Pragmatic Economist and some of his blogs

John T. Harvey, Contributor Forbes
I want to explain how things work, not what you should believe.

The Real Job Creators: Consumers

Today on Face the Nation (hosted by fellow Horned Frog, Bob Schieffer), I heard Mitt Romney add his voice to the chorus of those saying that economic recovery would follow if only we relieved the terrible burden that the government has placed on the nation’s job creators: business. Were taxes and regulations relaxed, this would reduce costs sufficiently to allow firms to do what they are already dying to do, which is expand operations.

But even if we grant the argument that business taxes and regulations are high (which is by no means clear–in fact, it’s easier to make a case for the opposite), this ignores two crucial facts. First, as my friend Mike Norman has pointed out, employees are a cost, usually the most significant one faced by firms (Mike Norman Economics). For that reason, every rational entrepreneur’s goal is to reduce, not increase, the number of workers they have to pay. And quite right. Entrepreneurs have families, too, and they need to feed and clothe them. It would be irresponsible to do otherwise.

Second and more fundamentally, no matter how much you lower costs, if you don’t have more customers, you won’t hire more workers. If the demand for goods and services stays where it is today and we only cut industry taxes and regulations, there is absolutely no reason to think that firms would expand employment. Rather, they would continue to produce at the same level and simply earn higher profits. On the other hand, if we leave taxes and regulations untouched but increase demand, entrepreneurs will happily add workers. And that is the root of the problem today. The bottom line, lost on Mr. Romney and many others, is that the real job creators are consumers. The direct route to reducing unemployment is boosting demand, not reducing costs.

Ask yourself this question: what do you really think caused firms to lay off so many workers that unemployment jumped from 4.4% in May 2007 to 10% in October 2009 (remaining at 8.2% today), a sudden spike in business regulations and taxes, or a collapse in demand? It is impossible to imagine that anyone truly believes the former to be the case. In reality, the reason we are stuck where we are is because the middle class lacks jobs and incomes–something that will get markedly worse if we continue to try to cut government spending and balance the budget (many of my other blog posts cover this issue so I’ll say no more here).

In conclusion, let me add my voice to the chorus of those who actually understand what’s happening in our economy: WE DEMAND AGGREGATE DEMAND!

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Aug. 12 2012 — 8:12 pm

Romney and Ryan’s Disastrous Economic Plan

I have been writing for some time that Obama’s misunderstanding of the nature of the federal budget is keeping us locked in a state of semi-slump (see for example The Real Reason Unemployment Isn’t Falling). His belief that Washington’s spending is constrained in the same manner as a household’s has the administration talking about budget cuts when our over twelve million unemployed Americans need just the opposite. Only the government–not households, firms, banks, or foreign countries–is in a position to immediately and dramatically increase the demand for goods and services and thereby put these people back to work. Unfortunately, the President and his advisors are concerned with a mythical day of reckoning when China asks for all its money back and our impoverished grandchildren become their economic slaves. It is utter foolishness.

That said, however, at least Obama, et al., have the general idea of what needs to be done (even if they are afraid to pursue it to the degree necessary). Obama mostly, if not completely, gets the fact that any real solution must involve the government and the recovery of the middle class and that our current woes are not a function of overregulation and oppressive taxation. Not so, Mitt Romney and new vice-presidential running mate, Paul Ryan. I have already argued that the latter’s proposed budget is an absolute nightmare (The Ryan Budget: A Mistake of Historic Proportions). It is premised on the existence of a fantasy world within which entrepreneurs, despite the decline in sales that would follow budget cuts, suddenly increase hiring and investment because they have been able to throw off the shackles of government interference. I don’t know any other way to say it–this is idiotic. A reduction in spending by any sector in the macroeconomy will reduce revenue in the private sector and thus make our predicament even worse. Say, for example, that for some reason we no longer had any need for a military presence anywhere in the world and therefore fired every American soldier, marine, airman, and sailor. Precisely how, Mr. Ryan, is this supposed to be good news for the entrepreneurs who sold groceries, gasoline, housing, clothing, etc., to these individuals? You don’t need a PhD in economics to answer that one–it’s not.

