Economists need to step outside themselves

Economist Paul Krugman's recently released book "Stop this Depression Now" reminded me of one of the basic truisms I have harbored about economics - the subject is so complex that although any economist who wants to build a career has to develop and publish hugely complex mathematical formulations and theoretical constructs, since there is no consensus on much of anything, in the end many famous economists are pretty clueless about what makes an economy work.


At the moment we are enduring the spectacle of Republican leaning Noble Prize winning economist's who shower data on folks to support their believe that Government taxes and spending are the problem with the economy, while Democrats have their Noble Prize winning economists who have volumes of data to support their view that Government spending is the cure for our economy.


If you took a group of average folks and asked them how to fix the economy, you would get a wide variety of responses, generally reflecting the emotional worldview each person is comfortable in rather than any real hard data.  We all adopt views in life so we have some default position from which to make decisions.  That adoption usually has more to do with our personality as it interacts with our life situation than it does with dispassionate careful study of all the diversity in human behavior.  We have to many decisions in life to spend time studying everything, and most of the time macroeconomics is pretty far removed from the things that touch our lives on a daily basis.


I don't think some economists are any different.  Early in life they found a viewpoint they felt comfortable with and they built their career's on developing data and theories to support their viewpoint.


Krugman's book cited a bunch of economists who agreed with his view Government spending is the way out of our current economic morass, and a bunch who believed  the private sector and the free market are the pathway to jump start our economy.  On the assumption the side of the political fence any particular economist falls on might be a function of his personality and background I randomly picked 10 names out of Krugman's book (including Krugman) and did a little spread sheet  with some basic data about each. 


Two of the 10 were born long ago.  Englishman John Maynard Keynes - the patriarch of the Government spending view, - who was born in 1883, and Milton Friedman - the patriarch of the supply side theories that were the intellectual justification for the Reagan and Bush tax cuts  - was born in 1912.


Of the other 8 the 4 cited as being the spokesperson for the tax cuts and deficit reduction wing of economics, were all born between 1925 and 1939.  The 4 (including Krugman) who are supporters of the idea Government spending is the cure for this economic doldrums were all born between 1939 and 1953.


Nothing scientific about this little survey, but it does suggest the possibility a more careful review may provide some support for the view that an economist's basic predilections may often have more to do with when they are born than with a hard headed view of all the available data.

Economic Illusions

When I was young I recall sometimes hiking with friends or siblings up a wild creek that was near where we lived.  From time to time we would find a stick and use a pocket knife to create a sharp point and then try to spear the fish in the cool, shaded waters of the pools in the creek.   It was extraordinarily difficult because the way the light refracted off the water the fish were never where they appear to be.


Republicans economic ideas sometimes remind of of that experience.  It seems like somehow the Republican view of the world is refracted so what they see isn't reality.


Republicans believe government is what stands between us and peace and prosperity.  In fact good Government is what allows society to be peaceful, productive and compassionate.  The cultural evolution of our species for the last several thousand years consists of an achingly slow evolution away from government that consisted of greedy and selfish people using others for their own benefit towards government that exists to serve all people.


Government is absolutely necessary.  But we are still a long way from Government that exists to serve all the people.  The use of government to line the pockets of a few is still a big problem.  Here in California the Prison Guards union typify the modern iteration of greedy government.  As of a year or so ago somewhere around 50 of the California State Department of Corrections employee's took home over 1/2 million dollars in salary a year.  The lowliest prison guard makes well over $100,000 a year, and the retirement programs are exceedingly generous.  How did the Prison Guards union get their members these extraordinary benefits?  They teamed up with law and order Republicans 30 years ago, who rewarded them with big budgets for their electoral support.


Contrast that with 30 years of Republican attacks on teachers and teachers unions (because they support Democrats).  The average prison guard probably makes twice the salary of the average teacher, and no person in public K-12 education is making anything like half a million dollars in salary.  Yet to this day Republicans all over the country are going after teachers and school budgets, and saying nothing about law enforcement budgets.


It is not that Democrats aren't overly accommodating with public employee unions sometimes, but they are up front about it.  Republican's rail against the unions on one hand, then quietly hand huge paydays at taxpayer expense to those who support them.


For the last decade California has stood common sense on its head, spending far more on prisons than universities, and paying corrections officers 2 or 3 times as much as even the most well payed teacher receives.  Even as the third world races to lift the poorest members of society up to become healthy, educated and productive citizens that can contribute to making their country a better place for everyone we in California seem to be moving the other direction.

