Politics and Markets: How Governments Help and Hurt Economies

Lots of political rhetoric is spewed across news and the social media.  Most of it is just ideology, repeated and spun by pundits or posted across the social media, appearing as Facebook  facts” where propositions come to be accepted as political truths.  But they reality is that so much of passes as political fact is simply ideology; untested assertions or simply statements about the world that fail to stand up to rigorous social science scrutiny.  This is the case with assertions about taxes, or voter fraud, or a slew of many other propositions.  Two of the most cherished theories held dear to many conservatives are that the government cannot innovate and that the pathway to economic recovery is through austerity and cuts in government spending and taxes.  Both of these myths are convincingly challenged in two recent books, Mariana Mazzucato’s The Entrepreneurial State, and  Mark Blyth’s Austerity: The History of a Dangerous Idea.
    Mazzucato begins her book by constructing the stereotype of a dynamic innovative private sector where the engine that drives businesses is the “creative destruction” that economist Joseph Schumpeter once described in contrast to the dull, risk-aversive bureaucratic behavior of the government.  The myth is that government cannot innovate; it instead impedes creativity and job creation, and that the best way to foster economic growth is by limiting government activity in the economy, including taxes and regulation on businesses and creative individuals.  Government in effect crowds out entrepreneurial activity.  A wonderful theory, but how accurate is it? 
    Mazzucato offers ample empirical evidence to challenge this myth.  Her work is drawn heavily from examination of US and European economic policy and data.  What she actually finds first is that government is often a risk taker, providing a significant portion of the venture capital that has produced some of the most important technological innovations since World War II.  On one score, US research and development (R&D) tax credits and investments in military technology, the internet, and in drugs have provided most of the capital in these fields, yielding some of the most important and significant inventions in these areas.  Mazzucato points out how Apple’s Ipad, Ipod, and Iphone all were made possible by technology investments underwritten by the US government.  Agencies and programs such as the Defense Advanced Research Projects Agency, the Small Business Innovation Research program, and the Orphan Drug Act (some of which were created under Ronald Reagan) have been remarkably good at fostering innovation.
    The second point that Mazzucato makes is that the government often funds innovation at stages and in places where private sector venture capital dare not go.  Private venture capital rarely funds projects in the infancy stage where the risk is too great and the expectations of payoff are slim.  Venture capitalists are smart–they do not enter the fray until the real risks are diminished and, they invest with a short time horizon there is a likelihood of a profit.  Venture capitalists are not gamblers–they want to invest but only on good bets and when their returns quick results.  Venture capitalists invest at later stages in technology of business development and often get out quickly.
    Not so with the government.  Mazzucato points to how the government often invests at early stages where payoffs are less certain and the risks are greater, paying the way for businesses and venture capitalists later on to profit.  Government socializes early risks, is willing to underwrite more risky but long term investments, and in effect helps nurture the conditions that make private entrepreneurial activity possible.  Government thus does not so much crowd out innovation but instead facilitates first a “crowding in” and then a “dynamizing in” of investment and innovation.
    In contrast to Mazzucato who challenges the myth that government activity crowds out business activity, Blyth assails austerity as a political economic policy.  Simply put, austerity argues that during recessions or in other times when the economy is performing badly, the cure is to cut government spending, thereby freeing up capital for investment.  The idea is based on Say’s Law–supply creates demand–a staple theory of supply-side and neoclassical economic thought.  It is the idea that once enough cuts have taken place–the damage and destruction that has occurred to the economy as a result of high wages, taxes, or government spending–a new economic equilibrium were be reached whereby investors will again invest and business will hire individuals.  Yet the power of Blyth’s book both is to question the theory of government austerity and then look to its practice to see if as applied it has actually led to situations where governments can “cut their way to prosperity.”
    Blyth begins by discussing John Maynard Keynes concept of the “paradox of thrift.”  Individually it might make sense in tough economic times for one person to refuse to spend or invest and instead save.  But multiple such a policy across millions of individuals and businesses and what one gets is a recession.  With no one willing to spend or consume no businesses are willing to invest.  Merely getting tax cuts will no induce businesses to hire since no one is going to buy their products.  What results instead is a variation of a reverse prisoners’ dilemma where no one invests for fear that the economy will not rebound.  The paradox of thrift in economics is Keynes rejoinder to Say's Law;  a challenge that merely cutting taxes or placing more money in peoples’ or businesses’ hands will stimulate the economy.  Instead, so long as the risk that others will not spend or consume continues the economy will not pick up.  Thus, the need for government to stimulate demand.
    Up to this point  Austerity is no more than a forceful defense of Keynesian economics.  But Blyth goes after bigger game, challenging those, such as Tea Party advocates who single-mindedly want to cut government spending as part of a broader battle to reduce government debt.  Their argument, as Blyth describes it, sums up as “more debt doesn’t cure debt,” is assuring but simplistic and wrong for many reasons.  On a theoretical level it assumes that what is good for one individual (saving) is good as a national policy.  This is the fallacy of composition.  Second, austerity is unfair.  It asks the poor and middle class who did not benefit from the economic good times to pay for the mistakes of the rich when the economy goes bad.  By that, in 2008, it was the finance sector and the banks that brought on the recession and austerity meant that they were bailed out while the poor suffered and continue to do so by cut to food stamps and other social welfare programs.   
    Third, austerity just does not work in theory as an economy theory.  This is the strength of Blyth’s book.  Many point to Germany as an example of how austerity works successfully or conversely, why a lack thereof is the cause of Greece’s problems.  Both are exceptions.  In the case of Germany which has run a high savings export driven economy, it only works because in part other countries run deficits.  Not every country can run surpluses and be export driven.  If no one consumes then there are no exports to buy.  Germany is a unique case, as is Greece because of its  high degree of corruption.  Simply cutting debt or spending to turnaround an economy does little to stimulate investment, it places burdens disproportionally on the poor, and it fails to lift the GDP over  time.  Instead, the more successful world economies balance debt-management with investments along the line Mazzucato suggests, providing support for demand and an infrastructure that facilitates growth.
    Together Mazzucato and Blyth paint a theoretical and empirical picture that severely damages arguments that the minimalist state is the pathway to economic growth and entrepreneurial activity.  They describe a more nuanced picture of how government and business can work together to sustain  economies while producing economic fairness and equity.   They move the discussion beyond ideology where all too often many anti-tax, anti-government advocates sit.  Policy makers in Minnesota and across the country wishing to get a better understanding of what governments really do and how they can make a difference would be well suited to read these books.  The same can be said of advocates of the myths Mazzucato and Blyth attack.

