Sunday, November 7, 2010

Was the Stimulus Too Small?

Given Tuesday’s election results, there has been much reflection and debate in the media and in Washington about what went wrong for Obama and the Democrats. As suggested by Kathleen Parker in a recent op-ed, and I agree with her, "The election was a referendum on policies that are widely viewed as too overreaching and, ultimately, threatening to individual freedom. It's that simple." Others, perhaps most notably Paul Krugman, state that the stimulus was simply too small and was consequently ineffective, thus not reviving employment and turning voters against the Dems. As Krugman says, "Mr. Obama’s problem wasn’t lack of focus; it was lack of audacity. At the start of his administration he settled for an economic plan that was far too weak. He compounded this original sin both by pretending that everything was on track and by adopting the rhetoric of his enemies."

Although it's important to understand the political climate, we must address the real issue when we start talking about the stimulus and our economic recovery. We all want to reduce unemployment, but the first question to ask is, is unemployment the real problem or is it a symptom of something else? To date, the Fed and the Obama administration have approached our economic woes as if we were merely in an ordinary recession. Following the standard cures for such an event, they believe all will be well with a little time, provided we can just keep the public spending. In essence, they're trying to load the citizenry onto an arc so we can ride-out a tsunami safely at sea, and once the waters subside from our island paradise, we'll return to the shore and resume our lives. Well, I would suggest that the shore is not there any longer, and never really was.

I absolutely agree that we need to buffer our citizens from the shocks of this downturn. However, the real problem is that the economy we have known for the past 30 years was a myth. With the inventions of credit cards, second mortgages, and the mortgage securitization markets (the one sponsored by the government and its evil cousin, sponsored by Wall Street), we have been riding a debt-fueled bubble since the Reagan era. Debt-fueled growth was an easy path for the Republicans to take because it kept the economy firing on all cylinders once the growth associated with the post-WWII/baby boom era began to subside. The bubble worked for the Democrats as well, because it supported their social agenda of home ownership, and it enabled growth in the tax base that supported the progressive agenda of big, "the-government-shall-provide" government. The ruse created an unholy alliance between left and right that went unspoken, even when it became very dangerous. In any event, as we have learned twice now in the past 10 years, bubbles are not sustainable, and we experienced the inevitable collapse.

What disturbs me is that our political leaders still don't seem willing to face the reality that we need to create a new economy. When the dot-coms went bust, everyone knew the early-stage dot-coms didn't have viable business plans, so no one advocated that we devise ways to keep their employees in place until the public came to their senses and started finally using Webvan and Instead, we let those businesses go bust, we provided unemployment benefits to the dislocated, and we waited for businesses to get back on their feet and start hiring again. It actually didn't take very long. The current situation is more insidious, though. Because we were riding an inflated economy for so many years, many excesses became baked into our culture that simply cannot be sustained: federal and state agencies that don't provide a return on investment; ridiculous salaries, benefits and retirement schemes for many government workers; plus we had a misallocation of labor, with many civilians working in bubble-related industries, such as mortgage banking and construction. All of these excesses need to be eliminated in order to create a new, sustainable economy, as we are not going to have the money available to pay for governmental waste or to keep people in jobs that provide goods and services that are no longer in demand. Instead, rather than returning to a consumption-based economy, we must create an investment-oriented economy that is supportive of innovation and entrepreneurship. We must build a new economy that is based on viable business models that generate in-demand goods and services.

The current stimulus may, in fact, have been too small, but that's not to say that what has been spent was wisely spent in an effort to bridge us over to a new economy. The spending has been incredibly scattershot (details here), and virtually all of it supported the "arc and tsunami" scenario noted above. So far, we have spent on tax cuts to support consumption, we have kept government workers in their jobs, we have helped states keep their Medicaid programs going, we've provided unemployment benefits, and we've created some temporary jobs at incredible cost, not to mention doled out billions in pork to individual Congressional districts as quid pro quo payoffs to our Congressional reps. All of this spending has been done with no one -- not Obama, or anyone in Congress, or any members of the intelligentsia, like Krugman -- painting a picture of the new world we would emerge into once all the spending was done, nor have they given us a realistic, properly prioritized spending plan or timeline for getting us there. And do you know why that is? It's because they still haven't faced the reality that our world must change, and that's because they've never really searched for the root cause of our problems.