Romney may not be as extreme as Ryan, but he is cut from the same cloth. As he states on his web page, “The only recipe for fiscal health and a thriving private economy is a government that spends within its means.” This is patently false. The only fiscally healthy or responsible policy is one that generates sufficient demand to hire all those willing to work. This does not include cuts to “non-security discretionary spending by 5 percent,” the shifting of federal government programs the private sector or state governments (entities that DO face a hard budget constraint), or, God forbid, a balanced budget amendment. Furthermore and as argued in an earlier post (The Real Job Creators: Consumers), the economy’s job creators are not, as Romney says, entrepreneurs and the wealthy, but the middle class. How can today’s unemployment be a function of overregulation and overtaxation when we are at or near historic lows in each? Rather, the problem, pure and simple, is demand. No amount of cost cutting will induce firms to expand employment in the absence of an increase in sales. Because this fact is lost on the Romney-Ryan ticket, their economic policies would be a disaster.

A popular means of increasing your credibility among Republicans is to compare yourself with Ronald Reagan. That’s a great idea. No president since WWII borrowed and spent more than he did. In fact, no one else (including Barack Obama) is even close. And those who argue that he was forced to do this against his will by a Democratic Congress simply don’t remember their history very well. Not only were the budgets passed never markedly different from those requested, but Reagan even famously quipped: “I am not worried about the deficit. It is big enough to take care of itself.” Quite right.

Mitt Romney and Paul Ryan–you are no Ronald Reagan.

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Jul. 18 2012 — 10:46 pm

Why You Should Love Government Deficits

The calls for cutting the federal government’s budget and perhaps even balancing it have continued and are likely to grow louder during this election year. Don’t listen to them unless you want to see a fall in your net assets! Government deficits, by definition, create private sector wealth, while surpluses drain it. It’s simple accounting.

To understand this, start by imagining a world in which there is no government and no foreign countries. All economic activity in the US would take place domestically and be carried out by our private sector firms and households. As a group, they would earn what they spent. If all American firms and households spent $1000, then–because one of them was standing on the other side of the cash register for each of these transactions–American firms and households would earn $1000. It is logically impossible for them, as a group (though not as individuals), to spend more or less than what they earned–the values must be identical because it’s really double-entry bookkeeping. Every transaction that takes place is both spending (for the person buying something) and income (for the person selling something).

Now create a government. It is only at this point that it becomes possible for one sector (private or government) to spend more than they earned or earn more than they spent. For example, say over its first year in existence, the government takes in $100 in tax revenues but doesn’t spend any of it. You might have something like this:

Government Budget Surplus and Private Sector Deficit

Private Government Total
Income $1000 $100 $1100
Spending $1100 $0 $1100
Balance -$100 +$100 $0

In this case, the private sector spent $1000 on the goods and services it created (which is what created the $1000 in income for them), plus they spent $100 for taxes. The government, meanwhile, earned $100 in income (via taxes), but spent nothing. The government budget is thus is surplus, while the private sector has gone into debt–by the exact same amount, of course. It is impossible for it to work out any other way. The balances must add to zero because, as the last column indicates, total spending must equal total income in a closed system. And with the government in surplus, the private sector goes into debt.

On the other hand, look at what happens when the government spends in deficit:

Government Budget Deficit and Private Sector Surplus

Private Government Total
Income $1100 $0 $1100
Spending $1000 $100 $1100
Balance +$100 -$100 $0

Now it is the private sector that gets the surplus! In this scenario, the government has collected no taxes, but spent $100 on goods and services produced by the private sector. This creates enough income for the private sector for them to actually save money rather than go into debt.