Liberalism in Retreat--The Conservatism of Barack Obama

It may very well be that the legacy of Barack Obama is that he will destroy whatever is left of the liberalism of the Democratic Party.  At least this is the conclusion one can reach given his recent budget proposals and his continued advocacy for the use of drone warfare.  In so many ways, Obama looks even more conservative than his adversaries on the right.

By now it is common place to assert that the Democrats are the party of liberalism.  It is the party of FDR and JFK, of the New Deal and the Great Society, civil rights and taxes, abortion and gay rights, for the rights of the accused and against guns. This is the party that first Richard Nixon and then Ronald Reagan stereotyped and successfully ran against.  These two elections resulted in what was once thought to be a political realignment in American politics as Reagan Democrats and the once solid south moved into the column of the Republican Party. It was barely a generation ago that  critics hailed the demise of the Democrats as too liberal.  Between 1968 and 1988 Democrats won only one presidential contest, they lost control of the Senate in 1980, and they looked doomed.  Throw in the 1994 congressional losses and then again the beatings they took in 2002 and one could  have put RIP next to the Democratic Party.

But along came Bill Clinton.  He along with the Democratic Leadership Council contended that the party had become too liberal and it needed to move to the center.  And it did.  Clinton was a pro-death penalty president who signed DOMA, Don’t Ask, Don’t Tell, welfare reform, and limits on habeas corpus for prisoners.  He dramatically moved the Democrats to the center, as the story goes, and the result was that his party again became more electable.

But politics is not static.  While Democrats moved to the right, the Republicans shifted even further.  First with Bush and then with the TEA Party.  The center of American political gravity on many issues moved rightward.  And so has Barack Obama.

