pinion A Real Look at the Economy

This is my last political column before Tuesday's presidential election. In my previous two pieces, I broke down some of the major issues concerning foreign policy and energy that weren't being addressed in the debates. But most of the email I have received centers around economic issues and confusion over deficit spending, tax policy and unemployment. Let's take a look at what's been missing there as well.

First, let's separate the rhetoric from the reality. The U.S. economy is challenged on several fronts. Some of it is systemic and will require root-level changes. Some of it is also deeply intertwined with forces that we have limited control over. And some of it is the result of a corrupt political system that does not reward real solutions.

In 2008/09 the United States suffered a historic economic collapse. The CBO estimates that a three and a half trillion dollar hole was blown into the economy. Millions of jobs were lost, tens of millions of peoples' earnings reduced, and nearly everyone's assets were adjusted downward. Entire industries contracted forcefully and many nearly collapsed. Savers and retirees have been clobbered by non-existent interest rates. Over the following three years, the problems rippled through exceedingly interconnected global economies, each tremor sending shock waves back to our shores.

The idea that these are simple problems and our failures to immediately correct such catastrophes are owed to ideological shortcomings is nothing short of absurd. No one has a real solution, because it's much more complicated than a five-point plan and a bumper sticker. But we need to start with honest debate on the system-wide level, if we're ever going to get to meaningful dialog on specifics.

Consumption

The United States is the largest consumer economy in the world. 70 percent of our GDP is consumption. Too much of that consumption is from imported goods causing large trade deficits. The trade deficits finance our government deficits, as we continue to spend much more in services than we take in in revenues (tax receipts). Before we get to trade policy though, let's acknowledge that a consumption-based economy needs a healthy supply of consumers, even if the long-term unsustainable borrow-and-spend model is going to work in the short term.

The biggest thing plaguing the U.S. economy at large through the recent downturn has been a contraction in disposable income among too many Americans, causing a reduction in consumption that ripples through the economy at nearly every level. A consumption-based economy has much more elasticity in demand. In a primitive economy in which people are living on a couple of dollars a day spent almost entirely on securing food and maintaining viable shelter, demand does not vary to nearly the degree that it does in a much more advanced one, where even the poorest consumers have infinite choices on goods that are both necessities and luxuries.

When unemployment goes up and wages flatten or decline, people spend (consume) less. Because so much U.S. employment is tied to flexible consumption, economic contractions like the one we just experienced have a terrible ripple effect. A person gets laid off and their unemployment benefits are only likely to be a portion of what their normal income had been. They stop most of their discretionary spending (dinner at a restaurant, going out to the movies, expensive lattes on the way to work). During panics, many consumers who remain employed lose confidence in their long-term financial well being (what if I get laid off too?) and make similar cutbacks to brace for possible turmoil.

This reduced consumption is felt by employers tied to these industries, who begin to see reduced profits. As demand falls, they tend to lay off employees, reducing the consumer base even further. As consumption continues to drop and consumer confidence further erodes, purchase decisions impact what are typically more insulated industries – the disease spreads. Soon investors lose confidence in many sectors, as the continuing downfall offers little hope that their investments will net a return since so much less spending is going on.

Even as the economy improves, hiring is usually the last investment rebounding companies will make. Manpower is expensive and more permanent than things like advertising or equipment upgrades. During recessions, companies tend to grow more efficient, trimming any excess fat, while asking more of employees less likely to quibble as they see so many of the unemployed struggle around them. Businesses capture new efficiency and increased profits, but job growth historically lags.

Companies add jobs for one reason alone – to meet increased or expected demand. The only way to spark hiring is to boost consumption and the only way to do that is to get more disposable income into the hands of more consumers, preferably via paychecks and pay increases rather than one-time handouts. Tax incentives are normally a great way to encourage desired behavior, the same way tax penalties are good at curbing negative ones. Hiring seems to be the exception to the rule. Tax breaks for hiring veterans or adding new employees might make for a good photo op, but they're bad policy. In practice, you end up surrendering much-needed revenues on hires that would have been made anyway, because once again, businesses hire for one reason and it's not a tax break. It's increased demand. 

Stimulus

The government's role in such cycles has been the subject of endless debate. The Keynesian School of Economics suggests that broad government intervention into the markets is needed to correct stalled or failing economies at such times, while the so-called Chicago School advocates minimum government involvement.

