The Gipper’s Wit

The American people always have a way of figuring out the facts. And that reminds me of a story. At my age, everything reminds you of a story. This is a story that happens to be about one of our intelligence agencies in Washington. They had an agent, a spy, who was over in a little town in Ireland, and they had to make contact with him. And they called in another agent and told him he was to go there and contact this man. The man’s name would be Murphy. And he said, “Your recognition so that he’ll know who you are is that you say, ‘It’s a beautiful day today, but it’ll be a better one tomorrow.’” And then he was on his way. Well, he got to this little town, and he figured the best place to start his search was in the pub. So, he went into the pub and up to the bar and said to the bartender, “Where would I find a man named Murphy?”

And the bartender said, “If it’s Murphy the boot maker you want, he’s in the second floor of the building across the street. And if it’s Murphy the farmer you want, he’s a half a mile down the road – the farm on the left. And,” he said, “my name is Murphy.”

And the agent said, “Well, it’s a beautiful day today, but it’ll be better tomorrow.”

And the bartender said, “Oh, it’s Murphy the spy you want.”

President Ronald Reagan told that story in 1988 while campaigning for Republicans in California. Mr. Reagan was born 99 years ago today. Happy Birthday, Mr. President!

Found on InsiderOnline.org

Government Borrowing Already Crowding Out Private Investment

A tidal wave of deficit spending by the U.S. government is already increasing the costs of borrowing, retarding economic recovery, and confirming again a key contention made repeatedly by critics of Keynesian-style stimulus plans: That government spending, on net, does not add to the economy. The more government borrows to finance its spending, the less capital is available to be invested in the private economy.

Last week, the Financial Times reported that since the end of December, the yield on the benchmark 10-year Treasury note has risen from just over 2 percent to 2.95 percent, and as a result mortgage rates are being pushed higher.

The Congressional Budget Office projects the 2009 federal budget deficit to reach $1.2 trillion. That budget gap amounts to 8.3 percent of gross domestic product, which shatters the previous post-World War II high of 6.0 percent reached in 1983. The 2008 deficit was “merely” $455 billion. The surge in debt reflects the anticipated costs of continuing to bail out banks through the Troubled Asset Relief Program and the government assumption of Fannie Mae and Freddie Mac’s obligations. But the CBO’s projections do not account for the fiscal impact of the stimulus plan that Congress is now debating. That plan would add $800 billion or so to the deficit over a two-year time period.

The prospect of even higher levels of deficits to come has some world leaders questioning U.S. economic policies. At the World Economic Forum in Davos, former Mexican President Ernesto Zedillo told the New York Times: “The U.S. needs to show some proof they have a plan to get out of the fiscal problem. We, as developing countries, need to know we won’t be crowded out of the capital markets, which is already happening.”

The interest rate for an average conforming mortgage now stands at 5.33 percent. J. D. Foster of The Heritage Foundation projects that new deficit spending will push that rate up by a percentage point or more by the end of 2010. Making it harder for people to finance new homes seems exactly the opposite of what our political leaders claim they want to do.

Found on InsiderOnline.org

A Nobel Dissent

The Keynesian construct, on which Congress’s stimulus plan is based, is alluring because it can be expressed as an equation and because it identifies levers for policymakers to pull to fix an economic crisis: If aggregate demand falls, then government must supply the deficit though increased government spending to maintain employment.

Could this framework be leaving something out? For an answer, turn to Friedrich Hayek’s 1974 Nobel Prize lecture (via Don Boudreaux at Cafe Hayek). Hayek pointed out that

unemployment indicates that the structure of relative prices and wages has been distorted (usually by monopolistic or governmental price fixing), and that to restore equality between the demand and the supply of labour in all sectors changes of relative prices and some transfers of labour will be necessary.

In other words, bad economic news tells us that adjustments are needed across various sectors in the economy, but Keynesianism says only: Maintain overall demand. In fact, said Hayek, pumping up aggregate demand distorts the price signals that would bring about the needed adjustments, which can only be avoided so long as government continues to pursue inflationary policies. Hayek attributed the stagflation of the 1970s to the demand management that Keynesianism had prescribed in earlier decades:

… the very measures which the dominant “macro-economic” theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity.