Initially though, Obama had everyone convinced that he was a liberal.  Maybe it was his race, or his appeal to a new generation of voters.  But back in 2008 many thought of him as the liberal candidate in the race, at least compared to Senator Clinton.  But compared to John Edwards and Dennis Kucinich he was a moderate.  That juxtaposition probably helped him in the battle for the Democratic Party nomination, but also his rhetoric at times sound progressive, especially when he talked of health care reform, gay rights, or the rights of workers.  His rhetoric sounded progressive, at least in comparison to the Bush era values as he spoke of closing Gitmo and ending the war in Iraq.  Even his 2009 inaugural speech trumpeted a liberal theme, but sadly the gap between rhetoric and reality grew.

Obama did call for major expansion of health care reform but he rejected calls for the more liberal single payer system that Senator Ted Kennedy and other liberals wanted.  He opted for the Republican solution–Romneycare–the Massachusetts model that the GOP and his 2012 presidential opponent once embraced.  Yes Obama also did end the war in Iraq but he also promised to commit  more troops to Afghanistan–transforming Bush’s war to his.  Additionally, Obama turned his back on many of his supporters.  He never supported the Employee Free Choice Act, a reform sought by labor unions to update the Wagner Act, he did not push for repeal of “Don’t Ask, Don’t Tell until  halfway through his first term, only getting it by capitulating on an extension of the Bush era tax cuts.  His health care reforms capitulated on abortion and reproductive freedoms for women, and he has never really pushed hard on global warming and the environment.  Finally, Obama continued  the Bush era initiatives to bail out the banks but not the home owners and Dodd-Frank, the major financial reform legislation, hardly will change banking behavior and discourage them from more risking lending in future.

One cannot deny that Obama has accomplished a lot and he deserves praise for all of that.  He has faced a hostile Congress, but do not forget that for the first two years he had significant Democratic majorities.  But with those majorities he has infuriated many in his party but a horrible set of negotiating skills.  He seems to give in, not negotiate.

But now there is a second term.  He began his quest by saying he had evolved on gay marriage.  He now supported it–an act of bravery when public opinion had already shifted.  He says he opposes the Defense of Marriage Act (DOMA) and his administration argued against its constitutionality before the Supreme Court, but his administration still enforces the law, prompting Chief Justice Roberts to exclaim that the President should have the courage of his convictions not to enforce the law if he thinks it is unconstitutional.

Obama’s second inaugural and his 2013 State of the Union speeches again sounded liberal.  He hit the themes of gay rights, guns, the environment, and economic justice.  Yet once again the gap between rhetoric and performance is wide.  Obama ended 2012 by securing tax hikes on the top earners and preserving it for the rest.  Yet he let the payroll tax expire, resulting in more of us paying more overall taxes now than before.

Obama continues to pursue economic policies that sound more conservative than liberal. His budget proposals to cut Social Security and Medicare give him little room to negotiate with Republicans.  Given his starting position, all he can do is move further to the right.  Sequestration was partially Obama’s idea and the percentage of government spending going to discretionary programs is lower now than it has been in a generation.  Obama has embraced austerity and deficit reduction as goals, again ideas favored by Republicans.  When push comes to shove, don’t be surprised if Obama endorses the Keystone Pipeline as an important jobs initiative for his administration.

But alas, there may even be one place where Republicans are to the left of Obama–drone warfare.  In a legal analysis as tortured as the memos drafted by the Bush administration, the Obama administration has endorsed presidential power to use drones in warfare, even up to the point of killing American citizens outside the United States.  Such brazen disregard for both domestic and international law must bring a smile to a Dick Cheney (who embraced gay marriage well before Obama).

How anyone can conclude that Obama is a liberal is beyond comprehension.  Nixon was more liberal, as was Eisenhower.  Obama’s liberal legacy is gone and now the question becomes how much of liberalism will he give away in his remaining second term.