The answer is that we need to spend little AND we need to spend large. In other words, the spending needs to be differentiated and prioritized. Our former economy popped, yet the Fed and our government are spending trillions in doomed fiscal and monetary strategies to try to reinflate the same bubble. It won't work. Rather than clinging to broken systems, we need to accelerate the destruction of the old and the creation of the new. We need to support our brothers and sisters who have been displaced, but we need to steamline our spending so we can marshal the rest of our resources and refocus them on revitalizing the economy. Inconsistent with revitalization is spending on "make-work" temporary employment. Tempting as it may seem, it should be avoided, as there is no lasting value in the jobs, the projects cost too much to plan and supervise, and the work only postpones the inevitable. Moreover, the cost of the labor can oftentimes be exceeded many times by the cost of materials; e.g., there's more to the cost of a bridge to nowhere than the cost of the labor. The people are better off spending their time learning a marketable skill.

There are many things that we can and should be doing, and that's where the big spending comes in. For example, maybe I'm dreaming, but how much would it cost and how huge would the benefits be if we completely revitalized the city of Detroit? Can you imagine the economic and societal benefits of lifting half a million people up a step or two on the economic ladder? Undoubtedly, the cost would be enormous. Doing so might involve paying to relocate half of the population to other parts of the country (voluntarily, of course) and demolishing entire sections of the city, then consolidating the rest in order to make the city a community again. The remaining people would need to be trained and businesses would need to be provided with incentives to move in. This is just one grand-scale project that would cost big, but until we take it on, a city like Detroit will forever be an anchor chained to this country's feet. Of course, there are many smaller initiatives as well that we should take on: provide business start-up loans and grants; provide salary-based tax credits to existing businesses to take the risk out of hiring new employees; provide vocational training; provide businesses with tax credits for relocating and hiring the unemployed from economically depressed regions, and so on.

It's no wonder many people questioned the value of the stimulus. The problem we were trying to address had never been defined, a picture of the end game had never been painted, the objectives of the spending were too unfocused, and the results were not visible enough or were not individually significant enough to demonstrate the kind of success that would win public support. For example, there was no Hoover Dam, Golden Gate Bridge, AlCan Highway, or Tennessee Valley Authority, which were all projects from the Depression era that generated huge economic benefits, past and present. Moreover, as many on the left have criticized, expectations were not properly set. It was a mistake to let the public believe that a real fix could be effected in just a year or two. We are attempting to rebuild from a disaster that was 30 years in the making. That's going to take time, patience, determination, and a real plan.

Saturday, November 6, 2010

Restoring Confidence is the First Step

I just read a good article by David Smick on the role of confidence in restoring and maintaining a robust economy.

To add my own thoughts, confidence comes from predictability and trust. Job #1 for the government is to stop creating uncertainty and to implement systems that ensure fair playing fields for all, whether they be entrepreneurs or ordinary taxpayers.

Job #2 is to eliminate government waste and other spending that isn't absolutely vital to restoring the economy, thereby allowing government funds to be aimed at viable investments and a reduced tax burden (which also helps with Job #1).

Job #3 is for government to make the targeted, huge investments -- that only it can make due to its size and reach -- in education and infrastructure that will enhance industrial productivity and enable new business formation.

Job #4 is to provide incentives for people and companies to invest their new excess capital (from #2's tax savings) here in the U.S. Creating abundant capital and making it easier to achieve returns on that capital will reduce the cost of that capital to those he want to use it. Many investments that have been off the table for a generation now -- like building a blue collar factory -- would become viable again. Despite all the press about everyone needing to be a knowledge worker, we can definitely make use of well-trained people who can work with their hands, as they do in Germany.

It is well within our means to put people back to work and to set the stage for sustained prosperity. Some sacred cows will need to be slayed, "business as usual" (e.g., earmarks) in Washington will need to change, and we'll need to endure some upheaval as government workers are displaced and redeployed in industry, but the effort would be worth it. We just need to get on with it.