Schumpeter
Remembering Drucker
Four years after his death, Peter Drucker remains the king of the management gurus
IN THE normal run of things the management world is divided into dozens of mutually suspicious tribes—theoreticians versus practitioners, publicity-hogging gurus versus retiring academics, supporters of “scientific” management versus advocates of the “humanistic” sort. But this month has seen unusual comity: the leaders of all the management tribes came together to celebrate the centenary of the birth of Peter Drucker, a man who is often described as “the father of modern management” and “the world’s greatest management thinker”.
The celebrations took place all around the world, most notably in Vienna, where Drucker was born, in southern California, where he spent his golden years, and in China, where he is exercising growing influence. The speakers were not limited to luminaries of management: they also included Rick Warren, the spiritual guru of the moment in America, Frances Hesselbein, a former head of the American Girl Scouts, and David Gergen, an adviser to both Republican and Democratic presidents.
To mark the centennial, the Harvard Business Review put a photograph of Drucker on its cover along with the headline: “What Would Peter Do? How his wisdom can help you navigate turbulent times”. Claremont Graduate University in California, where Drucker taught, boasts not one but two institutions that are dedicated to keeping the flame alive: the Peter Drucker and Masatoshi Ito Graduate School of Management and the Drucker Institute. The institute acts as the hub of a global network of Drucker societies that are trying to apply his principles to everything from schools to refuse collection. It also produces a “do-it-yourself workshop-in-a-box” called “Drucker Unpacked”.
Why does Drucker continue to enjoy such a high reputation? Part of the answer lies in people’s mixed emotions about management. The management-advice business is one of the most successful industries of the past century. When Drucker first turned his mind to the subject in the 1940s it was a backwater. Business schools were treated as poor relations by other professional schools. McKinsey had been in the management-consulting business for only a decade and the Boston Consulting Group did not yet exist. Officials at General Motors doubted if Drucker could find a publisher for his great study of the company, “Concept of the Corporation”, on the grounds that, as one of them put it, “I don’t see anyone interested in a book on management.”
Today the backwater has turned into Niagara Falls. The world’s great business schools have replaced Oxbridge as the nurseries of the global elite. The management-consulting industry will earn revenues of $300 billion this year. Management books regularly top the bestseller lists. Management gurus can command $60,000 a speech.
Yet the practitioners of this great industry continue to suffer from a severe case of status anxiety. This is partly because the management business has always been prey to fads and fraudsters. But it is also because the respectable end of the business seems to lack what Yorkshire folk call “bottom”. Consultants and business-school professors are forever discovering great ideas, like re-engineering, that turn to dust, and wonderful companies, like Enron, that burst into flames.
Peter Drucker is the perfect antidote to such anxiety. He was a genuine intellectual who, during his early years, rubbed shoulders with the likes of Ludwig Wittgenstein, John Maynard Keynes and Joseph Schumpeter. He illustrated his arguments with examples from medieval history or 18th-century English literature. He remained at the top of his game for more than 60 years, advising generations of bosses and avoiding being ensnared by fashion. He constantly tried to relate the day-to-day challenges of business to huge social and economic trends such as the rise of “knowledge workers” and the resurgence of Asia.
But Drucker was more than just an antidote to status anxiety. He was also an apostle for management. He argued that management is one of the most important engines of human progress: “the organ that converts a mob into an organisation and human effort into performance”. He even described scientific management as “the most powerful as well as the most lasting contribution America has made to Western thought since the ‘Federalist Papers’.” He relentlessly extended management’s empire. From the 1950s onwards he offered advice to Japanese companies as well as American ones. He insisted that good management was just as important for the social sector as the business sector. He acted as an informal adviser to the Girl Scouts. He helped inspire the mega-church movement. The management school that bears his name recruits about a third of its students from outside the business world.
Scout’s honour
The most important reason why people continue to revere Drucker, though, is that his writing remains startlingly relevant. Reading “Concept of the Corporation”, which was published in 1946, you are struck not just by how accurately he saw the future but also by how similar today’s management problems are to those of yesteryear. This is partly because, whatever the theorists like to think, management is not a progressive science: the same dilemmas and difficult trade-offs crop up time and again. And it is partly because Drucker discovered a creative middle ground between rival schools of management. He treated companies as human organisations rather than just as sources for economic data. But he also insisted that all human organisations, whether in business or the voluntary sector, need clear objectives and hard measurements to keep them efficient. Drucker liked to say that people used the word guru because the word charlatan was so hard to spell. A century after his birth Drucker remains one of the few management thinkers to whom the word “guru” can be applied without a hint of embarrassment.
Europe's public finances
Europe's public finances
Weighed down
The recession has left a fiscal burden that many countries will struggle to shed
THE BAD thing for politicians about good news on the economy is that they can no longer avert their eyes from the state of public finances. Figures released on November 13th showed that the euro-area economy crawled out of recession in the three months to the end of September. GDP rose by 0.4%, the first quarterly increase for more than a year. Given the scale of the downturn, the recovery is modest: GDP was still 4.1% lower than a year earlier.
Such a deep slump has wrecked public finances. The average budget deficit in the 16-country euro area will be 6.4% of GDP this year, rising to 6.9% in 2010, according to the European Commission’s forecast. If no action is taken to tame deficits, public debt will rise to 88% of GDP by 2011, a third higher than it was before the crisis (see chart).
This mix of fragile economies and weak public finances creates a policy dilemma. There is a risk that public debt will eventually spiral out of control unless taxes are raised or spending cut. But if fiscal support is withdrawn too quickly, the economy could tip back into recession. To address this, European Union countries have agreed in principle to an “ambitious” tightening of fiscal policy, but only from 2011. By then, it is hoped, the economy will be strong enough to withstand it.
The commission will play the role of co-ordinator and monitor, though it remains to be seen how binding its prescriptions will be. On November 11th it proposed that 13 EU countries with big deficits should get them below 3% of GDP by 2014 at the latest. EU ministers will consider those plans on December 2nd. Countries in the worst fiscal shape have most to do. Ireland, for instance, will need to raise taxes or cut spending worth 2% of GDP each year for five years to meet the targets, says the commission. Germany, by contrast, will need to tighten by an average of only 0.5% of GDP for three years.
A repair job on public finances stands a better chance of being durable if it relies on spending cuts rather than tax increases. But this remedy will be hard to apply too strictly, especially in the worst-hit countries such as Ireland and Spain. Ireland’s tax receipts have declined by a third since 2007, far more than the 13% fall in nominal GDP. As in Spain, revenues stemming from the housing boom—value-added taxes (VAT) on new homes, capital-gains tax, and transaction levies—have dried up and will not return.
A shift in both economies away from domestic spending has also hurt. Export-led growth has its appeal but offers less help for public finances where expenditure taxes are a big share of total revenues (see article). Burst housing bubbles have revealed how thin the tax base is.
Ireland has already tightened fiscal policy by some 5% of GDP since July 2008, in the midst of a savage recession. The government will set out its budget plans for 2010 on December 9th, and is expected to find €4 billion of savings or extra taxes to stabilise the deficit. Its pre-budget report drew attention to the big increases in public-sector wages and jobs over the past decade. That is a strong hint that pay cuts are among options being considered. Spain plans to trim its deficit by raising the main VAT rate from 16% to 18% next July, phasing out tax rebates and cutting back on the small investment schemes that were part of the fiscal stimulus.
What’s French for retrenchment?
Such actions to address budgetary problems owe more to fears of retribution from bond markets than lectures from Brussels. The euro-zone’s largest members will need to stick with the commission’s programme if it is to carry any weight. Joaquín Almunia, the EU’s economics commissioner, seems relaxed about the new German government’s plans for tax cuts, though they were not part of his reckoning. Germany has enough capacity and credibility to tighten its policy a bit later than others. Italy has been remarkably disciplined. With investors so skittish during the crisis, Italy could ill afford to add much to its huge public debt. It eschewed any meaningful fiscal stimulus in recession so now has less to do to control the deficit.
The commission’s strictures may chafe far more with France. Brussels wants a cumulative fiscal tightening of 5% of GDP by 2013. France may want the deadline extended. Even if granted that, it will still struggle. The share of public spending in the economy is the highest in the euro area. Cuts in entitlements, not tax increases, would be the best remedy for the budget gap. But it is hard to imagine an assault on social spending with a general election due in 2012. France has so little practice at fiscal retrenchment that a 3% deficit seems a distant prospect.
A more immediate problem is what to do about Greece (see article). Its new government now says that the budget deficit would be 12.7% of GDP this year, far higher than its previous forecasts. What is worse, last year’s shortfall was revised up to almost 8% of GDP—partly, it seems, because of unpaid bills to medical suppliers. Fitch, a ratings agency, immediately cut Greece’s bond rating from A to A- and gave warning of a further downgrade if the government does not spell out how it will right its public finances.
The commission has judged that “no effective action” has been taken by Greece to tackle its deficit, a rebuke which it expects to be endorsed by EU ministers next month. It will set a new action plan for Greece by February. Without remedial action, public debt is expected to reach an alarming 135% of GDP in 2011. Yet investors seem sanguine: Greece’s ten-year bond yield is comfortably below 5%. That may reflect an assumption that its euro-zone partners will save Greece should it run into trouble. The anger about its persistent laxity means that cannot be relied upon.
The countries with the deeper pockets have enough troubles of their own. The money sprayed around to make recession less painful—in wage supplements, make-work schemes and subsidies for car purchases—has to be financed. Cutting back fiscal support will weigh on a recovery that has started quite slowly. Given the scale of the adjustment needed in some countries, it is hard to be too optimistic about the euro-zone’s growth prospects.
The week ahead
The coming days
The week ahead
Retailers hope that Thanksgiving will mark the start of an intense, festive shopping season
• AFTER the frugality of the economic slump, America's retailers are hoping for a stampede of eager shoppers on “Black Friday”, a traditional day of buying frenzy after the Thanksgiving holiday on Thursday November 26th. Sales figures should give some indication of consumers’ confidence in the tentative economic recovery on one of America's busiest days for retailers, which marks the beginning of the Christmas shopping season. Will consumers forget about the recent recession or will they stay away, hoping to pick up better bargains on the internet on “cyber Monday” after window shopping over the weekend?
• A DEAL to exchange hundreds of Palestinian prisoners in Israel for Gilad Shalit, an Israeli soldier held captive in the Gaza strip may be concluded soon. German intermediaries have been attempting to hammer out a deal between Israel and Hamas that would see Mr Shalit, captured in a raid on an Israeli border post in 2006, win his freedom. In early October, 20 Palestinian women were freed from Israeli jails in return for a video proving that Mr Shalit was still alive. Some sources suggest that Mr Shalit could be released by Friday November 27th to coincide with Eid al-Adha an important Muslim festival that marks the end of the haj, the annual pilgrimage to Mecca.