America's Paradoxical Economy

    The economic situation and choices for America are not terrific.  This is clearly the case after the April 2013 unemployment  report indicated only 88,000 new jobs generated last month, coupled with nearly 500,000 individuals leaving the job market.  But the jobs’ numbers only point to one part of the overall American economic paradox.
    One the one hand the stock market is at a record high along with many companies showing record profits.  This should be good news for the economy but not necessarily.  First, the record profits are coming at a time of high unemployment.  Companies are making products or delivering goods and services but they are not hiring workers.  The profits are coming via increased productivity through automation or via flat wages that can be maintained as a result of high unemployment.  In short, companies have failed to hire workers because they are being replaced by machines as in manufacturing, or simply they do not need to increase wages because high unemployment is not pressuring wages up.  Couple that with weak unions and there is no real pressure to increase wages.
    The consequences of a flat labor market mean that there is insufficient consumer demand for significantly more goods and services.  Couple that with still high consumer debt (along with student loan debt) and there are structural limits to how much consumer demand can drive the economy out of a recession.
    Now consider data demonstrating that the economic growth is weak.  The GDP is not expected to grow much in the coming year and the best evidence is that the sequestration will perhaps take approximately .05 off annual GDP growth that is essentially not expected to grow more than about 1-2% this year.  Sequestration will also lead to government layoffs and add to the unemployment program.  What we have here is an economic austerity program similar to Europe that is not a recipe for economic growth.
    Now think about one potential bright spot for the economy–the housing market.  The real estate market appears back with stronger demand and increased prices.  Yet here too there is a problem.  The growth in part is stimulated by record low interest rates that appear to be overheating the market.  There is no question that it is a great time to borrow for housing and there are indications that the low interest rates are encouraging speculative building.  None of this is really good.  Why?  We really do need to increase interest rates to cool down the market otherwise we are headed for another bubble.  The low interest rates fueled the last real estate bubble that burst in 2008.  Moreover, we have done very little since 2008 to reform the real estate and housing markets.   Dodd-Frank, the financial reform law, has done little to change behavior here.
    But if one increases interest rates at the Federal Reserve Board to cool off the housing market then that rate increase could very well hurt the rest of the economy.  Cutting back on economic demand while raising interest rates is a terrific way to throw the economy into a recession.
    Now consider that sequestration is already cutting back on the safety net for the poor and unemployed.  Obama is now talking about agreeing to further cuts in government spending for Social Security and other similar programs.  These cuts too will hurt the most vulnerable and also damage the economy in the sense of cutting back on money that money to consume.
    Finally, think of all those individuals who have left the job market.  They cannot find jobs, perhaps lack the training to find new ones, face job discrimination, and often lack the resources or capacity to borrow for retraining.  We have in these individuals significant underutilization of their skills and talents–letting them go to waste.
    In sum, we have a tremendously paradoxical economy.  It is both overheated and underperforming at the same time.  Tools to fix one part of it may damage the other.  There is no question we need to develop and grow the economy but at the same time we need to attend to the redistributional aspects of an economy that is the most skewed in terms of wealth and income in many generations.  Policies are needed to grow the economy, cool the growing housing bubble, train workers for reemployment, and relieve many from the continued high consumer and other debt that they hold.

Sesquestration and Its Discontents

Absent a dramatic turnabout in events, sequestration begins to kick in on March 1.  Once was thought of as the dumbest of all dumb ideas now has the real possibility of coming to fruition and its impact on the economy will not be good since it is essentially an austerity program.  But even without sequestration, US economic policy is already one of sequestration, raising doubts about the medium and longer term prospects for American economic growth.

Let’s first be clear about what sequestration is.  Back in 2011 when Obama and the House Republicans were at logger heads about raising the debt limit the core of the disagreement then was insistence by the Republicans that they would not raise the debt ceiling unless there was a significant effort to cut future US spending.  Obama and Speaker Boehner were close to a grand bargain to cut several trillion dollars in future spending, but the deal was scuttled by GOP refusal to go along with some tax increases. 

In the end, the deal to raise the debt ceiling was postponed to the end of last year–the Fiscal Cliff.  But part of the 2011 deal was also the creation of the mother of all poison pills--sequestration.  The idea behind sequestration was that if the Republicans and Democrats (Obama) could not agree on future spending cuts there would be automatic cuts to military and discretionary spending so severe that the mere threat of these cuts would force each side to reach a deal.  By self-description both sides then described the sequestration cuts as stupid or unwise.  Sequestration was supposed to occur at the end of last December as part of the Fiscal Cliff but it was kicked down the road two months to allow time to deal.  You could have practically predicted what would happen–the day of reckoning is again upon us.

It is looking less and less likely a deal will occur by the end of the month.  Both sides are yelling and accusing the other of bad faith and being unwilling to compromise. 