The Romney economic plan

I have seen a couple of articles recently where supporters of Mitt Romney's economic plan have argued that the Romney plan follows President Reagan's plan for dealing with the recession in 1981-82, and that that is a good thing. (See side comment in footnote)


The articles generally compare that 1981-82 recession with the current recession, throw in some similar arguments how the Bush tax cuts last decade were great for the economy and conclude the Romney plan is the cure for our economic woes.  


To me these comparisons are either woefully ignorant or a cynical effort to sell the Romney plan to get their guy elected regardless of the consequences.


1.  They seem to be either unaware, or unwilling to face the fact the two recessions were caused by completely different events.  The 1981-82 recession, which was pretty mild, followed a decade long period of high inflation as the Government tried to inflate away the deficit from the Viet-Nam war rather than imposing taxes to pay the cost of the war.  The current recession was caused by a private sector meltdown and the continuing malaise in the economy is rooted in deep seated problems in the private sector.


2.  The article assumes if you put more money in the pocket of rich folks, they will create jobs.  It ignores the fact big corporations have been making record profits, and stockpiling money for years.  There is no shortage of investment capital, the shortage is on the demand side of the equation - there are few opportunities for investment because ordinary folks don't have much money to spend.

3.   As a country we are in a completely different place than in 1981.  The Baby boomer generation was then just beginning to flood the labor market with energetic young workers.  Now they (we) are just beginning to leave the job market in droves to retirement and the percentage of the population in their prime working years is much smaller in comparison.


4.  Their arguments ignore the deficit.  They tout the Reagan and Bush tax cuts as curing the recession, but ignore the fact both the Reagan and Bush tax cuts caused a huge spike in our National Debt.  In effect the Reagan and Bush plans were sort of like if you or I stopped  paying our bills.  Heck yes, we would have more money to spend - for awhile.

5.  Perhaps most damning is the fact they ignore empirical economic studies that have looked at what happens when a country cuts government spending and found that, in a low interest rate environment, there is virtually a 100% correlation between cutting government spending and a rise in unemployment and a drop in GDP. 


Basically, if the Romney plan is implemented we face one of two options.  If we chop government spending dramatically, we will sink into another recession or perhaps a depression. If we cut taxes without cutting government spending we put the deficit back onto its skyward trajectory, and since our problem isn't a lack of investment capital, we will see very little economic improvement in return.


We can't get out of our current economic problems by handing out more candy to rich folks, which is what the Romney plan is all about.


Footnote - Romney's plan has much in common with the Herbert Hoover plans in 1930-32 that turned a stock market crash into the great depression.  Ironically, the most recent article I read pushing the Romney plan was by a Hoover Institute Fellow in the San Francisco Chronicle Insight Section for July 15, 2012 - evidently the Hoover Institute is still unwilling to accept that the depth of the Great Depression might be related to Hoover's private sector based attempts to reinvigorate the economy.

Fair taxes - How taxes on Capital should be structured

If one assumes that all income should be taxed equally so people share the burden of expense of government equally here is how taxes on Capital should be structured:


Dividends should be treated as ordinary income (as they used to be before the Bush tax cuts).  They are distributed profits from a business and there is no reason to give them favorable tax treatment.


Capital Gain should also be treated as ordinary income.  But there should be two special provisions, one for fairness purposes and one to encourage investment.


For fairness gain should be reduced by how long you held the asset to account for inflation.


To encourage investment you should be allowed to sell an asset and immediately roll the proceeds over into a new asset.  All the rollover proceeds would not be taxed, and you would carry the same basis into the new asset (basis is how much of your own money you originally put in).  This would need rules to ensure it is not abused, particularly when you are using borrowed money to buy an asset.

Income inequality

Heard an interview of author Edward Conard, a Bain Capital guy, who has written a book called "Why Everything you Have Been Told About the Economy is Wrong".   The interview focused on what is apparently his main thesis, that income inequality is a good thing.  In the interview it seemed the crux of his argument was that we are richer than Germany or Japan, and we have greater income inequality, therefore the reason we are richer is because the investor class in Germany and Japan are more highly taxed.


His argument in the interview did not address some pretty basic facts, so it makes me wonder if he addresses issues like:


1.  He seemed to be focused on the period since WW II, does he address that time in our history that is most like our current situation, the roaring twenties and the Great Depression?  Where we had rising income inequality and then an housing and finance based collapse that led to years of economic weakness.


2.  In citing Germany and Japan does he address the fact we started from different places?  At the end of WW II our country, our infrastructure and manufacturing capability were untouched, and in fact had been pumped up on steroids by the war.  In Germany and Japan, on the other hand, the major cities were piles of rubble, big chunks of their infrastructure were destroyed and their manufacturing base was in tatters.  We had a huge economic head start and the fact we are still are richer says nothing about our economy beyond the fact we have avoided catastrophe and kept moving forward.