• MONTHS of political crisis in Honduras, sparked by a military coup that ousted President Manuel Zelaya in June, may not be resolved by a presidential election on Sunday November 29th. An American-backed deal to end the troubles stipulated that Honduras’s Congress should vote on Mr Zelaya’s reinstatement but it will not do so until after the election. Roberto Micheletti has been the de facto president since the coup. Mr Zelaya, who is living in the Brazilian embassy since sneaking back into the country, has told his supporters to boycott the poll. Brazil and Argentina say they will not recognise the results of the election unless Mr Zelaya is first returned to power.
• VOTERS in Equatorial Guinea, a tiny oil-rich country in West Africa, go to the polls on Sunday November 29th to re-elect Teodoro Obiang Nguema as president. Mr Nguema has ruled Equatorial Guinea since coming to power in a coup in 1979. He will doubtless deploy some of these talents to avoid the humiliation he suffered in legislative elections 2008, when his party won just 99 seats out of the 100 in the country’s parliament. He may be hoping to strengthen his mandate by increasing his share of the vote above the 97.1% he won in 2002. Polling information is hard to come by but opposition parties should prepare themselves for disappointment.
Sunday, November 22, 2009
Peter Schiff speaks at the WRTC meeting Nov. 19
Saturday, November 21, 2009
China Three Gorges dam in trouble - 20 Nov 09
A new government report says that China's Three Gorges Dam project has doubled in cost.
It will now require $25bn more than the initial cost of $25bn to resettle people displaced by the project and to fill the reservoir with enough water.
A lack of rain and other problems are delaying the opening of the dam - designed to be the world's biggest flood control and hydropower facility.
Al Jazeera's Melissa Chan reports.
US - China relations -Tact and diplomacy 18 Nov 09
Tact and diplomacy, a sign of mutual respect, and cautious optimism between an established superpower, and an emerging giant. They're two of the world's biggest economies and the world's two biggest polluters...
Is China hoping to grow to match the United States' economic and military might? And can Washington succeed in gaining its biggest creditor, as an ally.
The Death of the Cool
The Death of the Cool
Whether or not it is true that you can’t go home again, as Thomas Wolfe claimed—and the claim is just a special case of the more general observation of Heraclitus that you cannot step into the same river twice—it seems that when we find we can’t, nostalgia is the place we go instead. Nostalgia has a mixed reputation. Outfits like Time-Life happily sell, and many of us happily buy, compilations of old photos or music that allow us to escape the present moment and all its cares and return to a vision of a past whose cares are omitted or at least denatured. It is those words “escape” and “vision” that critics rightly fasten upon. So if the following remarks seem strained or just wrong, put it down to nostalgia run riot.
Right now I am listening to one of the great jazz recordings, “Stolen Moments,” from a 1961 album by the saxophonist Oliver Nelson, accompanied by Freddie Hubbard on trumpet, Eric Dolphy on flute and alto, Bill Evans on piano, and others. It is a thoughtful, bluesy eight or nine minutes during which, it seems to me, as I drift into the music, that the group pretty well summarize an America at the tipping point of a deeply unsettling change. Yes, that probably overstates the case just a tad, but in nostalgia you can do that. You can remember visiting the Big Rock Candy Mountain if you want to.
What it seems to me that I am remembering is a time when we admired people who were cool. Some movie stars were cool, a few television personalities were cool, some writers were cool, even one or two politicians may secretly have been cool (there was certainly talk about Stu Symington). There were cool people we never heard of. Here I am using the term “cool” in an expansive sense. Narrower senses of cool mostly point to styles of behavior that are, in fact, distinctly not-cool. They are more like codes of conduct and appearance for wannabes: goatee, beret, and a sneer for poets; all black and a blank look for dancers or art students; full beard, rimless glasses, army jacket, and a defiant glare for revolutionaries or sociology grad students; and so on. We’ve all learned to decode the game.
It may simply be that some are born cool, or at least with the requisite quanta of intelligence and temperament, and the rest of us are not.
No, true cool is both easier to describe and far harder to achieve, if in fact it is achievable at all. It may simply be that some are born cool, or at least with the requisite quanta of intelligence and temperament, and the rest of us are not. (There is no record of anyone’s ever having had cool thrust upon them.) But that’s fine. We don’t all have to be cool. What is important is how the rest of us respond to the ones who are.
Who and what was cool? Cary Grant was cool, and of course Steve McQueen. Thelonious S. Monk (anybody remember when Time captioned a picture of him “Melodious Thunk”?) and Horace Silver, Fairfield Porter, E.E. Cummings (bear in mind that that “e.e.” business was the bright idea of his publisher), Bob Cousy, P.G. Wodehouse, Philip Marlowe, Gus Grissom … a list is pointless except to suggest the breadth of the concept. For contrast, here are some more or less parallel non-cool types: James Dean, Chet Baker, Andy Warhol, Allen Ginsberg, Kobe Bryant, Norman Mailer, Howard Roark, Frank Borman.
Cool is not dependent on achievement, or vice versa. Cool is how you get there. Cool is just doing the job; not-cool is making sure, while you’re at it, that everyone sees just how tough the job is and thus how cool you are to be doing it. Cool is self-direction, self-possession, self-sufficiency, capability, discretion, and a bit of wit. Not-cool is angst, conspicuous display, disdain, tropisms toward bright lights, crowds, and media—in short, all those adolescent traits that so many people fail to grow out of.
Cool is self-direction, self-possession, self-sufficiency, capability, discretion, and a bit of wit. Not-cool is angst, conspicuous display, disdain, tropisms toward bright lights, crowds, and media.
I’m looking at my copy of the June 1959 issue of Playboy. Here’s an ad for a Lord West summer dinner jacket. Well, score one for the olden days to begin with. Our contemporary dress code, if there were one, would doubtless recommend for a summer dinner party a nice tee in preference to a muscle shirt, and might go so far as to plump for your newest pair of flipflops. Anyway, the illustration shows a tall, slim fellow who is entirely at home in his clothes—relaxed but not slouched, one hand casually in a pocket, and the smile on is face is one of genuine good cheer, no smirk, no leer, no vacuous stare back at the viewer. Easy, manly elegance is the theme, and more than a suggestion of cool.
But the reason to have the magazine, as we all understand, is the articles. On page 31 begins a piece by Jack Kerouac on the origins of the Beat Generation. “Beat,” for Kerouac, was a deep and rather elusive concept, but he insisted upon its spiritual content against those who saw in it only an attitude to strike and a style to be bought at the Salvation Army store. He begins by writing about a publicity photo taken of him wearing a crucifix on a chain around his neck. He is dismayed that it was reproduced in several publications with the crucifix airbrushed out; only the New York Times left it alone.
“Therefore the New York Times is as beat as I am, and I’m glad I’ve got a friend. I mean it sincerely. God bless the New York Times for not erasing the crucifix from my picture as though it was something distasteful … I am not ashamed to wear the crucifix of my Lord. It is because I am beat, that is, I believe in beatitude … So you people don’t believe in God. So you’re all big smart know-it-all Marxists and Freudians, hey? Why don’t you come back in a million years and tell me all about it, angels?”
Cool outlasted beat as a word but devolved into a general term of approbation that your clergyman uses as easily as your drug dealer.
Of course it was some big smart know-it-alls who took over the job of deciding who was truly beat, and it turned out to be the big smart know-it-alls who enjoyed playing at hipster, plus Maynard G. Krebs for the rest of us.
I do not mean to suggest that cool and beat are synonyms. But they are complementary, hence their frequent confusion. Nor do I claim that cool is a virtue. Styles change, but virtue abides. I only point out that the sort of cool I am talking about was once associated with such virtues as reticence, savoir-faire, and irony, none of which is much practiced or regarded these days. Cool outlasted beat as a word but devolved into a general term of approbation that your clergyman uses as easily as your drug dealer. As a term denoting a certain admirable way of being in the world, not so much.
The problem was that admiration bred imitation, and imitation lives on exaggeration. Thus reticence was exaggerated, transformed from a quality of character into a mere tic, that produced, among others, Clint Eastwood’s “thousand-yard stare” characters; savoir-faire became the faux sophistication of a James “shaken, not stirred” Bond; irony became the mugging knowingness of Dave Letterman.
What replaced cool? Nothing did, not in the sense of a one-for-one substitution. But what we seem to have been left with instead is sour. Sour is what you get when irony gets into the hands of poseurs, the professionally not-cool. Instead of the needle-sharp barbs of Mort Sahl—“Are there any groups I haven’t offended yet?”—you get the ramblings of a Lenny Bruce throwing cow pies blindly until someone tells him the set is over and he can stumble off. Instead of Sid Caesar you get “Laugh-In.” Over Clark Gable’s wry worldliness, paint in George Clooney’s slightly imbecile simper.
What replaced cool? Nothing did, not in the sense of a one-for-one substitution. Instead of Sid Caesar you get ‘Laugh-In.’ Over Clark Gable’s wry worldliness, paint in George Clooney’s slightly imbecile simper.
The thing is, not-cool is so much easier to get than cool. The masses get it; agents seek it out and hone their protégés to empty perfection; cultural entrepreneurs publish it like so much salt pork in barrels. And so it becomes the national standard.
Where literature once gave us models to emulate in creating lives for ourselves, media now give us merely images to ape. Of one of his characters Raymond Chandler wrote, “his voice was the elaborately casual voice of the tough guy in pictures. Pictures have made them all like that.” That was in 1939.
And media have taught us a self-subverting double consciousness about achievement. Not more than three or four years after Roger Bannister’s sublime conquest of the four-minute mile in England in 1954, a cartoon by the acute Giles, late of the Daily Express, showed an obviously American press photographer shouting to a runner straining across the finish line: “Let’s have it again, Bud; not enough agony for a winner.”
Oliver Nelson must have been a seer. “Stolen Moments” is a blue celebration of true cool, and at the same time it is an elegy anticipating a wake that won’t get under way in earnest for another couple of years. It’s one of those pieces I’m careful not to play too often. Nostalgia can really hang you up the most.
Robert McHenry is the former editor of Encyclopædia Britannica.
State of the Stimulus
On Friday, the Labor Department announced that the national unemployment rate rose by 0.4 percentage points to 10.2 percent. This increase is larger than expected for October and represents the highest unemployment level in 26 years. However, this is probably not the end of the unemployment rate’s upward trend. One reason may be that the stimulus funds did not target high unemployment states.
Using numbers from the administration’s website Recovery.gov and September 2009 labor force data from the Bureau of Labor Statistics, the chart below plots the number of jobs created for each 100,000 people in every state’s labor force and the corresponding unemployment rate in that state.
The solid green line estimates what the number of jobs created or saved should look like if the administration were allocating relatively more money to the states with higher unemployment rates and if that money, in turn, created more jobs.
However, the data show that this is not the case. The chart shows that many higher-unemployment states (the states on the right) saw similar numbers of jobs created as lower-unemployment states (the states on the left), or even worse, saw relatively fewer jobs created.