What the above means is this: government deficits create private sector wealth, while government surpluses drain it. There is no trickery here. When the federal government spends in deficit, it does so by putting financial assets, usually in the form of Treasury bills, in the hands of the public; when it spends in surplus, the net quantity of Treasury bills held by the public declines. Thus, federal government deficits not only create the extra demand necessary when the economy is at less than full employment (which is what I have argued many times in this blog; please see for example Why You Should Learn to Love the Deficit: Federal Budget Fallacies and The Horror Movie That Is Fiscal Responsibility) but it puts money in the bank, too. And the US could never be forced to default on the debt because it is denominated in dollars (see Who Should Really Be Downgraded, the USA or S&P?, Downgrade Part II: More Evidence of the Ignorance of S&P, or Alan Greenspan). Furthermore, this is exceedingly unlikely to be inflationary under current conditions–indeed, it has not been (for more on what does and does not cause inflation, see here: Money Growth Does Not Cause Inflation and What Actually Causes Inflation).

So, next time you hear Obama or Romney talking about reducing the deficit, be sure you put that into the proper context. They are talking about draining your savings account! That’s hardly a sound policy when we have over 12 million unemployed.

NOTE: I’m sure many of you are thinking that the above ignores our debt to China. However, 100% of our debt to China (which amounts to less than 10% of the total, incidentally) is a function of our trade deficit with them, not the budget deficit. Even if the federal budget were balanced or in surplus, we’d owe just as much to China. The only difference would be that they would probably be holding fewer Treasury bills since they would not be available in such quantity. Instead, they would hold more US private sector assets. For a more detailed discussion of how the budget deficit and national debt work, see this article:

The Big Danger in Cutting the Deficit

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Jul. 1 2012 — 11:19 pm

The Terrifying Texas GOP Platform

I named this blog Pragmatic Economics in part because of my desire to avoid politics. That’s why my tag line is, “I want to explain how things work, not what you should believe.” However, I am so distressed by the 2012 platform released by the Texas Republican Party that I find it impossible not to comment. While I am hardly in agreement with everything forwarded by the Democrats (and have taken aim at President Obama on a number of occasions, especially with respect to his desire to balance the federal budget), it is difficult to believe that what the Republicans put together during their convention in Fort Worth was even written in the 21st century. It is anything but pragmatic.

The document (available here) has already made headlines with the portion that opposes the “teaching of Higher Order Thinking Skills” and “critical thinking skills.” Although a partial retraction followed, this was in terms of the wording, not the general meaning. It appears that their fear is that these “focus on behavior modification and have the purpose of challenging the student’s fixed beliefs and undermining parental authority.” Think about that for a moment. First off, do they really and truly believe that teachers and school boards across the State of Texas are designing curricula specifically aimed at training children to challenge their parents? Second, do you know which values and concepts are rejected in the absence of higher order and critical thinking? None! Therefore, depending on the time and place when we decide to stop challenging ideas and meekly accept what we are told, we might thereafter and forever be racists, sexists, communists, fascists, democrats, capitalists, Christians, Buddhists, Lutherans, geocentrists, pacifists, Wiccans, or whatever the prevailing views of that day were. Nothing would ever again be questioned. Were we to implement such a policy, we’d have to be certain that we had already identified the concepts and values that were “correct” (whatever that really means). Even a cursory reading of their platform makes it very clear that this is precisely what Texas Republicans believe and what those concepts and values are. This begs the question, who is really aiming to force their beliefs on our children, Texas schools or Texas Republicans? Personally, I prefer what I learned during my twelve years of Catholic school and eight years of public higher education: if a belief cannot stand up to scrutiny, then we shouldn’t believe it; and if it does, we will hold it all the more strongly for the very reason that it withstood our challenge.