2.  Does he address population distribution?  Because of our success in WW II we had a ton of kids between 1947 and 1957, the so called baby boomers.  No such event occurred in Germany or Japan (or the rest of the world as far as I know).  A result of that explosion in the number of children meant that in the period from the late 1970's through the early 2000's we had an extraordinarily high percentage of our population in what economists consider the prime productive years - the time of our life we we create a lot of wealth and build our financial life.  The simple fact is if 5 out of every 10 people are in that time of life in country #1, that country is going to be richer than country 2 where only 4 out of 10 are in that period of life.


Perhaps he deals with these issues in his book.  I'm sure the Economist will review it soon, unless that review suggests he deals with issues like these I will see no reason to read the book.

Bain Capital and whether Obama understands the economy

A lot of commentators, including some Democrats, are suggesting Mr. Obama's criticism of Mitt Romney's ties to Bain Capital show he does not understand how the economy works.  What these comments suggest to me is that the commentators are the ones where the failure to understand is found.

Perhaps the commentator's could explain to we the audience how Mr. Romney's economic ideas differ from the  ideas of the Coolidge/Hoover era Republicans who led the nation into the great depression, with its 25%  unemployment.  Or how his ideas differ from the ideas of the Republicans who seized control of both houses of Congress in 1995, and led the nation into the Great Recession and the economic morass we are still attempting to climb out of?


Perhaps the commentators could convince me it was just dumb luck that Democrats could control both Houses of Congress for 14 year, 24 year and 8 year stretches between these two periods of Business Republican domination without managing to blow up the economy.  Perhaps the commentators could make the case the rising inequality, bubbles in housing and equities followed by spectacular economic collapse that marked the only two periods of Business Republican domination of government in the last 100 years were just coincidence.

The question isn't whether Bain Capital acted wisely or legally, or even whether hedge funds are a leech or a building block of our economy.  It is whether the ideas that made the folks at Bain Capital lots of money can be translated to Government successfully and history suggests the answer is a resounding no.  Business and Government have different purposes and goals, and business Republican's have a long history of demonstrating success in business is often an impediment to success in Government.  In the private sector firing a bunch of people and paying off investors often makes for resounding success because the fired folks aren't the businesses problem.  That approach does not work for Government because the laid off people are their problem, and are crucial to the consumer base on top of it.

Even the publication I read most regularly, the Economist, has gone down this "Obama doesn't understand" road. Yet that esteemed publication some months ago published economic data that suggested the initial collapse of 2008 was in fact worse than the initial collapse of 1929.  Mr. Obama's bad luck was that, although he has done a
remarkable job of preventing another Great Depression, since the Republicans left the scene of the crime as the collapse was happening, they now can come back and argue Mr. Obama is the cause of the countries economic problems, and offer the same solutions they offered that twice crippled the economy.  


Back when the great depression first began, luckily for FDR (unlucky for the country), Republicans remained in control for the first three years of the Great Depression, at which point unemployment was 25% so it was readily apparent to voters who really did not understand how to create jobs.  Democrats elected FDR and controlled both house of Congress for the next 14 years.

Bring back the item veto

One of the huge issues that Republican's and Democrats beat each other over the head with is earmarks.  Earmarks, those dollops of Federal dollars that members of Congress hand out to their districts to curry favor are made possible by the budget process where the President, when he gets a budget from Congress, faces an all or nothing choice.  He can either veto the entire budget, or swallow any objections and sign it.

Some states, including California, provide the chief executive with the power to veto individual expenditures while still approving the overall budget.  It is called the line item veto here in California.  Item veto's are not a cure for all government fiscal impropriety, but they are a useful tool, particularly in the sense that they give taxpayers one person to hold accountable for funding programs that really don't deserve taxpayer dollars.

Back in the early 1990's, Republicans trying to get back into power in Washington by hammering Democrats on the deficit, pushed through a bill giving the President a line item veto.  A year or two later the Supreme Court held it was unconstitutional.  One would think the Republicans, who by that time controlled both houses of Congress, would have proposed and pushed a constitutional amendment to allow the line item veto.  But, since they were now the ones handing out earmarks to curry favor with voters, they evidently lost interest - probably in part because Bill Clinton was President and they didn't want to give him the power to veto their pet projects.  The notion of a line item veto sank into oblivion.

It should be revived.  Whats happening in Europe is an object lesson on how hard it is to control government expenditures.  An item veto would be a useful tool.