Michigan is a good case in point. The state has a 15.3 percent unemployment rate, the highest in the country. So far, the Obama administration claims to have created or saved some 466 jobs per 100,000 members of the labor force in Michigan. That’s roughly the same number of jobs created by states with lower unemployment, such as New Jersey. And there were fewer jobs saved or created in Michigan than in California, Washington, or Montana—all states with relatively lower unemployment.
The data show that much of the money has been allocated randomly among states without regard for the level of unemployment in those states.
Now let’s look at North Dakota. With a 4.2 percent unemployment rate, there were roughly 356 jobs saved or created—more jobs than many states with much higher unemployment.
This suggests that there is no real correlation between unemployment rates in the states and the number of jobs “created or saved” with stimulus money.
This lack of correlation could be explained in several ways. First, perhaps the causes of Michigan’s high unemployment rate cannot be countered just by spending money. In other words, structural factors (such as tax rates, regulations, or labor laws) in the state could mean that more money is needed to create a job in Michigan than it takes to create a job in, say, Montana (if so the best way to create jobs in that state would be to address these underlying factors of unemployment).
Another reason could be that stimulus funds are being allocated without any connection to the level of unemployment within states. If government spending could in fact create jobs, then the problem of unemployment could have been mitigated by distributing funds to states based on their relative unemployment levels.
Reports have shown that the stimulus funds have been used to pay for employees whose jobs were never in danger.
Finally, the money could be properly allocated but states are wasting it, hence not creating enough jobs.
The reality is likely at the crossroad of these three explanations. First, the data show that much of the money has been allocated randomly among states without regard for the level of unemployment in those states.
Second, much of the money has been spent to close budget gaps in the states, which often means keeping union-protected school teachers in their jobs and paying for public-sector jobs rather than creating jobs in the private sector. For instance, according to Recovery.gov data, so far a little over 13,000 contracts went to independent contractors and over 116,000 grants went to public agencies. Also, reports have shown that the stimulus funds have been used to pay for employees whose jobs were never in danger (see California for instance).
Finally, the data on Recovery.gov reveals that many private-sector jobs were created at very high cost to taxpayers. For instance, $437,675,000 was awarded to CH2M WG IDAHO, LLC, in Washington to create 496 jobs. That’s $882,409 per job. That’s not as bad as the $257,613,800 awarded to the Brookhaven Science Associates, LLC, in New York to create 25 jobs. That’s over $10.3 million per job.
It’s worth noting that due to over-reporting issues, the White House’s claim of 640,329 jobs created or saved is likely inaccurate. USA Today noted that “the federal government sent Bob Bray $26,174 in stimulus aid to fix a fence and replace the roofs on public apartments in Blooming Grove, Texas, a town of fewer than 900 people outside Dallas. He hired five roofers and an inspector to do the job. But the number of jobs he reported to the government looked very different—450 jobs.”
Veronique de Rugy is a senior research fellow at The Mercatus Center at George Mason University.
Economic Prosperity: A Step of Faith
Several years ago a group of Arab intellectuals came together to study the economic malaise—fueled by high unemployment, massive illiteracy, and anemic GDPs—that grips much of the Muslim and Arab world. Their 2002 study, “The Arab Human Development Report: Creating Opportunities for Future Generations,” remains one of the most sober self-assessments of what has gone wrong with Arab economies and why. The report’s authors lament the “bridled minds” and “shackled potential” of nations which deny their citizens basic civil liberties.
Their candor, however, cannot disguise a fundamental evasion: There is no admission of the cultural hostility toward religious freedom and pluralism that infects Arab societies. This mental state of denial prevents Muslim leaders from recognizing the strong relationship between economic prosperity and religious liberty.
Christian reformers of the seventeenth century, in fact, were among the first to grasp the importance of freedom of conscience to the stability and economic well-being of the state. Thomas Helwys (1550-1616), an early leader of the English Baptists, produced the most principled defense of religious liberty in his day. His Short Declaration of the Mistery of Iniquity (1612) insisted that a man’s religion was no business of the king, and that people of all faiths—“let them be heretiks, Turks, Jews, or whatsoever”—should be left alone. If every sect were granted freedom of worship, he reasoned, there would be far less strife and contention. “Behold the Nations where freedome of Religion is permitted,” he wrote, “and you may see there are not more florishinge and prosperous Nations under the heavens then they are.”
Muslim intellectuals complain about the ‘deprivation of human capability’ in the Arab world, but exonerate regimes that deprive people of their inalienable rights.
Some of the most provocative pro-toleration statements came from lay people whose vocations exposed them to the benefits of pluralism. Henry Robinson (1605-1664), a merchant and son of a wealthy London tradesman, traveled widely on the Continent. In works such as Liberty of Conscience (1643), Robinson regarded the right of private judgment in matters of faith as essential to human flourishing, akin to the right to private property or private enterprise. These rights were connected, and the repression of religious freedom produced blowback in the economic realm. A persecuting state, he wrote, forced Puritans to leave England and “carry with them their gifts, arts, and manufacturers into other countries, to the greatest detreiment of this commonwealth.” Economic ruin, he predicted, would be the fate of nations that seized their citizens’ property or drove them into exile over religion.
These were radical ideas in Europe in the seventeenth century. The Treaty of Westphalia had ended the religious wars on the Continent, but only by creating a system of national church establishments, which were free to harass and penalize religious minorities within their borders. Catholics were the first to develop both the theory and machinery of religious persecution; Protestants, though not as brutally systematic, followed the same dreary pattern. Both traditions predicated political and social stability on religious conformity: dissent was viewed as an incubator of sedition.
England experienced a commercial revolution alongside the rapid growth of religious sects, undercutting the fear that spiritual disunity and heresy invited divine judgment.
Many factors help explain the triumph of religious toleration in Europe. Yet historians such as John Coffey believe that rising prosperity “probably made a significant impact on religious mentalities.” In his book, Persecution and Toleration in Protestant England, Coffey notes that the last decades of the seventeenth century—when debates about religious freedom reached a crescendo—saw an economic boom. England experienced a commercial revolution just prior to its Glorious Revolution, as trade flourished and living standards improved. This occurred alongside the rapid growth of religious sects, undercutting the fear that spiritual disunity and heresy invited divine judgment. Meanwhile, the economic dynamism of the Dutch Republic—the most religiously tolerant state in Europe—helped create a new narrative. “Prosperity and toleration were now seen as twins,” writes Coffey, “rather than as mortal enemies.”
That may overstate the case, but several prominent reformers argued in just these terms. Peter Pett (1630-1699), a lawyer and politician, said the best way to attract entrepreneurs to England and advance trade was to create an open, welcoming society—“which cannot be done without the giving them a due Liberty of Conscience.” The tireless Quaker agitator, William Penn, blended theological, moral, and practical reasons for toleration in his Great Case of Liberty of Conscience (1670). His treatise included an economic critique of religious establishments and their legal regimes. Penal laws against religious dissenters, Penn observed, often plunged families into poverty, thus robbing society of productive economic activity. “Such Laws are so far from benefiting the Country, that the Execution of them will be the assured ruin of it, in the Revenues, and consequently in the Power of it,” he wrote. “For where there is a decay of Families, there will be of Trade; so of Wealth, and in the end of Strength and Power.”
‘Prosperity and toleration were now seen as twins, rather than as mortal enemies.’
Though they represented a minority view, these voices of toleration would find powerful advocates among classical liberal political thinkers such as John Locke. In A Letter Concerning Toleration (1689), Locke explained that sectarian rulers, by authorizing the economic impoverishment of dissenters, permanently unsettled governments and societies. As long as governments demanded religious conformity, there would be “no peace and security, no, not so much as common friendship” among the members of civil society. “Nobody therefore … neither single persons, nor churches, nay, nor even commonwealths, have any just title to invade the civil rights and worldly goods of each other, upon pretence of religion.”
The insights of these religious thinkers are finally receiving support from the secular social sciences. Brian Grim, a quantitative sociologist with the Pew Forum on Religion and Public Life, has compared various socio-economic indicators with measures of religious freedom in over 100 countries. Grim is careful not to infer a causal relationship between religious liberty and economic prosperity. Yet his research reveals a correlation, prompting a frank suspicion: “A regulated and restrictive religious economy does not benefit all God’s children.”
Even the libertarian Cato Institute, not usually attentive to religion, has begun to explore the issue. Writing in the Cato Journal, scholars Ilan Alon and Gregory Chase argue that international businesses should be concerned about the problem because “it affects the general business environment, political relationships among countries, and consumer sentiment of companies doing business in countries that suppress religious freedom.” Their findings—based on indicators of economic and religious liberty in 75 countries—seem to vindicate the Christian reformers of Locke’s generation. “Although our results are preliminary, they suggest that religious freedom has a positive impact on a country’s prosperity.”
These facts still seem to be lost on many Muslim intellectuals. They complain about the “deprivation of human capability” in the Arab world, but exonerate regimes that deprive people of their inalienable rights. They link economic growth to new forms of “social cohesion,” but tolerate political arrangements that guarantee social strife. They even call for a “fundamental rethinking” of how Arab states should approach cultural and religious diversity—yet refuse to rethink their assumptions about the nature of religious belief or the moral demands of human dignity.
It requires no leap of faith—just, perhaps, a little historical memory—to realize this is not the road to economic development. It is the long and fractious and familiar detour to permanent stagnation.
Joseph Loconte is a lecturer in politics at the King’s College in New York City and a contributing editor to The American.
Limited Utility
What happens when populist politicians try to micromanage public utilities? Venezuelans found out recently when President Hugo Chavez unveiled his blueprint for dealing with water and electricity shortages: No singing in the shower, the comandante ordered. The firebrand strongman used a live broadcast earlier this month to insist that his countrymen cut their showers short. “Three minutes is more than enough,” Chavez lectured. “I’ve counted—three minutes—and I don’t stink.”
Well, as an economic manager, Chavez is all wet. He tried to blame the lack of rain for depleting the nation’s hydroelectric dams. The truth is that Venezuela’s infrastructure is crumbling under the weight of an incompetent, interventionist regime run by cronies picked for their loyalty to the president rather than their technical know-how.
Not to put too fine a point on it, Floridians may wonder if they are getting a taste of this caudillo management style from Governor Charlie Crist’s campaign against a rate hike that the state’s energy companies say they need to make a $1.5 billion investment in power generation.
It appears that Governor Crist intends to pack the state’s regulatory board with people he thinks will vote his way on proposed rate hikes.
In most market economies, private power companies amass capital to make timely investments in the infrastructure that is required to generate sufficient power to meet ever-growing demand. Before making costly improvements, they must be able to reassure potential investors who are putting up these massive sums that they will be able to recover their costs and turn a fair profit by charging equitable fees. In most jurisdictions in the United States, those fees are set by public utility regulators, who are called upon to strike a balance between fairness to the consumer and to the power company. If politicians disrupt that delicate balance, they undermine the market forces and may have the rest of us taking cold showers.