Many Chicago School economists argue that the $800 billion stimulus passed in response to our recent crisis is proof that stimulus failed. However, that's not a very insightful argument. As noted, the size of the hole left in the economy was well over $3 trillion. Most Keynesian economists advocated a stimulus on that scale. Most were also very disappointed how the money was spent.

Democrats insisted on spending a lot of money on resource-heavy green energy initiatives that, even if they succeeded, were going to provide little bang for the buck. Republicans insisted on spending nearly half of the money on tax cuts – not a good way to stimulate the economy at such a time. Whether rich or poor, people are more likely to sock away found money during severe economic recessions. That doesn't help put a very big dent in the lost consumption.

One of the areas where the stimulus was successful was in backstopping depleted state and municipal funding. Many teachers and first responders who would have been laid off during the recession remained employed because of stimulus funds. The problem is that there are few political points for saving a job and many more for “creating” one, even though the former tends to help the economy much more than the latter.

There's greater efficiency in helping someone remain employed because they are less likely to blow through their savings, run up debt and remain a healthy consumer once they're reemployed (often at a lower wage). Jobs like teachers, police officers or social workers don't suffer reduced demand during depressed economies, so the institutions that employ them still need them as much as ever, even once their source of funding (tax revenues) is reduced.

Entitlements

Entitlement spending is becoming an increasingly big part of our domestic budget, mostly because we took it off-budget back in the 80's, hiding the giant IOU's we were writing to trust funds that supported the programs. Politicians like to say that entitlements are breaking the bank because it sounds better than we robbed the entitlement bank for decades and have no money to put back, and would rather you take less benefits than dare tell anyone we want to raise their taxes.

Medicare can be reformed by getting rid of the wasteful Medicare Advantage plans that simply give free tax dollars to insurance companies by overpaying subsidies, and then restructuring the nonsensical deal the last administration cut where it gave away its bargaining rights on prescription drugs. Then it can address and standardize the tremendous graft that is skimmed out of the system during end-of-life care when expensive procedures that offer little to no chance of success are routinely administered simply because they will be reimbursed by the government.

Social Security, which is already more solvent than any comparable insurance plan on the private market, can be fixed into the next century with one stroke of the pen. Scrap the cap that begins exempting high income earners from Social Security taxes after the first $106,800 of income. By asking around 1 percent of Americans who have done very well to simply do what nearly every other worker does (pay Social Security taxes on their entire earned income), the problem is solved. Considering that this class of earners has benefited the most from the unfunded tax cuts and artificially low top brackets that were enabled by hiding the money that was being stolen from the trust, this would hardly seem like a sacrifice.

Deficits

The current deficit spending of the federal government is unsustainable and the eventual consequences only worsen as time goes by and the debt piles up. Conservatives who beat this drum, must acknowledge that without raising taxes and grossly reducing military spending, none of the other cuts they favor will even put a dent in the deficits we are running. Politicians love to attack PBS and the NEA as political red meat “we can't afford,” but remember, the Ryan Plan, billed as a silver bullet to ending our Washington spending spree, actually adds $6 trillion to the debt – and for a reason – it doesn't go after any of these Republican holy grails. Democrats must acknowledge that if these measures are taken, middle class earners will still have to pay more in taxes to close the gap.

If we instead continue these political games with the budget that have become the norm, while doing little to solve the root-level problems, we will see our options diminish until the only end-game is monetizing our debt – printing purely fiat money out of thin air to give our creditors, which will likely be the end of the petrodollar and our world reserve currency status, a reality that would make the last couple of years look like a picnic. Canada was able to solve similar (when compared by percent of GDP) deficit issues in the 90's, but only because they broke the political gridlock and tossed out the special interests. Our Congress has inspired little faith in that department.

The idea that the U.S. can simply reduce spending all the way to a balanced budget is a pipe dream. Look at the debates over sequestration. One after another, Republican members of Congress rose to the dais to plea for the thousands of jobs that would be lost if the U.S. cut its military spending. It was a very Keynesian argument for these so-called conservatives who usually argue that government doesn't create jobs and whose Chicago school mentors would have argued that the money would have simply found its way into the most efficient allocation of resources elsewhere in the economy, creating new and better jobs.