But the truth be told, both sides are responsible but in very different ways.  The Republicans are responsible for the problem by their refusal to consider any tax increases to go along with the cuts.  Remember this is the same party that when asked of its presidential candidates two years ago would they go along with one dollar of tax increases for nine dollars in spending cuts, none of the contenders said yes.  The GOP also seems to hold to a mythic fairyland belief that all taxes are bad, that the only way to help the economy is by spending less, that government is evil, or that it crowds out the economy.  They essentially lack an economic plan and instead simply have  failed dogma to which they cling.  No surprise here.  For the most part Congress is devoid of members who know much about economics.  One of my favorite books is Paul Gary Wyckoff’s Policy and Evidence in a Partisan Age (2009).  He highlights the lack of understanding in economics among members in Congress, finding few with any formal training and literacy in this field.  He also points out that often what elected officials use as evidence for their ideas are  anecdotal stories—the least reliable types of evidence there is.  Few seem to grasp statistics, regression, or correlations and what they mean.  Effectively, Congress in general and the GOP specifically seem largely ignorant about basic economics.

But Obama too is at fault.  His fault is that he has already conceded the battle.  While he talks a good game about jobs he has largely embraced the austerity agenda.  He is largely committed to spending cuts and seems really to have given up on any major efforts to revitalize the economy and jobs.  We have produced several million new jobs in his first four years but the recovery is still tepid and it will take years if at all to make up the lost ground from the last few years. Obamanomics has not been terrific.

But even if sequestration is avoided, there will be cuts.  The Saturday February 23, 2013 New York Times reports that states are worried about the impact of sequestration on their economies and budgets, but equally worried about the cuts that will happen in the alternative to sequestration.  In either case, we are headed into a longer term austerity plan.  A plan that really does not produce jobs, future investments, or which tries to grow the economy out of its budget problems.  It is austerity similar to what many European countries are doing, and the results for them are not good.

But the other tragedy of sequestration beyond the foolish commitment to austerity and a blind faith in thinking that cutting federal spending and investments are the gateway to economic Nirvana is this idea that somehow gimmicks can solve budget problems.  Sequestration needs to be thrown into the dustbin of failed ideas that include PPBS, the Balanced Budget Amendment, the Gramm-Rudman Act of 1985, and line-item vetoes.  The history of budgeting in America is told of special commissions (Simpson-Bowles) and gimmicks yet none work simply because they are poor substitutes for political will and reasoned and informed judgment.

The Economic Case for Gay Marriage (and two dumb ideas)

Politics and economics are interconnected.  We saw that in the State of the Union speech the other night where the president hung his second term political fortunes on helping the middle class.  He offered a set of ideas surely opposed by the GOP but potentially popular with the voters, hoping that the Republicans will vote them down or not vote on them, lending political fodder and ammunition to the Democrats in 2014.

But Obama’s speech is also a great occasion to discuss some economic issues, seeking to separate fact from fiction.

The Economic Case for Gay Marriage

Legalizing gay marriage in Minnesota and across the country is ethically correct thing to do.  Whatever religious reasons those opposed to same-sex marriage have, their preferences should not preempt or be binding upon those who wish to marry.  The case for gay marriage is not different than the case for mixed-race marriages 50 years ago.  Back then religion often reinforced racism (“God did not intend Blacks and whites to marry.”)   The same is true today.

But there is also an economic argument supporting gay marriage in Minnesota.  Were Minnesota  to legalize gay marriage the economy would benefit both in direct and indirect ways.

Directly, several studies have demonstrated that legalizing gay marriage reaps immediate economic benefits to a community.  Studies regarding legalization of gay marriage in Massachusetts by the Williams Institute, New York by CNN, and Tasmania, Australia point to the economic benefits of legalizing same-sex marriage.  Such legalization leads to more tourism by same-sex couples and couples spending money on weddings.  According to the UCLA Williams Institute in a study looking at the economic benefits of legalizing same-sex marriage in Maine, Washington, and Maryland may generate more than $166 million over the next three years.

But indirectly, legalizing same-sex marriage will also benefit communities.  Richard Florida’s highly influential The Rise of the Creative Class documents the importance and relationship between cultural amenities and support for gay-friendly policies and economic development in a community.  Support for gay-friendly policies highly correlates with the most economically successful communities across the United States.  Additionally, as many business leaders know (as evidenced by the CEO of General Mills speaking out against the Marriage Amendment in Minnesota last year), a new generation of employees exists that look to support for gay rights as an important factor in considering where to live and work.  The majority of these individuals are highly educated and skilled.  Supporting gay rights and marriage is an important key to attracting this new generation of workers and with that, employers who wish to locate to take advantage of these skilled workers.  Thus, supporting gay marriage is a smart jobs and economic development initiative that Minnesota should consider.