It is one thing for the chief executive to jawbone against price increases. Other prominent politicians have opposed pending rate hikes for their impact on the Sunshine State’s beleaguered consumers, and populist attacks on public utilities is something of a tradition in Florida. However, it appears that Crist intends to pack the state’s regulatory board with people he is convinced will vote his way on proposed rate hikes. One of his nominees is a former editorial writer (who was given a one-sentence interview by the governor’s staff), and the other runs a nightclub. Skeptics are wondering if Crist really expects these newcomers to master the arcane issues and make independent judgments.
Here’s the mark of a caudillo (Spanish for “strongman”): In 2003, Chavez sacked more than 5,000 able technocrats at the nation’s once mighty petroleum company and turned it over to inexperienced political loyalists who have since run the company into the ground—forfeiting about a third of the country’s oil production to gross incompetence and underinvestment. Because of Chavez’s unpredictable, populist policies, from 2007 to 2008, Venezuela attracted about one-fifth the foreign investment it garnered in the two years just before the leftist president took office in 1999. Investment in oil production, power plants, and other basic infrastructure is in steep decline.
No one is served—least of all consumers or their governor—if Florida’s reputation as a good place to do business is tarred by populist politics.
No one is saying that Governor Crist is Florida’s Hugo Chavez. However, by attempting to intervene so transparently in a regulatory case, he risks crossing a line. The delicate balance between the interests of the state’s power companies and consumers requires a bona fide process where regulators—in this case, the appointed members of Florida’s Public Services Commission—are able to make decisions based on a fair consideration of the complicated facts presented by all sides. Devouring reams of data and economic modeling in a pending rate case is the job of duly-sworn commissioners, not the governor.
Industry analysts have noted that replacing experienced regulators and stalling consideration of rate cases until new commissioners take office has further undermined confidence in the process, which could drive up the cost that Florida’s power companies pay to borrow money. Last month, Moody’s Investors Service cited what it called “political intervention in the utility regulatory process” and noted the lack of experience of new commissioners. In a report to investors issued in mid-October, Barclays Capital reported the threats to replace commissioners.
If the state’s regulatory board is under a cloud, Governor Crist should work with the legislature to make systemic changes to improve transparency and accountability. He is not alone in demanding reform of the panel and its procedures.
But no one is served—least of all consumers or their governor—if Florida’s reputation as a good place to do business is tarred by populist politics.
Roger F. Noriega, a senior State Department official from 2001 to 2005, is a visiting fellow at the American Enterprise Institute and managing director of Vision Americas LLC, which represents U.S. and foreign companies.
Wherefore Art Thou, Green Obama
China is proving to be a major challenge to President Obama’s ambitious environmental agenda. Designed to reinvigorate flagging hopes for the Copenhagen climate summit, his recent trip yielded no commitments that the Chinese are willing to significantly curb carbon emissions. He also returned home to the dismal news that China may be benefiting more than the United States from his job creation policy, which he has tied in significant measure to promised investments in green technology. While the employment market at home continues to falter, China’s recovery is gaining steam—bolstered in part by American-based companies investing in green projects.
Consider Boston-Power, a New England-based battery manufacturer. In June, it announced it would build a new manufacturing plant to produce environmentally sustainable lithium-ion batteries, creating 600 green jobs. “Our goal is to make Massachusetts a manufacturing hub for the advanced batteries that will power the nation’s clean energy future, and Boston-Power’s plan to create this facility in Auburn is a big step toward that goal,” said Massachusetts Governor Deval Patrick. It was exactly the kind of initiative Obama had anticipated when he began shoveling money into green projects, one of the centerpieces of the jobs recovery act. The Massachusetts plant was hailed as a sign that the green jobs renaissance was indeed materializing.
Earlier this month, the company quietly scrapped its plans after it couldn’t get stimulus money or an investment commitment from banks to build the plant. Boston-Power is now looking to build in China, where green investment dollars are more readily available.
The president made a grievous tactical mistake by hyping green jobs as a recession palliative.
With the chorus of politicians calling for increased government investments to create “green collar” jobs, it brings to mind the bellowing Wizard of Oz overseeing the Emerald City—an all-powerful disembodied figure formed out of steam from a giant cauldron. Then Dorothy’s Toto pulls back the green curtain, revealing that the verbally awe-inspiring Wizard is a tiny man furiously spinning dials in a frantic attempt to keep the fantasy alive.
Green Shell Game
Mr. Wizard, meet President Obama. Throughout this dismal year, President Obama has promised that upwards of 5 million jobs would result from a huge injection of investment in alternative energy technology. The green jobs proposal was also the lynchpin of the European Union’s alternative energy legislation, dubbed the “Community Strategy and Action Plan: Energy for the Future.” Its goal: create a job boom by funding massive new investments in renewable energy.
So far, we’re left with sizable handouts, no coherent vision, few concrete results, and lots of speeches: there’s “room for debate” on how we do it, there’s “no silver bullet,” blah, blah, blah. Obama is doling out $80 billion as part of his energy policy, but it’s going out in a helter-skelter manner, and green job creation is meager at best.
Those hoping for a green jolt to the economy must come to grips with three serious misconceptions:
First, green stimulus works slowly. New York State illustrates the problem. Of the $25 billion allocated for energy efficiency in the U.S. package, it collected $394 million. By October, the government estimated, it had produced 43 New York jobs. It doesn’t mean the money has been wasted; it does mean the green investment strategy must be understood as a long-term commitment, and not mis-marketed, as the administration is doing, as a quick fix. Retrofitting an aging energy infrastructure takes time and planning (and, ironically, is being brought to a crawl because it is embedded in a bureaucracy created by activists determined to vet every detail against preservation rules and bureaucratic environmental regulations).
Most of the new wind and energy manufacturing jobs created by the European and American stimulus grants are going to overseas manufacturers.
Second, most of these anxiously anticipated green jobs won’t pay much. The biggest engine of job creation over the past two decades was the technology industry. But let’s face it: the majority of those jobs consist of manipulating tiny chips into circuit boards. They’re low wage jobs, which is why they’re concentrated in Thailand, Bangladesh, and elsewhere. Although the term “green jobs” may conjure up images of dazzling high-tech solar panels and glass-sheathed new buildings, the nuts and bolts of turning the world green is making nuts and bolts, but in an energy conscious way. That’s not a solution to the Great Jobs Depression in the U.S. or any industrialized country.
Third, the green jobs that we do get, whatever they might pay, cost a lot to create. As a candidate, Obama estimated each green job would cost $30,000 to create. Even his political allies mocked that total. A study sponsored by the left-leaning Center for American Progress, released in 2008, estimated that each job would cost $50,000. That estimated the number of jobs that might be added if the government spent more money on clean energy. It didn't count jobs that might be lost elsewhere in the economy if the country shifted to alternative energy, which is costlier than traditional sources. Alternative energy projects will clearly lead to higher energy prices in the short to medium term and put a drag on the economy. But those numbers were pies in the sky. There are some hard figures on green-job creation in Europe, and the story is sobering.
The Obama administration has pointed to Spain and other European countries as a “reference for the establishment of government aid to renewable energy” to create jobs, but the experience there suggests caution at best. According to estimates in a study by economists at Spain’s Universidad Rey Juan Carlos, the Spanish green job program cost $43 billion in recent years, creating green jobs at an astounding cost per worker of $854,000. Why the high figure? These economists factored in the number of jobs that were not created by force-feeding investments into alternative energy. By diverting investments from other sectors, the study estimates that for every green job created upwards of 2.2 jobs were lost.
While there remains a bubble in investment money available to finance green projects, the demand for alternative energy technology is just not there yet.
While “it is not possible to directly translate Spain’s experience with exactitude,” reads the report, the United States could lose “at least 6.6 million to 11 million jobs, as a direct consequence were it to actually create 3 to 5 million ‘green jobs’ as [President Obama has] promised (in addition to the jobs lost due to the opportunity cost of private capital employed in renewable energy).”
In other words, Spain’s hyper-aggressive (expensive and extensive) green employment policy generated far fewer jobs than expected, and only about one-tenth of those were the permanent high-paying operational and maintenance positions necessary to shake the economy out of its doldrums.
China Syndrome
The story, sadly, gets worse. Over the past two years, there have been numerous announcements of high-profile, technology-intensive projects in alternative energy funded in part by government money. In 2008, the Democratic Governor of Massachusetts backed an $58 million incentive package for Evergreen Solar, an energy panel maker promising 350 new jobs and promoted as the centerpiece of the state’s efforts to make itself a green energy and job hub. At about the same time, General Electric was sweeping up subsidies for its solar-panel manufacturing facility in Delaware that employed 82 workers.
The Spanish green job program cost an estimated $43 billion in recent years, creating green jobs at an astounding cost per worker of $854,000.
Both have turned into job-creating busts. GE announced this fall that it is shutting down production. While there remains a bubble in investment money available to finance green projects, the demand for alternative energy technology is just not there yet. Evergreen Solar did temporarily add workers, but the expectations (read: green hype) far exceeded sales, and the company, which lost $167 million this past year, is now shuttering capacity and shifting what’s left to China. Hope does not yet equal business.
Then there’s the Texas Green Jobs Massacre. There was a burst of excitement in late October accompanying the announcement that a large-scale $1.5 billion wind farm would be developed in West Texas using federal dollars. But any anticipation of the 330 American jobs that would be created was quickly overshadowed by the sobering reality that the most important components to be manufactured, 240 wind turbines, would be made in China. That’s a 2,000-job windfall, courtesy of Uncle Sam.
Even Democratic Senator Charles Schumer was angry: “I’m all for investing in clean energy, but we should be investing in the United States, not China,” he said. “The goal of the stimulus was to spur job creation here, not overseas. This project should not receive a dime of stimulus funds unless it relies on U.S.-manufactured products.”
Retrofitting an aging energy infrastructure takes time and planning, and, ironically, is being brought to a crawl because it is embedded in a bureaucracy created by activists determined to vet every detail against preservation rules and bureaucratic environmental regulations.
But here’s the rub: Most of the new wind and energy manufacturing jobs created by the European and American stimulus grants are going to overseas manufacturers because there is not enough demand yet for a green U.S. manufacturing infrastructure to have developed. “Socialized” Europe and centrally controlled China don’t have to deal with those economic realities. Forced by public authorities to invest in alternative energy and even in carbon-free nuclear energy, European and Asian companies are now poised to take advantage of the green-energy dollars flowing in the United States. They also get most of their seed capital not from U.S. banks, but from overseas financial institutions with years of familiarity with these kinds of projects and therefore a much higher comfort level about dispensing green risk capital. The U.S. partners in the West Texas wind farm couldn’t get financing in the United States, which forced them to seek out a partner in China, where commercial banks readily came up with the financing.
Despite the stimulus package’s dismal track record for creating sustainable green American jobs, there are arguments to support the alternative energy boondoggle of 2009—really, truly. One of the main reasons there is not enough green manufacturing capacity is because the United States has had an appalling track record in supporting nascent industries. It takes years to develop an alternative energy infrastructure, and the United States is way behind Europe and Asian countries. Over the past two decades, the United States probably made the better bet. As Geoffrey Styles of Energy Tribune notes, because of generous tax benefits to inefficient alternative energy producers and hidden tariffs, “European taxpayers and consumers have borne much of the pain of driving down the costs of wind power to a point at which it can begin to compete with power generated from natural gas (and to a much lesser extent from coal) with only the modest subsidies U.S. taxpayers have been willing to provide.”
