Chris's Plan to Fix America #2: Stimulus Plan

The Theory:

The question of proper economic stimulus is one of the areas where economists disagree. It should speak to the complexity of the economic dynamics that thousands of PHDs study an issue and yet fail to come to consensus. The two schools of thought I'll talk about are Keynes and Hayek. For a fun summary of each schools' thoughts, watch this youtube rap (yes, I said rap… about economics): 

In short, Keynes argues that once circular flow is established, market participants will have the resources to enact the necessary market changes in a timely manner. As a result, the government should focus on spending money on just about anything to restart circular flow. Hayek disagrees. 

Hayek argues that people choose to stop spending and save because demand patterns change. As a result, no matter how much money you spend, people still don't demand the existing product mix. When the government spends excessively, it distorts demand for a particular market and generates inflation. Hayek argues that it's actually our actions, particularly low interest rates and borrowing, during the expansion that creates the recession. 

Hayek's arguments make a lot of sense. If millions of people and billions of dollars of capital are employed making something that either isn't demanded or is demanded at a much lower rate, those people and that capital need to move out of the industry. Imagine if 10% of our economy had been involved in the production of typewriters when computers started hitting the markets. Suddenly, people no longer demand typewriters. No amount of government spending could keep people employed making typewriters. 

The question is how does this affect stimulus plans? One of the biggest complaints with Hayek's philosophy (and conversely the biggest draws to Keynes) is that it requires followers to sit and do nothing, but that isn't exactly true. Hayek merely warns about creating inflation and distorting markets.

Why current stimulus plans don't work:

Will a pure Keynesian approach work? Yes. However, if your goal is job creation, it won't work well. Stop and think about where the money from the stimulus plans go: building roads and bridges, environmental research, high speed rail systems, low-income housing, etc. Not one of these creates initial jobs, and most of the spending is on things that were not in demand before the recession. What this means is that the effects of the stimulus will be slow and obscenely expensive.

Think about the resource structure created when the government pours money into road construction. People are hired to build roads, capital is purchased to build roads, and the roads get built. Now what? People had jobs, but the private industry isn't buying new roads. If the government doesn't keep spending money, these created "jobs" will cease to exist. Therefore, government spending outside of areas in demand by private markets can only create secondary jobs (Road construction worker got money from job, now spends it, giving someone else a job).

The New Plan:

Any company that employs fewer than 50 people may take up to a $25,000 tax credit for expanding their workforce by 1 person and paying them at least $50,000.

What it does:

Puts small businesses in a position to quickly adapt to market conditions and decreases the risk of trying to expand into new opportunities. 

Why it works:

Current stimulus plans attempt to "stimulate the economy" or "increase investment", but the big picture is that all of these efforts are attempts to get people employed. In fact, it's the unemployment that makes recessions so bad. Very few people care about reduced output or exchange rate implications. Why then, shouldn't our stimulus focus on the very thing we're trying to fix?

Ask an entrepreneur how much money it would take for them to hire someone new at $50,000, $60,000, or $80,000 a year. The answers you get will fluctuate widely, but not one of them will exceed the salary paid. How then is it that the current stimulus plan is estimated to have cost over $250,000 per job? Mismanagement and ideology. 

Does this plan distort markets? Yes. But it distorts the labor market, causing wages to rise. It distorts the market for new business, which brings new products and innovations to the economy. Further, since the plan is a tax credit, if it doesn't work, it costs us nothing. Finally, when the credit goes away in a year, the products being built and services being offered are still the ones in demand by the market, since the market has been the customer all along. Sure the profitability goes down without the credit, but the business still has a chance to be profitable.

Chris's Plan to Fix America #1: Debt

With the government default looming and congress scrambling to push their stop-gap measures, it's a good time to analyze how we got here, how it affects us, and what we should do. 

You can think of this situation like a person with a credit card. The person knows that they won't have enough money or credit to pay all of their bills, and they know there is no way to forego the spending or raise the money before they run out. As a result this person calls the bank to get a credit limit increase. In reality, the bank would require the limit to go down again in a month or 2. However, the spend-happy politicians don't want it to, and are fighting against debt-ceiling plans that cut spending back to this level in the future.

How we got here

We in America have a long tradition of wanting what we can't (or shouldn't) have. We have lots of problems with delaying gratification, and in large measure, our populous is financially uneducated. I'll refer you to the Illinois man interviewed on national TV while waiting for a government payout claiming that he was "waiting for obama money" which he thought came from "Obama's stash". I'll also show you this graph of the personal (not government) savings rate:

In addition to failing to save, our population is borrowing more than ever before. Look at this graph of consumer (not government or business) credit outstanding:

Since our population can't seem to constrain their spending, why would a governmental body elected by our population? We are in a period of extreme gluttony, but we may be hitting the ceiling of what our government can hand out. 

How it affects us

We've come to rely on the government for lots of things that we don't even realize. One of the hidden dependencies is a little thing called risk-free debt. The government issues bonds, which hold no risk, and provides the markets with liquid, low-interest alternative to holding cash. This allows big banks (and investment firms) to forego unprofitable investments in leu of flexibility and guaranteed return. All the while, the money is funneled into banks that have lots of highly profitable opportunities, for a cost. In addition to the people who would fail to get paid in the event of a government default, this vital banking mechanism would crumble.

Thousands of people are currently employed by the US government. Many more than I think should be, but that's a topic for the next section. While I may not agree with their employment, you cannot argue that they provide a service. If the government defaults and cannot pay their debts, they also cannot pay their wages. In addition to thousands of people losing jobs, any services that are depended on will cease to exist. 

Social services such as social security, medicare, medicaid, etc. which people have planned for, depended on and expect on a regular basis will cease to function. 

When the government needs to step in and intercede in a situation, it costs money. It doesn't matter if that means buying trailers for hurricane evacuees or sending in the military to stop genocide in a foreign country. A government default would throw serious concerns on the validity of all government debt and not only make it harder for the government to raise money, but make it significantly more expensive (the government does pay interest on its debt, and after a default that rate would increase).

What we should do

A large part of the problem is that the federal government is already far too large. It's easy to expand the government to do something if they're only taking 15% of your income to begin with. When the government can't pay it's bills and it's taking over 30%, people get upset. Many of the services offered by the federal government are also offered in the private industry. Our government needs to begin transitioning out of these industries. 

All stimulus programs need to be immediately ceased (I'll writeup why in another CPFA note). 

Alternatives to the current social services need to be explored. (I'll also have a individual write-ups on many of these)

National defense spending is our largest budget item (as it should be) but it's too big. While the specifics of any plan should be drafted by the military's generals, we need to focus on shrinking our presence in non-war countries. We need to reanalyze which capital investments can be prolonged without catastrophic results. We need to focus on transitioning peace-keeping operations to local governments, and we need to encourage non-essential personnel to move to the reserves and seek jobs in private industry. 

A constitutional amendment prohibiting deficit spending without a 2/3 majority needs to be put in place. Our national debt has climbed to the size of our economy. We can't hope to fix it unless we stop making the problem worse. As long as politicians can garner support by spending money we don't have, they will.