Friday, December 30, 2011

Short Term Outlook for the Economy Not So Good ... But the Future Looks Bright

David Brooks of the New York Times has written a solid editorial titled Midlife Crisis Economics. Since it's not lengthy, we'll quote it in its entirety:

"The members of the Obama administration have many fine talents, but making adept historical analogies may not be among them.

When the administration came to office in the depths of the financial crisis, many of its leading figures concluded that the moment was analogous to the Great Depression. They read books about the New Deal and sought to learn from F.D.R.

But, in the 1930s, people genuinely looked to government to ease their fears and restore their confidence. Today, Americans are more likely to fear government than be reassured by it.

According to a Gallup survey, 64 percent of Americans polled said they believed that big government is the biggest threat to the country. Only 26 percent believed that big business is the biggest threat. As a result, the public has reacted to Obama’s activism with fear and anxiety. The Democrats lost 63 House seats in the 2010 elections.

Members of the administration have now dropped the New Deal parallels. But they have started making analogies between this era and the progressive era around the turn of the 20th century.

Again, there are superficial similarities. Then, as now, we are seeing great concentrations of wealth, especially at the top. Then, as now, the professional class of lawyers, teachers and journalists seems to feel as if it has the upper hand in its status war against the business class of executives and financiers.

But these superficial similarities are outweighed by vast differences.

First, the underlying economic situations are very different. A century ago, the American economy was a vibrant jobs machine. Industrialization was volatile and cruel, but it produced millions of new jobs, sucking labor in from the countryside and from overseas.

Today’s economy is not a jobs machine and lacks that bursting vibrancy. The rate of new business start-ups was declining even before the 2008 financial crisis. Companies are finding that they can get by with fewer workers. As President Obama has observed, factories that used to employ 1,000 workers can now be even more productive with less than 100.

Moreover, the information economy widens inequality for deep and varied reasons that were unknown a century ago. Inequality is growing in nearly every developed country. According to a report from the Organization for Economic Cooperation and Development, over the past 30 years, inequality in Sweden, Germany, Israel, Finland and New Zealand has grown as fast or faster than inequality in the United States, even though these countries have very different welfare systems.

In the progressive era, the economy was in its adolescence and the task was to control it. Today the economy is middle-aged; the task is to rejuvenate it.

Second, the governmental challenge is very different today than it was in the progressive era. Back then, government was small and there were few worker safety regulations. The problem was a lack of institutions. Today, government is large, and there is a thicket of regulations, torts and legal encumbrances. The problem is not a lack of institutions; it’s a lack of institutional effectiveness.

The United States spends far more on education than any other nation, with paltry results. It spends far more on health care, again, with paltry results. It spends so much on poverty programs that if we just took that money and handed poor people checks, we would virtually eliminate poverty overnight. In the progressive era, the task was to build programs; today the task is to reform existing ones.

Third, the moral culture of the nation is very different. The progressive era still had a Victorian culture, with its rectitude and restrictions. Back then, there was a moral horror at the thought of debt. No matter how bad the economic problems became, progressive-era politicians did not impose huge debt burdens on their children. That ethos is clearly gone.

In the progressive era, there was an understanding that men who impregnated women should marry them. It didn’t always work in practice, but that was the strong social norm. Today, that norm has dissolved. Forty percent of American children are born out of wedlock. This sentences the U.S. to another generation of widening inequality and slower human capital development.

One hundred years ago, we had libertarian economics but conservative values. Today we have oligarchic economics and libertarian moral values — a bad combination.

In sum, in the progressive era, the country was young and vibrant. The job was to impose economic order. Today, the country is middle-aged but self-indulgent. Bad habits have accumulated. Interest groups have emerged to protect the status quo. The job is to restore old disciplines, strip away decaying structures and reform the welfare state. The country needs a productive midlife crisis.

The progressive era is not a model; it is a foil. It provides a contrast and shows us what we really need to do."

Here's my take. First, Brooks gets it right and provides reasonable grounds for optimism about our American future.

(1) The really good news is that 64% of Americans now believe, as did President Reagan, that "Government isn't the solution; it's the problem." Since most of us now see big government as our country's biggest threat, we can conclude that Americans don't believe the words that "we're from the government and we're here to help."

(2) Here's another important thing that we now get. The U.S. employment problem won't be solved by more wasteful government spending. To reduce unemployment meaningfully, we need to experience sustainable economic growth, and that kind of growth can only be fueled by the private sector. Additional government "stimulus" spending and more government jobs aren't the answer. We've already tried that wrongheaded approach.

(3) There seems to be developing a widespread understanding that the century long progressive era needs to end. Along with Europe, we are witnessing the debilitating effects of big government. It's negatively impacting both jobs and economic prosperity. The current worrisome European situation is an illustrative example of why a social-democratic welfare society won't work in America. It doesn't work in Europe either, but that's another matter.

(4) Even though many things have changed in the U.S. over the years, some things haven't and never will. To wit, debt isn't a free lunch. It has to be repaid. While free spending governments can create a "sugar high" in the short term, if it becomes habitual it leads to an unsustainable level of debt. The short term feel good gain is never worth the inevitable long term pain

(5) Similar to habitual profligate government spending, free spending individual consumers and households can create an equally difficult dilemma for themselves.

(6) Finally, collateral (such as a home which is mortgaged) isn't unchanging in value. The collateral's value can decrease. If we borrow $X to support a purchase of Y (which is used as collateral for the loan) and Y's value later declines to 1/2 Y, we still owe a full $X. Thus, the lesson is that we need to beware of asset inflation bubbles financed by cheap and easy credit terms. The debt will come due regardless of how much the asset is worth at the time of sale.

(7) Our accumulated American bad habits of recent decades, of which we admittedly have many, are absolutely within our power to address and solve. All we have to exhibit is the will to straighten things out.

To recap, here's the best news of all. We the American people understand the problem. That means the incumbent politicians won't be far behind in "leading the way" to dealing with it. And if the incumbents don't deal with it, we'll elect a new batch of politicians who will.

In a competitive, open and free market based society where representative government is genuine but limited, and where we the people are free, informed and therefore resolved to live within our means, we will do just that, because it's in our own best interests to do so. both individually and as a nation. The rest of the world, too, for that matter.

That's where the U.S. is headed--again. But it's going to take a few years to get us there. We've a lot a of house cleaning to do along the way.

Meanwhile, let's not lose hope or faith in our fellow Americans. After all, it took us approximately an entire century to get to our current sorry state of affairs.

Thanks. Bob.

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