As U.S. production acumen in the green sector matures, opportunities will open up. Money flows both ways. Europe provides generous tariffs for infrastructure investment available to manufacturers from around the world, including American players. Last month, Duke Energy struck a deal with ENN Group in China to develop commercial solar projects in the United States. This bodes well for the dream of a greener economy in the United States over the long term. And as alternative energy costs come down, private money will start flowing.
As a candidate, Obama estimated each green job would cost $30,000 to create. Even his political allies mocked that total.
But swallow hard: to achieve its long-range goals, in the short term, to stoke demand, Washington may need to continue backing select green projects, even though some of the money will go into foreign company coffers willing to do business in the United States despite the dismal economy. This is not an argument for reflexive massive subsidies. Rather, the United States needs to establish a stable regulatory framework and a long-term policy for its green sector. To create sustainable employment, we need long-term commitments to build new business infrastructures, not just short-term money dumps. To soften the trade-off, there is an argument for consideration of local content laws—the crude name is “Buy American”—to justify the short-term subsidizing of foreign companies.
The Vision Thing
The wild card in all this is the president. Where is Obama’s Great Green Narrative to focus the nation? In a recent speech promoting a “smart grid,” Obama compared the U.S. electrical system to American highways before President Eisenhower launched the blacktop-building boom of the 1950s. But energy reform is a bigger project than the Interstate Highway System, bigger than the great water projects of the Tennessee Valley Authority, and faces more domestic opposition than did the space program.
The key to Americans meeting the challenges of the past has been their willingness to believe in a vision of change, hope, and growth to justify the risk and sacrifice. The president made a grievous tactical mistake by hyping green jobs as a recession palliative. We all know that Obama can play the tiny man behind the green curtain spinning a story with the help of a teleprompter, but it remains to be seen whether he has the fortitude and indeed the real vision of a leader to define and carry forward a transformative Great Green Narrative.
Jon Entine is a visiting scholar at the American Enterprise Institute and director of AEI projects Global Governance Watch and NGOWatch.
WELCOME TO THE DEBT ECONOMY
WELCOME TO THE DEBT ECONOMY
It's a Debt Economy World, and we're just living in it. James Surowiecki writes in the upcoming New Yorker:
"John Kenneth Galbraith wrote that all financial crises are the result of “debt that, in one fashion or another, has become dangerously out of scale.” The recent financial crisis was no exception, with everyone—homeowners, private-equity investors, our biggest banks—taking on enormous amounts of debt. If it’s frustrating that the government is footing the bill to clean up the mess, it’s even worse that the government helped pay for the debt binge that created the mess in the first place, thanks to a tax system that actually subsidizes borrowing. Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked.
The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a “debt bias.” It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments. Likewise, the system skews the decisions that companies make about how to fund themselves. Companies can raise money by reinvesting profits, raising equity (selling shares), or borrowing. But only when they borrow do they get the benefit of a “tax shield.” Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity. So it’s not surprising that many companies prefer to pile on the leverage." (Read more...)
Friday, November 20, 2009
A Pro-Free-Market Program for Economic Recovery
A Pro-Free-Market Program for Economic Recovery
Good afternoon, ladies and gentlemen:
As you all know, we are in a severe economic downturn. The official unemployment rate now exceeds 10 percent and according to many observers is actually substantially higher. Within the last year or so, our financial system has been rocked to its foundations. The collapse of the housing bubble and the numerous defaults and bankruptcies connected with it brought down major financial institutions, such as Bear-Stearns, Lehman Brothers, and Merrill Lynch. It also brought down numerous small and medium-sized banks and threatened to bring down even such banking giants as Citigroup and Bank of America. The Dow Jones stock average fell from a high of 14,000 to about 6,500. Important retailers such as CompUSA, Circuit City, Mervyns, and Linens 'N Things went under, as did countless small businesses throughout the country. Practically every shopping mall gives testimony to the severity of the downturn in the form of vacant stores.
The collapse of the housing bubble and the massive losses and mounting unemployment that have resulted from it have unleashed a veritable firestorm of hostility against capitalism, in the conviction that it is capitalism and its economic freedom that are responsible. It is now generally taken for granted that any solution for the downturn requires massive new government intervention, to curb, control, or abolish this or that aspect of capitalism and its alleged evil.
Reflecting this view, in an effort to avoid financial collapse, the government's response was the enactment of an $800 billion "stimulus package" designed to boost spending throughout the economic system, and the pouring of more than $1.1 trillion of new and additional reserves into the banking system, along with the direct investment of capital in the country's most important banks and in major automobile firms, in order to prevent them from failing.
As a result of its so-called "investments," the government now owns a majority interest in the common stock of General Motors, once the flagship company of capitalism. There have been important extensions of government control over the economic system in other areas as well. For example, the stimulus package contains substantial funding for new bureaucracies to control healthcare and energy production.
The new and additional bank reserves, moreover, are not only massive, but almost all of them are excess reserves. Excess reserves are the reserves available to the banks for the making of new and additional loans, i.e., for new and additional credit expansion. They are the difference between the reserves the banks actually hold and the reserves they are required to hold by law or government regulation.
To gauge the significance of today's excess reserves, one should consider that total bank reserves as recently as July of 2008 were on the order of just $45 billion, and excess reserves were less than $2 billion. Those $45 billion of reserves supported a total of checking deposits in one form or another on the order of $6 trillion (a sum that included traditional checking deposits, so-called "sweep accounts," money-market mutual-fund accounts, and money-market deposit accounts insofar as checks could be written against them). That was a ratio of checking deposits to reserves in excess of 100 to 1, or equivalently, a fractional reserve of less than 1 percent.
Today, of the $1.1 trillion-plus of total reserves, all but approximately $62 billion of required reserves, are excess reserves. As of the week of November 4, excess reserves were $1.06 trillion.
Fortunately, for the time being at least, the banks are afraid to lend very much of this sum, but the potential is clearly there for a massive new credit expansion and corresponding increase in the quantity of money. Recognition of this potential is reflected in the current surge in the price of precious metals. Indeed, since $1.06 trillion of new and additional excess reserves are more than 22 times as large as the $45 billion of reserves that were sufficient not so long ago to support $6 trillion of checking deposits, they might potentially support checking deposits in excess of $132 trillion. In effect, what has happened is that our recent brush with massive deflation has turned out to be an occasion for a massive inflationary fueling period in the effort to avoid that deflation.
Inflation and Deflation: Credit Expansion and Malinvestment
The title of my talk, of course, is "A Pro-Free-Market Program for Economic Recovery." What this entails changes as the government adds new and additional measures that create new and additional problems. If I were giving this talk a year ago, my discussion would have been weighted somewhat more heavily toward deflation and somewhat less heavily toward inflation than is the case today.
A fundamental fact is that our present monetary system is characterized both by irredeemable paper money, i.e., fiat money, and by credit expansion. There is no limit to the quantity of fiat money that can be created. This is the foundation for potentially limitless inflation and the ultimate destruction of the paper money, when the point is reached that it loses value so fast that no one will accept it any longer.
The fact that our monetary system is also characterized by credit expansion is what creates the potential for massive deflation — for deflation to the point of wiping out the far greater part of the money supply, which in the conditions of the last centuries has been brought into existence through the mechanism of credit expansion.
Credit expansion is what underlay the housing bubble, and before that, the stock market bubble, and before that a long series of other booms and busts, running through the Great Depression of 1929 that followed the stock market boom of the 1920s, through the 19th and 18th Centuries all the way back to the Mississippi Bubble of 1719, and perhaps even further back.
Credit expansion is the lending out of money created virtually out of thin air. It is money manufactured by the banking system, always with at least the implicit sanction of the government, which chooses not to outlaw the practice. Since 1913, credit expansion in this country has proceeded not only with the sanction but also with the approval, and active encouragement of the Federal Reserve System, which, as I've shown, is now desperately trying to reignite the process as the means of recovering from the current downturn.
The new and additional money is created by the banking system through the lending out of funds placed on deposit with it by its customers and still held by those customers in the form of checking accounts of one kind or another. The customers can continue to spend those checking deposits themselves, simply by writing checks or using other, similar methods of transferring their balances to others.
But now, at the same time, those to whom the banks have lent in this way also have money. To illustrate the process, imagine that Mr. X deposits $1,000 of currency in his checking account. He retains the ability to spend his $1,000 by means of writing checks. From his point of view, he has not reduced the money he owns any more than if he had exchanged $1,000 in hundred-dollar bills for $1,000 in fifty-dollar bills, or vice versa. He has merely changed the form in which he continues to hold the exact same quantity of money.
But now imagine that Mr. X's bank takes, say, $900 of the currency that he has deposited and lends it to Mr. Y. Mr. Y now possess $900 of spendable money in addition to the $1,000 that Mr. X continues to possess. In other words, the quantity of money in the economic system has been increased by $900. Mr. Y's loan has been financed by the creation of new and additional money virtually out of thin air. This is the nature and meaning of credit expansion.
Now, nothing of substance is changed, if instead of lending currency to Mr. Y, Mr. X's bank creates a new and additional checking deposit for Mr. Y in the amount of $900. (This, in fact, is the way credit expansion usually occurs in present-day conditions.) There will once again be $900 of new and additional money. There will be altogether $1,900 of money resting on a foundation merely of the $1,000 of currency deposited by Mr. X.
The $1,000 of currency that Mr. X's bank holds is its reserve. If Mr. Y deposits his currency or check in another bank, it is the banking system that now has $1,000 of reserves and $1,900 of checking deposits. On the foundation of these reserves, it can create still more money and use it in the further expansion of credit. Indeed, as we have seen, the process of credit expansion is capable of creating checking deposits more than 100 times as large as the reserves that support them.
Credit expansion makes it possible to understand what caused the housing bubble and its collapse. From January of 2001 to December of 2007, credit expansion took place in excess of $2 trillion. This new and additional money made available in the loan market drove down interest rates, including, very prominently, interest rates on home mortgages. Since the interest rate on a mortgage is a major factor determining the cost of homeownership, lower mortgage interest rates greatly encouraged buying houses.
This artificially increased demand for houses, made possible by credit expansion, soon began to raise the prices of houses, and as the new and additional money kept pouring into the housing market, home prices continued to rise. This went on long enough to convince many people that the mere buying and selling of houses was a way to make a good living. On this basis, the demand for houses increased yet further, and finally a point was reached where the median-priced home was no longer affordable by anyone whose income was not far in excess of the median income, i.e., only by a relatively few percent of families.
In the middle of 2004, the Federal Reserve became alarmed about the situation and its implications for rising prices in general, and over the next two years progressively increased its Federal Funds interest rate from 1 percent to 5.25 percent. This rise in the Federal Funds rate signified a reduction in the flow of new and additional excess reserves into the banking system and thus its ability to make new and additional loans. This served to prick the housing bubble.