In reality, everyone knows it is not that simple. In any free market economy, government plays a big role in directing resources to places where they are needed, but are unlikely to arrive at the hand of normal market forces. If the government quickly reduces spending, it will continue to be felt elsewhere in the economy only more immediately. Remember, less employed people equals less consumption, less demand, more layoffs. As the economy contracts, less tax revenues are also created. Hence, spending decreases on the budget are offset by falling revenues and an increased need for services like unemployment, food stamps, Medicaid, etc., as more people fall into poverty. If we balanced the budget tomorrow, we'd quickly find it unbalanced once the tax receipts stopped rolling in.

Until we get the economy growing at a healthy pace, there will be deficits of one sort or another, which was the argument for go big or go home with the stimulus bill. There was measurable growth after the stimulus, just not enough, or roughly about a third of what was needed. Perhaps if we'd done a much larger stimulus in the beginning, we could have filled the hole immediately, got revenues back up and safety net services down, and not run the large deficits in all the years that followed. Hindsight is 20/20, but a lot of smart people were making that argument back then. 

Other Factors

Some of the challenges we face are accidental and not as easily addressed. Capacity has had an enormous impact on our economy. Technological advancements have led to huge gains in economic productivity that have not resulted in corresponding increases in earnings for the vast majority of Americans. We have the ability to produce much more (capacity) through much less labor (productivity). In an ideal world, these gains would have been shared. The work day would have shortened, vacation times increased, and earnings risen. Instead, it's simply meant less jobs for the same pay, and longer, rather than shorter hours, while the additional wealth has accumulated almost entirely at the top (where it is also least likely to be spent on consumer goods).

Automation has cost us more domestic jobs than off-shoring by most estimates and perhaps nothing has done so much to devalue the average American worker. There's no rule that companies have to share such gains with workers and there certainly exists much more incentive for executives to use such gains to pad their own compensation and pass the rest on to shareholders.

We can argue all day about what is “right” or “fair.” But what isn't debatable, is that the end result has been a society that is more economically stratified between having enormous wealth and barely enough to live on, than anytime in the last 80 years. No matter what you think of that in a moral sense – that the billionaire count has quadrupled since 1980, while more Americans are currently living in poverty than anytime in history -- you cannot argue that such inequality is good for an economy which is so dependent on consumption.

In the bigger picture, many of our systemic problems relate to the massive fall in personal savings and the rapid rise in personal debt loads that also hamper economic expansion. But how do we get to the point where we can even discuss how average Americans can save more, before we figure out how they can even spend enough to keep the whole thing from falling apart? You don't, not without crafting tax and wage policies that help keep the disparity viable like minimum wage indexed to inflation and top tax brackets that are tied to the wealth gap. 

One opposing school of thought has been that by further lowering revenues through tax cuts, mostly to the wealthiest, while simultaneously waging war on unions, minimum wage increases or any other tool likely to raise incomes for beleaguered consumers, and cutting benefits on poverty-reducing programs like Social Security and Medicare, we will somehow become a prosperous nation in that same consumption-based economy. If you've made it this far in the article, I hope you understand why that's not possible.

What's the real agenda of those that make such arguments? I suspect that most of them don't really see a problem with the current inequality and think that if wages can be forced down even further as such programs dwindle and then ultimately disappear, we ca n transition into a more feudalistic society, where low wages, poor working conditions, longer work hours and no benefits are much more acceptable, once the alternative is to fight like dogs in the street for scraps of rancid food – not much different than the turn of the previous century.

Keep in mind, this is an ideological war 100 years old that cuts to the very fabric of our social order. As the world continues to flatten, those on the highest rung no longer need a domestic economy to prosper. They can keep their wealth in offshore havens, use loopholes to avoid paying their fair share on what's kept here, and profit in a stock market that no longer has anything to do with the domestic economy at large.

Corporate profits are at an all-time high. The wealth of the top 1 percent of Americans is greater than its ever been. Americans will manage the next phase of the American empire in the sort of wind down that Great Britain executed half a century ago, or it will play it out until the end the way Rome did centuries before. But the idea that either presidential candidate or political party offers an easy fix is little more than gold spray paint on a piece of coal.

Further Reading:

Budget Hawks Can't Be Two-faced on Defense Spending

Let's Stop Redistributing Wealth and Enact Sound Fiscal Policy

Get Skin in the Game, Broaden the Base and Let Them Eat Cake

Why Too Much Inequality is Bad for Everyone