Why is making the economic case for gay-marriage important?  First, it might move some Republicans and Democrats to support it if they can use as a cover that it is good for the economy.  Second, if one can document the economic consequences of discriminating against GLBT then that gives Congress the ability under the Commerce class to take action.  Ordinarily the issue of marriage is a state issue and a matter beyond the authority of Congress to address. However, demonstrate how GLBT discrimination affects interstate commerce then Congress can act.  In 1964 the Civil rights Act was justified and upheld as a valid at of Congress based on finding of fact demonstrating that  racism impeded and affected interstate commerce.   Bottom line-think about gay marriage as a bottom line issue.

Tax-Dodging Millionaires: The New Welfare Queen

Remember the welfare queen of the Reagan era?  In a 1976 speech Ronald Reagan referred to a woman in Chicago on public assistance:  “She has eighty names, thirty addresses, twelve Social Security cards and is collecting veteran's benefits on four non-existing deceased husbands. And she is collecting Social Security on her cards. She's got Medicaid getting food stamps, and she is collecting welfare under each of her names. Her tax-free cash income is over $150,000”  This welfare queen was a glaring indictment of all that was wrong with government and of those lazy individuals—mostly women—who were simply squeezing out more and more children in an effort to avoid work and stay on government assistance.   She was also the impetus of major policy reform to lower benefits and kick needy people off of public assistance.  However, she did not exist.

Largely the welfare queen was a myth as I point out in my new book.  But myths die hard.  The newest myth is the tax-dodging millionaire.  He is the rich guy who migrates from one state or country to another in search of a lower tax rate.  He is the bogeyman trotted out by opponents of higher taxes–individual or corporate–and used to argue that if taxes are increased rich people will leave and head elsewhere to a low tax area.  Gerard Depardieu in France and Phil Michelson in California are trotted out to prove this point.

Yet while a few individuals may migrate if taxes are increased, the tax-feeling millionaire is largely a myth.  James Stewart’s most recent column in the New York Times reviews several studies demolishing this myth.  This should be no surprise.  We already know that taxes are a relatively minor factor affecting business location and investment decisions (again see my American Politics in the Age of Ignorance).    Additionally, many years ago in two articles of mine examining tax commuters I found little evidence that tax rates across states affect employment migration patterns ( See:  “State Taxation of Interstate Commuters:  Constitutional Doctrine in Search of Empirical Analysis,”16 Touro Law Review, 435 (2000) ; “State Tax Commuters:  Classifications and Estimates,” 15 State Tax Notes, 355 (1998)).  Many factors, and not simply tax rates, affect where the affluent live.  Factors such as health care, cultural amenities, weather, friends, and family all dictate residential choices.  Taxes are only one part of the mix in making decisions about where to live. 

Minor changes in tax rates are not going to produce any mass exodus from a state.  Conversely, simply lowering taxes is not going to result in much immigration either.

Sequestration and the Economy

Europe is sinking back into a recession and the go global economy is weak.  One cause of that weakness has been a wrong-headed economic policy favoring austerity over economic growth.  Great  Britain and other economies have prematurely cut government spending, with the result being a serious damage to economic demand for goods and services.  Austerity has not produced prosperity.

It would be nice if the United States learned this lesson.  Yet it appears the Congress is ready to allow for sequestration to occur.  The stupid budget deal of 2011 that was supposed to scare Congress and the president to reach a new deal included a call for government spending cuts so awful is about to occur.  The cuts will be nearly a trillion dollars, triggering according to many estimates, the loss of hundreds of thousands of jobs across the United States.  The American economy is barely growing, sequestration may well throw the US into another recession.

But even if sequestration is avoided, Obama has effectively endorsed a Herbert Hooverism austerity  program.  He wants to cut government spending as a way to deal with the deficit.  Deficits do matter but the primary goals still should be to reduce unemployment and grow the economy.  Those twin objectives will generate additional tax revenues to help reduce the deficit.  Spending cuts simply create a downward spiral of economic decline and will fail to revitalize the economy.