But before its end, perhaps as much as a trillion and a half dollars or more of credit expansion and its newly created money had been channeled into the housing market. Once the basis of high and rising home prices had been removed, home prices began to fall, leaving large numbers of borrowers with homes worth less than they had paid for them and with mortgages they could not meet.
The investments in housing represented a classic case of what Mises calls "malinvestment," i.e., the wasteful investment of capital in inherently uneconomic ventures. The malinvestment in housing was on a scale comparable to the credit expansion that had created it, i.e., about $2 trillion or more. That's about how much was lost in the housing market. When the money capital created by credit expansion was wiped out, the lending, investment spending, employment, and consumer spending that depended on that capital were also wiped out.
And, particularly important, as vast numbers of home buyers defaulted on their mortgages, the mounting losses on mortgage loans increasingly wiped out the capital of banks and other financial institutions, setting the stage for their failure.
The current plight of the economic system is the result of credit expansion and the malinvestment it engenders. Capital in physical terms is the physical assets of business firms. It is their plant and equipment and inventories and work in progress. As Mises never tired of pointing out, capital goods cannot be created by credit expansion. All that credit expansion can do is change their employment and shift them into lines where their employment results in losses. The empty stores and idle factories around the country are very much the result of the loss of the capital squandered in malinvestment in housing.
Other Consequences of Credit Expansion
The plight of the economic system is also the result of other consequences of credit expansion, namely, the encouragement it gives to high debt and dangerous leverage. This is the result of the fact that while credit expansion drives down market interest rates, the spending of the new and additional funds it represents serves to drive up business sales revenues and what the old classical economists called the rate of profit. This combination makes borrowing appear highly profitable and greatly encourages it. Individuals and business firms take on more and more debt relative to their equity. They expect borrowing to multiply their gains.
In addition, credit expansion is responsible for many business firms operating with lower cash holdings relative to the scale of their economic activity, in many cases, dangerously low cash holdings. Many businessmen develop the attitude, why hold cash when credit expansion makes it possible to borrow easily and profitably? Instead, invest the money.
Thus, when credit expansion finally gives way to the recognition of vast malinvestments and the accompanying loss of huge sums of capital, the economic system is also mired in debt and deficient in cash. Thus, it is poised to fall like a house of cards, in a vast cascade of failures and bankruptcies, first and foremost, bank failures.
The Road to Recovery
The road to recovery from our economic downturn can be understood only in the light of knowledge of credit expansion and its consequences. The nature of credit expansion and its consequences imply the nature of the cure.
The prevailing — Keynesian — view on how to recover from our downturn totally ignores credit expansion and its effects. It believes that all that counts is "spending," practically any kind of spending. Just get the spending going and economic activity will follow, the Keynesians believe.
This conception of things, which underlies the support for "stimulus packages" and anything else that will increase consumer spending, is mistaken. It rests on a fundamental misconception. It ignores the fact that the fundamental problem is not insufficient spending, but insufficient capital due to the losses caused by malinvestment. It ignores the further facts that credit expansion has brought about excessive debt and, however counterintuitive this may seem, insufficient cash. Too little capital, too much debt, and not enough cash are the problems that countless business firms are facing today as a result of the credit expansion that generated the housing bubble.
Just as a reminder: the way that credit expansion brings about a situation of too little cash while itself constituting a flood of cash is that it makes it appear profitable to invest every last dollar of cash in the expectation of being able easily and profitably to borrow whatever cash may be needed.
What this discussion implies is that an essential requirement of economic recovery is that the widespread problems in the balance sheets of business firms must be fixed. Business firms need more capital, less debt, and more cash. When they achieve that, business confidence will be restored.
Ironically what could achieve at least less debt and more cash in the hands of business, and thus actually do some significant good is if when people received government "stimulus" money, they did not spend very much of it, or, better still, any of it at all. To the extent that all people did with money coming from the government was pay down debt and hold more cash, they would be engaged in a process of undoing some of the major damage done by credit expansion. They would be reducing their burden of debt and increasing their liquidity, thereby increasing their security against the threat of insolvency. Such behavior, of course, would be regarded by Keynesians as constituting a failure of their policies, because in their eyes, all that counts is consumer spending.
The 100-Percent Reserve
The most important single step on the road to economic recovery is the establishment of a 100-percent reserve system against checking deposits. Ideally, the 100-percent reserve would be in gold. And that's ultimately what we should aim at, for all of the reasons Rothbard explained. But even a 100-percent reserve in paper would do the job of totally preventing all future credit expansion and, equally important, all declines in the money supply.
(Because the 100-percent gold reserve standard is the long-run ideal of advocates of sound money, I cannot help but feel a sense of great satisfaction in the fact that a major step toward its achievement is what turns out to be urgently needed as a matter of sound current economic policy.)
In the simplest terms, to establish a 100-percent-reserve system in terms of paper, the government would simply print up enough additional paper currency so that when added to the paper currency the banks already have, every last dollar of their checking deposits would be covered by such currency. (Strictly speaking, a significant part, and for some months now the far greater part, of the reserves of the banks are not in actual currency but in checking deposits with the Federal Reserve. For the sake of simplicity, however, we can think of the checking deposits held by the banks with the Federal Reserve as a denomination of currency, since, for the banks, they are fully as interchangeable with currency as $50 bills are with $100 bills and vice versa.)
To illustrate the process of achieving a 100-percent reserve, imagine that total checking deposits are $3 trillion. In that case, the Fed would give the banks new and additional reserves that when added to their existing reserves would bring them up to $3 trillion. Through various programs, such as purchasing bad assets, the Fed has in fact already brought the total reserves of the banks up to over a trillion dollars, but almost all of those reserves, as we've seen, are excess reserves, a ready foundation for a massive new credit expansion, since excess reserves can be lent out.
What my example implies is adding to the $1.1 trillion of reserves the banking system now has, a further $1.9 trillion and making all $3 trillion of reserves required reserves. This would mean that the banks could not engage in any lending of these reserves and thus would be unable to finance credit expansion or any increase in the supply of checking deposits on the strength of them. The money supply in the hands of the public and spendable in the economic system would thus not be increased. That would happen only if and to the extent that the 100-percent reserve principle were breached.
Under a 100-percent reserve, checking depositors could simultaneously all demand their full balances in cash and the banks would be able to pay them all. Depositors' demand for cash would not create a problem and no amount of losses by the banks on their loans and investments would prevent them from honoring their checking deposits immediately and in full. Thus the checking deposit component of the money supply could not fall and nor, of course could its other component, which is the paper money in the hands of the public, usually described as the currency component. Thus, there could simply be no deflation of the money supply. And, as I've said, because all reserves would be required reserves, there would simply be no reserves whatever available for lending out, and thus no credit expansion whatever. The expression "killing two birds with one stone" could not have a better application.
In a addition, a significant byproduct of a 100-percent reserve system would be that the FDIC would no longer serve any purpose and thus could be abolished.
Now an essential prerequisite of the 100-percent reserve is knowing the size of checking deposits, so that it will be known how much the 100-percent reserve needs to cover. At present, when one allows for such things as "sweep accounts," money-market mutual funds, and money-market deposit accounts, the magnitude to which the 100-percent reserve would apply can plausibly be argued to range from about $1.5 trillion to $8 trillion. It is very solidly $1.5 trillion, but does in fact range up to $8 trillion in that checks can be written on the additional sums involved, at least from time to time and for some large minimum amount.
To clearly establish the magnitude of checking deposits, bank depositors should be asked if their intention is to hold money in the bank, ready for their immediate use and transfer to others, or to lend money to the bank. In the first case, their funds would be in a checking account, against which the bank would have to hold a 100-percent reserve. In the second case, their funds would be in a savings account, against which the bank could hold whatever lesser reserve it considered necessary. In this case, the bank's customers could not spend the funds they had deposited until they withdrew them from the bank.
As I've said, the long-run goal in connection with the 100-percent reserve would be ultimately to convert it to a 100-percent gold reserve system. At that time, following the ideas of Rothbard further, the gold reserve of the Fed would be priced high enough to equal the currency and checking deposits of the country and be physically turned over to the individual citizens and the banks in exchange for all outstanding Federal Reserve money. The Fed would then be abolished. But this is a distinct and much later step in pro-free-market reform.
The 100-Percent Reserve and New Bank Capital
It should be realized that a major consequence of the establishment of a 100-percent-reserve system could be a corresponding enlargement of the capital of the banking system and thus an ability to cover even very great losses and thereby avoid such things as government bank bailouts and takeovers.
Consider the balance sheet of an imaginary bank. It's got checking deposit liabilities of $100. Initially, it has assets of $105, which implies that on the liabilities side of its balance sheet it has capital of $5 in addition to its checking deposit liabilities of $100.
Now unfortunately, malinvestment has resulted in a loss of $20 in the banks' assets, in the part of its assets consisting of loans and investments. As a result, its total assets are reduced from $105 to $85 and its capital is completely wiped out and becomes negative in the amount of $15.
However, on its asset side the bank still has some cash reserve, say, $10. If $90 of new and additional reserves were added to these $10, to bring the bank's reserves up to 100-percent equality with its checking deposits, the bank's asset total would also be increased by $90. This $90 increase on the bank's asset side would have to be matched by a $90 increase on its liabilities side, specifically by a $90 increase in its capital. Its capital would go from minus $15 to plus $75.
Applying this to the banking system as a whole in transitioning to a 100-percent reserve, we can see that the creation of such a vast amount of new bank capital would be entailed as easily to overcome whatever losses the banks might have suffered in their loans and investments.
As explained, if checking deposits were $3 trillion, the Fed would give the banks new and additional reserves that when added to their existing reserves would bring them up to $3 trillion. If this had been done in September of 2008, bringing reserves up to $3 trillion would have required adding $2.955 trillion of new and additional reserves to the $45 billion or so of reserves the banks already had. This vast addition on the asset side of the banks' balance sheets would have implied an equivalent addition to the banks' capital on the liabilities side. No matter how bad the banks' assets were, I think it's virtually certain that an additional sum of this size would have been far more than sufficient to cover all the losses that the banks had incurred in their bad loans and investments. Their capital would have ended up being increased to the extent that the additional reserves exceeded the losses in assets under the head of loans and investments.
The government's bailout program of stock purchases in the banks would have been avoided, along with all of its subsequent interference in matters of bank management.
Now, as we've seen, in fact the Fed has already supplied a vast amount of reserves, about $1.1 trillion, to the banks through various programs, such as purchasing bad assets. If the 100-percent reserve principle were adopted now, many or most of those assets could be taken back, and the programs that created them cancelled.
Thus, what I've shown here is how transitioning to a 100-percent reserve would guarantee the prevention both of new credit expansion and of deflation of the money supply. It could also provide additional capital to the banking system on a scale almost certainly far more than sufficient to place it on a financially sound footing. To avoid what would otherwise likely be an excessive windfall to the banks, it would be possible to match a more or less considerable part of the increase in their assets provided by the creation of additional reserves, with the creation of a liability of the banks to their depositors, perhaps in the form of some kind of mutual-fund accounts. Thus, the newly created reserves might provide a financial benefit to the banks' depositors as well as to the banks.