Hayek’s lecture actually concerned the larger topic of intellectual hubris that can result from misapplying scientific methods. Keynesianism, he argued, gave policymakers the illusion of control over the economy, when in fact they were as ever hampered by the knowledge problem. The “knowledge problem” is the reality that government planners can never possess the sort of local and specific knowledge that they would need to make better economic decisions than would occur in a free economy. Hayek concluded:

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants. There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, “dizzy with success”, to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Found on InsiderOnline.org

Recovery Means Capitalists Making Profits

Arnold Kling:

What a recovery will look like will be a profit recovery. … our Marxist conditioning leads us to berate profits. If ever we needed profits in our economy, it’s right now. From third quarter of ’07 to third quarter of ’08, wages and salaries rose 3 percent; profits fell 9 percent. Profits are the most cyclical part of the economy. The capitalist system runs on profits. We can’t have profits continue to fall and have a recovery. So we need more profits.

Another reason we need more profits is we are not running an economy on credit anymore. That’s just a fact. You can try to promote lending and beg banks to lend but we are in the process of deleveraging and if businesses are going to expand, it’s not going to be by borrowing; it’s going to be by expanding using profits. And so we need a profit-driven recovery. That’s where things like using the employer contribution to the payroll tax would be perfect. Ordinarily, in a full-employment economy, if you cut the employer contribution to the payroll tax, in order to compete for workers, firms would just raise wages to compensate so that there wouldn’t be much net effect. In fact the benefit would all go to workers. But in today’s economy with unemployment, the cut in the employer contribution to payroll tax would actually flow through into profits. It would also increase labor demand, because it would make labor cheaper to hire. So that would be helpful.

But most importantly, it would increase corporate profits, and that would lead to more investment, and it would use the decentralized-process of the market to figure out where skills are needed and where the next growth opportunities are, rather than having Washington say: “Well, the next growth opportunity is to build school classrooms or roads and bridges or green projects.” Let the market decide where the resources are used most productively.

ALSO: Listen to entire Cato podcast with Kling for an excellent discussion of the flawed thinking behind the notion of a government multiplier.

Found on InsiderOnline

What Not to Do

In Monday’s Wall Street Journal, Harold Cole and Lee Ohanian provide evidence that the New Deal should not be anybody’s model of how to recover from an economic downturn:

Why wasn’t the Depression followed by a vigorous recovery, like every other cycle? It should have been. The economic fundamentals that drive all expansions were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful. We have calculated on the basis of just productivity growth that employment and investment should have been back to normal levels by 1936. Similarly, Nobel Laureate Robert Lucas and Leonard Rapping calculated on the basis of just expansionary Federal Reserve policy that the economy should have been back to normal by 1935.

The National Industrial Recovery Act was one of the main pillars of the New Deal. Cole and Ohanian identify it as one of the main sources of drag on the economy. The Act allowed over 500 industries to collude in setting prices and wages as much as 25 percent higher than the level that would have prevailed otherwise. With higher prices came lower production and lower employment. Those lucky enough to have jobs in an organized industry benefited, but everyone else suffered.

Cole and Ohanian further observe that the “recession within a depression” of 1937-1938 followed the Supreme Court’s 1937 decision upholding the constitutionality of the National Labor Relations Act which pushed wages up even further.

So what ended the Great Depression? Cole and Ohanian point out that the economy improved in the late 1930s when the government reversed course and resumed prosecuting cartels under antitrust laws. Also helping bring wages back in line was the erosion of union bargaining power that occurred when the Supreme Court ruled that the sit-down strike was illegal and later when the National War Labor Board limited large union wage settlements to cost-of-living increases.

According to Cole and Ohanian, “New Deal labor and industrial policies prolonged the Depression by seven years.”

Found on InsiderOnline

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