Another disturbing feature of the document is that while they “urge the Legislature to direct expenditures to academics as the first priority,” they also contend that “Since data is (sic) clear that additional money does not translate into educational achievement, and higher education costs are out of control, we support reducing taxpayer funding to all levels of education institutions” (emphasis added). Not only is the second statement inconsistent with the first (not to mention rather frightening), it isn’t true. The implications of the data are far from clear. In point of fact, economists have found that–not surprisingly–it matters how the money is spent (see here for a survey of the relevant literature). For example, reducing class sizes and adding remedial help appear to be particularly cost effective. Thus, contrary to the Texas GOP’s assertion, there are programs that both add to costs AND increase educational achievement. Furthermore, the most significant finding in the literature over the years has been that teacher quality is the absolute, number one factor driving student attainment. Surely the Texas GOP is not arguing that higher salaries would not tend to attract higher quality teachers or that funds for training and apprenticeship would not be well spent? The bottom line is, the actual evidence flies in the face of their claim that the research shows unequivocally that there is no connection between funding and outcomes. It simply isn’t true. A cynic might be tempted to conclude that the real goal of the Texas Republican Party is simply to find a means of circumventing Article VII of the Texas Constitution, requiring the State to “establish and make suitable provision for the support and maintenance of an efficient system of public free schools” (wherein, according to the Texas Supreme Court in Edgewood ISD vs. Kirby, efficient is not equivalent to “economical,” “inexpensive,” or “cheap”). I hope that’s not the case.

The economic policies recommended by the document are equally impractical and ill-considered. Bearing in mind that the fundamental problem faced in an advanced capitalist economy is insufficient demand to generate employment for all those willing to work (see Why Do Recessions Happen?), the following recommendations would operate to make this problem even worse:

• We urge state and federal legislators to reduce spending.

• We urge Congress to adopt balanced budgets by cutting spending and not increasing tax rates.

• We recommend repeal of the Sixteenth Amendment of the U.S. Constitution, with the goal of abolishing the I.R.S and replacing it with a national sales tax collected by the States. In the interim we urge the income tax be changed to a flatter, broader, lower tax with only minimal exemptions such as home mortgage interest deductions.

• We favor abolishing the capital gains tax.

• State Tax Reform – We encourage: Abolishing property taxes…Shifting the tax burden to a consumption-based tax

The first two would directly reduce the demand for goods and services, thus causing contraction and unemployment, while the last three would create a much more regressive tax system that shifted the burden onto the sector of the economy that would otherwise generate the highest level of demand per dollar of income: the poor and middle class (the top 20% of Americans spend 62% of their income, as compared to 87% for the rest). In other words, those who don’t spend would be left with relatively more after-tax income than those who do, creating yet another drag on the economy. Note, too, that the second point above (regarding balanced budgets) is based on a false premise, i.e., that the federal government is budget constrained (see The Big Danger in Cutting the Deficit). One of the least understood economic facts today is that it isn’t, the reason being that the entire debt is owed in something we and only we are permitted to print: US dollars. Nor is this inflationary except when the economy is near full employment–-at which point there is no need for the government to continue deficit spending (see Money Growth Does Not Cause Inflation).

The Texas Republican Party Platform also argues that, in contradiction to my last blog post (The Real Job Creators: Consumers), lower business taxes and deregulation will solve our jobs problem. This is false. What we really need is increased demand, which comes via consumers. In addition, they believe that the Federal Reserve system should be abolished and that the US should return to the gold standard:

Our founding fathers warned us of the dangers of allowing central bankers to control our currency because inflation equals taxation without representation. We support the return to the time tested precious metal standard for the U.S. dollar.

Above and beyond the fact that it is based on an unwarranted premise (i.e, that central-bank control of currency leads to inflation while a precious-metals based standard does not), it is worth remembering that our founding fathers were operating with economic theories now over 200 years old. They probably had sage advice on how to load a musket and powder a wig, too, but that’s not terribly helpful today.

This is not to say that there are not portions of the Texas Republican Party Platform that are perfectly reasonable. There are. But, by and large, it reads as if it were written in another age and in ignorance of the social, economic, and scientific evidence of the past half century. Let there be no mistake about it: the Texas Republican Party Platform is terrifying. Were its recommendations implemented, the US would resemble a third-world country with a cheap, uneducated workforce and a massive gap between rich and poor. Unemployment would be rampant, growth stagnant, and answers few and far between thanks to the systematic repression of higher order and critical thinking. I don’t know what happened to the Republicans of fifty years ago, who were willing to discuss, reason, and compromise and who respected logic and reason, but they are sorely missed.

By the way, don’t take my word for what the Texas Republican Party Platform says, read it for yourself:

Texas Republican Party Platform

Please!