Toward Gold
Of course, a 100-percent reserve system in which the reserves are fiat money does not address the problem of preventing inflation of the fiat money. It would still be possible for the government to inflate the fiat money without restraint. That is why it is necessary to have gold in the monetary system, serving as a restraint on the amount of currency and reserves.
Thus, an important ancillary measure in connection with the transition to a 100-percent paper-reserve system would be for the government to demonstrate a serious intent to move to a gold standard. Obliging the Federal Reserve to carry out a program of regular and substantial gold bullion purchases might accomplish this. In any event, it would be an essential prerequisite for someday achieving gold reserves sufficient to make possible the establishment of a 100-percent-reserve gold system. Along the way, this measure should lead to the day when purchases of gold bullion were the only source of increases in the supply of currency and reserves.
Establishing the Freedom of Wage Rates to Fall
Along with stabilizing the financial system through the adoption of a 100-pecent reserve, it's absolutely essential to establish the freedom of wage rates and prices to fall. This is what is required to eliminate mass unemployment. Whatever the level of spending in the economic system may be, it is sufficient to buy as much additional labor and products as is required for everyone to be employed and producing as much as he can.
Nothing could be more obvious if one thinks about it. Assume, as is the case today, that there is 10 percent unemployment, with only 9 workers working for every 10 who are able and willing to work. The same total expenditure of money that today employs only 9 workers would be able to employ 10 workers, if the average wage per worker were 10 percent less. At nine-tenths the wage, the same total amount of wages is sufficient to employ ten-ninths the number of workers. It's a question of simple arithmetic: 1 divided by 9/10 equals 10/9.
(Obviously, this is an overall, average result. In reality, some wage rates would need to fall by less than 10 percent and others by more than 10 percent.)
Of course, total wage payments are not fixed in stone. They can change. And in response to a fall in wage rates to their equilibrium level, to eliminate mass unemployment, they would increase. This is because prior to their fall, investment expenditures have been postponed, awaiting their fall. Once that fall occurs, those investment expenditures take place.
Finally, with debt levels sufficiently reduced and cash holdings sufficiently high, and thus business confidence restored, there is no reason to believe that a fall in wage rates could abort the process of recovery as the result of already employed workers earning less and thus spending less before new and additional workers were hired. The cash reserves and financial strength of business firms would enable them easily to ride out any such situation. And thus mass unemployment would simply be eliminated.
What stops wage rates from falling, what makes it actually illegal for them to fall, and which thus perpetuates mass unemployment, is the underlying pervasive influence of the Marxian exploitation theory. That doctrine is responsible for the existence of such things as minimum-wage laws and coercive labor unions and their above-market wage scales.
The most important fundamental requirement for achieving a free market in labor is the total refutation of the exploitation theory and its complete discrediting in public opinion. Such a refutation will show that it is not government and labor unions that raise real wages but businessmen and capitalists, and that essentially, all that unions do is cause unemployment and a lower productivity of labor and thus prices that are higher relative to wage rates. This knowledge is what is required to make possible the repeal of minimum-wage and pro-union legislation and thus achieve the fall in wage rates that will eliminate mass unemployment
Summary
In summation, my pro-free-market program for economic recovery is a provisional 100-percent-paper-money-reserve system applied to checking deposits, accompanied by a demonstrable commitment to ultimately achieving a 100-percent-gold reserve system. The 100-percent reserve in paper would put an end to all further credit expansion and at the same time make the money supply incapable of being deflated. Its establishment would also greatly increase the capital of the banking system. It would do so by more than enough to cover all the losses on loans and investments incurred in the aftermath of the collapse of the housing bubble and thus make possible the elimination of government ownership of common stock in banks and its interference in bank management. What it would not do is control the increase in paper currency and paper-currency reserves. That will require a 100-percent gold reserve system.
Finally, the freedom of wage rates and prices to fall must be established through the repeal of pro-union and minimum-wage legislation, and more fundamentally, the education of the public concerning the errors of the Marxian exploitation theory and their replacement with actual knowledge of what determines wages and the general standard of living. To say the least, this will certainly not be an easy agenda to follow, inasmuch as it must begin in the midst of a Marxist occupation of our nation's capital.
Thank you.
Mexico's economy
Mexico's economy
A different kind of recession
In some ways the pain is less bad than the statistics suggest. But recovery will be harder than in the past unless complacency gives way to reform
THE last time Mexico suffered an economic slump, in 1995, it turned to its northern neighbour for help. The United States organised a $50 billion bail-out. Together with the boost provided by the enactment of the North American Free-Trade Agreement shortly before, that helped Mexico to rebound smartly from devaluation and recession.
This time the United States is the problem, rather than the solution. The impact of the recession triggered by the bursting of America’s housing bubble has been even more severe south of the Rio Grande: although data for the third quarter, due to be released on November 20th, should confirm that Mexico has finally pulled out of recession, its GDP shrank by 9.7% in the year to June. That is a shocking number, far worse than the performance of countries like Canada or the Dominican Republic whose economies have similarly close links to the United States.
Yet in other ways too, this recession is very different from 1995 (see chart). The impact on daily life is much less apparent. In Mexico City restaurants remain full and rush-hour traffic as snarling as ever. That is because those in jobs have been relatively unaffected, while in 1995 the purchasing power of their wages was crushed by inflation. The rise in unemployment has been temporarily blunted by a government subsidy that helps companies postpone lay-offs. Those that lose their jobs can tap their retirement accounts, or draw on less formal savings. Samuel Sánchez, a bricklayer waiting at a day labourer’s market in Mexico City, says his wife has been selling off farm animals every fortnight to feed their family. The poorest Mexicans have been largely unaffected, since they are concentrated in the south and mainly work in farming, where output has held up.
Yet all this is cold comfort. The recession has exposed structural weaknesses in Mexico’s economy. NAFTA brought a torrent of American investment as manufacturers set up plants south of the border to take advantage of lower labour costs. This influx brought modernisation and new technology, and underpinned rapid economic growth in the late-1990s.
But NAFTA has left Mexico highly dependent on the health of the American economy, and on a few lines of cross-border business in particular. These include car manufacturing, the construction industry and tourism. They have been among the hardest hit by this recession. Scarcer credit and shredded confidence have caused American consumers to delay as many purchases as possible, particularly those of the pricier durable goods Mexico produces. With exports plummeting, unemployment in northern industrial cities such as Saltillo has leapt into double digits.
Had the decline been limited to manufacturing, the effect on the economy as a whole would have been modest. But many services, such as transport and logistics, are tied to trade flows. Another misfortune was the outbreak of swine flu in April, which shut down Mexico City for a week and scared off tourists for months. Unlike Canada, Mexico’s banking system is largely foreign-owned; credit was squeezed a year ago when head offices ordered their subsidiaries abroad to retrench. As a result of all this, output of services dropped by 6% in the second quarter compared with the same period last year.
Just as this recession differs sharply from 1995, so will the recovery. Mexico’s GDP growth tends to correlate closely to industrial production north of the border. And this is set to rise by only 3-4% next year, even though the American economy is already recovering. So Mexico must look elsewhere to boost its growth.
Although it has signed trade agreements with other countries, Mexico’s preferential access to the world’s largest market caused it to neglect them. “We didn’t have to learn how to deal with other business cultures,” says Alejandro Werner, a deputy finance minister. “It was too easy to just export to the United States.”
NAFTA’s benefits were largely confined to export industry in northern Mexico, in part because transport links farther south are poor. It brought little change to the domestic economy, which has not been a motor of growth for decades, and where cumbersome regulation, protected monopolies and oligopolies and intransigent trade unions carry on much as before.
The government, rather than contributing to a rebound, is making matters worse. Thanks to revenue from the nationalised oil industry, Mexico’s governments have traditionally collected little tax. Despite recent fiscal reforms, federal tax revenue amounts to only 11% of GDP, among the lowest in the world (see article). But oil output is falling rapidly, mainly because of a constitutional ban on private investment in energy. The finance ministry cleverly hedged much of Mexico’s oil output this year back in 2008, when prices were near their peak. But oil income will fall in 2010. As a result, Mexico may see its credit rating downgraded, even though the public debt is only 43% of GDP.
To try to prevent that, the budget for next year tightens the belt, raising taxes by 1% of GDP and cutting spending. That will be a further brake on recovery. Mr Werner estimates that income per head will not recover its level of 2008 until 2012.
Unlike in 1995, Mexico was an innocent bystander in the genesis of this recession. But its politicians will only have themselves to blame if they fail to undertake the structural reforms—of energy, labour markets and competition policy—required to speed recovery.
The deficit problem
The deficit problem
Dealing with America's fiscal hole
Don’t cut the deficit now—but explain how, eventually, you will
FOR years America’s fiscal problems had a surreal quality. No one disputed that an ageing population and health-care inflation could bust the budget, but that prospect was decades away and procrastination seemed painless. No longer. A giant hole has opened in the budget because of stimulus, bail-outs and a recession that has savaged economic growth and tax revenue. On current policies the publicly held federal debt, 41% of GDP last year, will double in the next decade (see article). Total government debt will move well above the G20 average. In a few years the AAA rating of Treasury bonds, the world’s most important security, could be in jeopardy.
A sudden crisis is unlikely. Other rich countries with far bigger debts relative to the size of their economies, from Italy to Japan, have soldiered on without hitting a wall. Stable politics, transparent laws and economic dominance give America unequalled credibility with lenders. For all the anxiety the declining dollar drew from China this week (see article), it has no serious rival as the world’s reserve currency. America has sensibly used this fiscal freedom to enact an aggressive stimulus programme. This should be maintained for as long as it is neededYet ignoring the future is also costly. The problem is not the deficits in the next couple of years, but in the years that follow. Uncertainty over how taxes may be raised to shrink deficits may already be weighing on business confidence. Worries about inflation or default could start to push up interest rates. Eventually, private investment will be crowded out.
Barack Obama and Congress can pre-empt such corrosive uncertainty with a plan to reduce the deficit now. Far from requiring immediate spending cuts or tax increases, a credible plan would reassure markets and allow an orderly exit from fiscal stimulus. The Federal Reserve provides a model: it does not plan to tighten monetary policy in the near future, but has signalled its willingness to do so when inflation threatens.
Where the cutting should begin
America’s deficit problem is in essence a spending problem, so spending must bear the brunt of adjustment. An ageing population and health-care inflation are inexorably driving up the cost of the country’s three big entitlements: Social Security (pensions), Medicare and Medicaid (health care for the elderly and the poor, respectively). Mr Obama has long promised that health reform would cover the uninsured without adding to the deficit, while reining in long-term costs. Unfortunately, the prospects for controlling costs are tenuous. Achieving large savings will require action on many fronts. Raising the retirement age for Social Security and Medicare would save money while encouraging Americans to work longer, thereby expanding economic potential. Medicaid could be converted to block grants, compelling states to assume more of the burden of cost control. Other spending should also be vigorously squeezed, to stop federal funds being wasted on highways of dubious value or trade-distorting farm subsidies.
