of the treasury, his first message introducing the tariff included the idea that the federal government could help create new industries in the young country by giving them special preference, special protection from competition, by selective use of the tariff schedule. Critics said perhaps these industrial infants might never grow up to support themselves, once accustomed to special favors. Much of the conflict and lobbying of the next 200 years can be traced to this policy.

During the Great Depression of the 1930's, John Maynard Keynes (later Lord Keynes) became famous for the ideas express in his monumental "General Theory...." which remade economics and established many of the concepts of macroeconomics. While many of his ideas were bastardized into crude cartoons,  his basic remedy for unemployment was manic government spending, since he viewed unemployed resources as a unambiguous deadweight loss. He even stated that society would be enriched by burying pound notes and launching a scavenger hunt. Disciples spread a gospel of the free lunch and a solution to the business cycle all over the Western world. The results of this political excuse for "stimulus packages" were major and long lasting. While in 1929 the US government spent less than three percent (yes 3%) of GDP, by 1975 they were spending more than twenty percent. Since fear of recession and depression were major fears for that generation, and experience of  inflation and devaluation were not, the federal budget was balanced only rarely from 1929 to 1998 (a few years during Eisenhower).

Some Good Colombian