Still, cold arithmetic suggests that spending cuts alone cannot deliver enough. Changes to entitlements take effect only gradually. And the scope for slashing non-defence discretionary spending is limited, since it makes up merely one-sixth of total outlays. So Americans are stuck with a budgetary conundrum: they seem to be opting for more government, at least in health care, yet they do not seem prepared to pay for it. Their leaders have indulged this fantasy. Mr Obama has foolishly sworn off higher taxes on 95% of households, and Republicans will not countenance them for anybody. This newspaper strongly prefers small government and low taxes, but if Americans are to have bigger government and a sustainable budget, tax revenues will have to rise.
Taxing politics
Raising tax revenue will hurt less if the tax system becomes more supportive of economic growth in the process. Compared with other countries, America taxes consumption too little and income too much (see article). Redressing this imbalance could, with time, help economic growth. First, broaden the income-tax base by eliminating exemptions, and if possible cutting rates. Second, introduce a carbon tax, the least distorting way to slow the growth in emissions. If that is not possible, sell rather than give away carbon-emission permits, or raise the federal fuel tax. A last resort is a broad consumption tax, such as a value-added tax. This is economically efficient, but could too easily become a politically convenient way to vacuum up more money and expand government.
The economics of fiscal reform are straightforward; it’s the politics that are tough. Mr Obama should start the process with a budget early next year that aims to stabilise, and preferably reduce, the debt-to-GDP ratio in the coming decade. The problem is getting Congress to pass the necessary laws. The polarisation of American politics has left Democrats more set on defending entitlements and Republicans determined to hold down taxes. With mid-term elections a year away, the incentive to compromise is shrivelling.
One way to finesse these toxic politics would be to establish a bipartisan commission to fix entitlements and taxes, as proposed by Kent Conrad and Judd Gregg, respectively the most senior Democrat and Republican on the Senate Budget Committee. Its membership would be drawn from both parties, both chambers of Congress and the White House. Democrats and Republicans alike would have to make sacrifices. To preserve this grand bargain, Congress would be allowed only to approve or reject the commission’s proposal, not amend it.
This is no magic bullet. Although similar processes have been used to negotiate trade deals, the stakes in this case would be far higher, as would the chances of failure. Republicans in particular may balk at co-operating. The commission could deadlock, or see its proposal voted down, precipitating the sort of market disruption the scheme was meant to avoid. But that actually may be an advantage: politicians may conclude that failure is not an option. The best defence against a crisis is to act as though you are facing one.
If Government Pays Us to Spend, Then Spend We Will
Commentary by Caroline Baum
The Commerce Department is expected to validate that premise later this week when it reports that the U.S. economy expanded at a 3 percent annualized rate or thereabouts in the third quarter, according to economic forecasters. It will be the first positive reading in five quarters and a sign the slump that started in December 2007 is over.
The official arbiter of such things -- the National Bureau of Economic Research’s Business Cycle Dating Committee -- isn’t about to bless the recovery just yet. The BCDC waited until July 2003 to declare an end to the March-to-November 2001 recession.
Of the four coincident indicators the committee uses to determine the onset of expansions and contractions, two have turned up -- industrial production and inflation-adjusted business sales -- and two are still falling, albeit at a slower rate.
The declines in employment and real personal income less transfer payments are one reason Main Street won’t be celebrating Thursday’s news on gross domestic product. The unemployment rate, currently 9.8 percent, is expected to top 10 percent in the next few months and remain elevated into next year, according to both Obama administration economists and private forecasters.
Permanent Separation
After that, it will be a slow slog for the out-of-work. The number of people who have been laid off permanently accounted for 56 percent of the unemployed in September, according to David Altig, senior vice president and research director at the Federal Reserve Bank of Atlanta. The share of permanent job losers (see Table A-8 in the monthly employment report) never rose above 45 percent in the six previous recessions, Altig writes on his blog, another piece of evidence supporting the forecast of a jobless recovery.
High unemployment isn’t the only reason the GDP celebration will be muted. Much of the third-quarter growth was manufactured.
This may sound whacky, but the federal government has been paying people to spend. Honest. You can’t make this stuff up.
Uncle Sam handed out your hard-earned tax dollars to prod people to scrap their old cars for more fuel-efficient models. The “Cash for Clunkers” program sent auto sales on a roller coaster ride -- first up, then down -- in August and September. Some of those buyers would have purchased a new car or truck anyway. Others used the $4,500 rebate as an inducement to strike while the iron was hot.
Pay to Spend
Just to recap: The government is paying people to do what they would have done at some point anyway.
Then there’s the $8,000 tax credit for first-time homebuyers, a program that failed to heed the lessons of the no- questions-asked-mortgage lend-o-rama earlier this decade. Some 74,000 claims may have been ineligible for the credit, including one from a 4-year-old boy, according to a report from the Treasury’s inspector general.
No one would dispute the idea that people respond to incentives: A temporary, one-time tax credit brings demand forward.
But it will take an increasingly large tax credit to get the same bang for the buck, according to Andy Laperriere, a managing director at the ISI Group in Washington.
Using estimates from the National Association of Realtors on the number of home sales that were borrowed from the future, Laperriere calculates that home sales will drop 11.5 percent next year even with an extension of the $8,000 tax credit. That’s better than the 29 percent decline he predicts if the credit expires, but the sign is still negative.
Expanding the eligibility beyond first-time homebuyers -- no toddlers allowed -- would alleviate some of the decline, Laperriere says.
Less with Less
Between the spending on houses and cars, the third quarter won’t look too shabby. The problem is that all these government actions designed to create a short-term economic boost have long-term implications.
For example, not all spending is created equal. Investment in the future, whether it’s the government improving roads or the private sector building a plant, is a plus for future growth.
“If increased government spending on retiree health care comes at the expense of business spending on capital equipment and R&D, then the productivity of the current labor force and long-run growth rate will be adversely affected,” says Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago in his October economic outlook.
Secular Shadow
That’s one reason there’s a secular shadow hanging over the upbeat cyclical indicators, starting with the Index of Leading Economic Indicators itself. The LEI bottomed in March before soaring in the last six months. The six-month annualized change of 11.8 is heralding a rebound, as is the spread between the federal funds rate and 10-year Treasury note yield -- the leadingest of the 10 leading indicators, according to the Conference Board, the keeper of the LEI.
The spread was even steeper in the early 1990s, another period when an impaired banking system depressed the monetary transmission mechanism. Until banks stop hoarding excess reserves and start lending -- they’re buying Treasuries but not making many loans -- the spread is an incentive waiting to happen.
Like all incentives, this one will work in time. I’m just worried it will run smack into some disincentives elsewhere.
California Was Among States With Record Unemployment
By Courtney Schlisserman
Nov. 20 (Bloomberg) -- California, Delaware, South Carolina and Florida registered record rates of unemployment in October as weakness in the labor market stretches from coast to coast and limits the economic recovery.
Joblessness rose in 29 U.S. states last month compared with 22 in September, the Labor Department said today in Washington. Michigan had the highest jobless rate at 15.1 percent, followed by Nevada at 13 percent and Rhode Island at 12.9 percent.
The national rate last month reached a 26-year high of 10.2 percent, weighing on consumer spending that accounts for about 70 percent of the economy. Federal Reserve Chairman Ben S. Bernanke said Nov. 17 that joblessness “likely will decline only slowly,” a reason policy makers will keep interest rates near zero to ensure growth is sustained.
“We’ve had a surprisingly sharp jump in the jobless rate,” said Richard DeKaser, president of Woodley Park Research in Washington. “Businesses have truly been doing an extraordinary job of wringing out productivity from the labor force.”
Stocks fell for a third day, with the Standard & Poor’s 500 Index declining 0.6 percent to 1,088.03 at 12:32 a.m. in New York. Dell Inc., the third-largest maker of personal computers, declined 9.5 percent after reporting a 54 percent drop in profit.
Declines in 13 States
The unemployment rate fell in 13 states, including Massachusetts, where it declined to 8.9 percent from 9.3 percent; New Hampshire, with a drop to 6.8 percent from 7.2 percent; and West Virginia, which fell to 8.5 percent from 8.9 percent.
The number of states with at least 10 percent unemployment held at 14 last month, the Labor Department’s report showed. The states reporting a record jobless rate were California at 12.5 percent, South Carolina at 12.1 percent, Florida at 11.2 percent and Delaware at 8.7 percent. The District of Columbia also set a high with an 11.9 percent rate.
“Virtually every sector aside from the health-care sector is losing jobs,” said Sean Snaith, University of Central Florida economist in Orlando. “Housing has been central to Florida’s economic story throughout the entire cycle. Unfortunately, it has spread well beyond the sectors directly involved in the housing market.”
President Barack Obama on Nov. 6 signed into law a plan to extend jobless benefits, expand a tax credit for first-time homebuyers and provide tax refunds to money-losing companies. The measure gives jobless people as many as 20 additional weeks of unemployment assistance.
The president has also announced plans to convene a jobs summit at the White House next month.
State Payrolls
Payrolls declined last month in 21 states, today’s report showed. New York showed the biggest drop, with a loss of 15,300. Florida had 8,500 job losses, followed by Georgia with 7,500 and Virginia with 7,100.
“When you apply for a job, because there are so many other people looking for jobs, you have to be the absolute perfect candidate and lucky, or be someone’s brother-in-law, to get a job,” said Mary Kough of Tellico Plains, Tennessee. “In this economy there are very few jobs for which to even apply.”
Kough has been looking for work for four months, applying for as many as 25 positions. She’s been interviewed once. The 47-year-old said she has about 20 years of experience, including jobs as a customer service manager, supervisor and purchasing agent. Tennessee’s unemployment rate held at 10.5 percent in October, the Labor Department’s report showed.
Taking Comfort
“I try not to get discouraged,” Kough said. “I know that you will get a certain percentage of what you apply for, and since there are less jobs to apply for, I know it will just take a little longer. I take comfort in knowing that. I have faith.”
Applied Materials Inc. is among companies still planning to cut jobs. The world’s biggest maker of chip equipment, based in Santa Clara, California, said Nov. 11 it plans to eliminate as many as 1,500 positions within 18 months.
Over the last year, California showed the biggest loss of jobs, with payrolls falling by 687,700 workers, today’s report showed.
Nationally, payrolls fell by 190,000 in October, the Labor Department said Nov. 6. The U.S. has lost 7.3 million jobs since the start of the recession in December 2007, the most of any downturn since the Great Depression.
Other measures corroborate that while firms are firing fewer workers, it is harder for the unemployed to find work. The number of people getting extended payments jumped in the week ended Oct. 31 even as the number of Americans filing first-time claims for unemployment benefits held at a 10-month low last week, according to government data released yesterday.
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