Defining Ideas

The Shortsighted Keynesians

Tuesday, November 1, 2011

Last week, I participated in a debate about the Obama jobs plan. The debate, sponsored by Intelligence Squared, was on the topic, “Congress Should Pass the Obama Jobs Plan—Piece by Piece.” This debate took place at New York University’s Skirball Center, where my debate partner was Daniel Mitchell of the Cato Institute. Speaking on behalf of the motion were Mark Zandi of Moody’s Analytics and Cecilia Rouse, now a professor at Princeton University and formerly in the Obama White House.

This was one debate in which the home-court advantage of my being a faculty member of NYU Law School served Mitchell and me naught. New York City was true to its liberal image. The vote was three to one against Mitchell and me when the debate started, and the lopsided sentiment in the audience only grew stronger as the debate dragged on.

Epstein
Illustration by Barbara Kelley

The most conspicuous feature of this debate was the restive nature of the audience from the opening remarks. As Elizabeth Weingarten later wrote on Slate, the dominant mood during the debate was one of impatience with the status quo, captured by Obama’s new slogan, “we can’t wait,” and evidenced by the audience’s hisses and boos that often erupted when Mitchell and I spoke. The constant question of the audience members was what could be done for them in the short run. That sentiment was captured by Shaila Dewan, a New York Times reporter present at the debate, who, to great applause, wanted to know “what do you do in the short run” to help the unemployed?

To that question, Zandi and Rouse gave the answer that the audience wanted to hear: adopt the Obama jobs plan, which will jump-start the economy today. Once we take the short-term steps to prevent a double-dip recession, they argued, then we can turn our attention to the larger issue of structural economic reforms that address, for example, serious regulatory difficulties in labor and capital markets.

It is never fun to be the bearer of bad tidings, but the blunt truth is that Obama’s jobs plan will not work. The audience, however, was in no mood to acknowledge that there is no magic short-term fix of the sort that Zandi and Rouse promised. Indeed, the full set of proposals in the Obama jobs plan is likely to set matters back even further. Zandi and Rouse’s misguided optimism demonstrates everything wrong in today’s thinking about job creation in the United States.

The only way to fix the short-term unemployment problem is by fixing the long-term issues that have fallen into treacherous disrepair over the past decade. Several long-term issues that must be fixed include, for starters, minimum wage legislation, unionization, and employer health-care mandates. Then, once we get an improved business environment, investors and employers will come off the sidelines and start investing and hiring. But without that change, prudent investors will shy away from productive ventures, preferring to hoard their money in treasury bills. The longer we wait to implement these overdue reforms, the more delayed the recovery will be. Here are four reasons why the left’s two-part strategy of stimulus now, and (maybe) reform later is doomed to fail.

Structural reforms must be made to our capital and labor markets.

First, no one knows when the short term ends and the long term begins. It is surely not sufficient to note that we are out of a recession simply because we have had no decline in gross domestic product in the United States for two successive quarters. That one measure is consistent with the joyless and jobless recovery that we have had over the past 15 months or so, which has done nothing to slake the demand for short-term fixes. There has to be, at the very least, a serious political consensus as to when it is appropriate to stop with the band-aids and begin with the serious task of reform. Yet that time will never come if we stick to short-term nostrums. Instead we will find that this nation will fall into a succession of half-baked short-term plans, each of which will be justified with the same breathless reasons as the last. It is harder to change course with a nation than it is with a battleship. This two-part strategy is a dead loser.

Second, there is no way to fix matters in the short term unless they are also fixed in the long term. The hard task of these economic fixes is to restore confidence to private actors that they will be able to earn a decent return on their labor and their capital. That cannot take place when there is constant uncertainty about the key determinants of public policy. Right now, no one knows what the income tax and capital gains tax rates will be in two years; prospective employers barely understand the costs that the president’s health-care plan will wreak on their businesses; and the possible impact of changes in labor law on employment markets remains unknown.

In this environment, it does little good to offer a one-year payroll tax holiday for employees if there is no certainty about whether it will be renewed next year, and every year thereafter. The economic losses from this top-to-bottom uncertainty will do more harm to the economy than any stimulus program could offset.

It is not just certainty that counts. It is certainty that the right kinds of institutions will remain in place for long periods of time. To be sure, certainty permits private parties to make judgments on what to do. But the task of sound economic policy is to ensure that the rules place as small a burden as possible on capital formation and job creation.

It is on this very point that the Obama jobs plan goes astray, for in its effort to jump-start the economy with a variety of programs, it manages to simultaneously create or entrench deformed institutions that will only reduce the efficiency of overall markets in the long run. During the Intelligence Squared debate, I mentioned that one of the most baleful features of the legislation was that it smuggled in the extensive protectionist devices of the stimulus bill. Zandi shot back, to rousing applause, that these “Buy American” provisions only amount to about $50 billion of the overall $450 billion spending package in the American Jobs Act.

Even if his number is right to the penny, he has offered exactly the wrong way to think about this and similar structural mistakes embedded in the jobs bill. The first question to ask is not what the size of the appropriation is, but whether this particular “Buy American” policy is sound. Regardless of its amount, “Buy American” is a protectionist scheme that has no place in any jobs bill. It makes American firms more inefficient in global markets.

''Buy American'' is a protectionist scheme that has no place in any jobs bill.

It was just at this point in the debate that short-term thinking took hold. The better strategy, Zandi and Rouse stressed, was to pass the jobs plan as it is and to worry about its structural problems in the future. This is a great debate tactic. But as a way of doing business, it is a recipe for disaster. Once the “Buy American” provisions, which got their start in the 2009 stimulus, get codified into law, they will become a feature in all government appropriations programs. Short-term expenditures come and go; structural changes endure for generations.

Back in the 1930s, Franklin Roosevelt also had a two-part program for the New Deal. The first part involved government spending in the short-term, and the second part involved various structural changes to labor and agricultural markets through the passage of the Fair Labor Standards Act of 1938 (regulating minimum wages and overtime pay) and the Agricultural Adjustment Act of 1938 (setting up agricultural cartels). Roosevelt’s stimulus payments have long been forgotten, but his legislation continues to do mischief year by year. There is nothing more dangerous than allowing short-term goals to serve as cover for nasty long-term legislative reforms.

Third, structural changes cannot work unless they are put in place for the long run. Suppose this nation were to decide to remove all minimum wage and overtime regulations. Suppose, too, that it eliminated the antidiscrimination legislation in employment, instead of adding in some new provision that deals with discrimination against the unemployed (yet another woeful feature of the Obama jobs plan). None of these reforms would do much long-term good unless there was confidence in the general public that these reforms would stay in place for a long period of time. If employers and investors think that these reforms will be undone by the next election, they will take the same suspicious view toward them that they take toward payroll tax deductions. It is not possible to base plans for long-term action in the private market on short-term legal reforms. Yet it is currently very difficult to make substantive reforms, given the volatile political situation.

That point came home when, during the course of the Intelligence Squared debate, I received yet another round of boos after I asserted that the eagerness of the Obama administration to direct its short-term money to teachers and construction workers is an effort to channel support to union members who would in turn lend vital support to Obama's reelection campaign. It was hard to tell whether the audience members were booing because they thought my statement was false or because they thought that this quid pro quo was an additional bonus from the president’s legislative package.

Once again there is a larger point here. Another neglected part of the Obama jobs act contains the creation of the American Infrastructure Financing Authority, which will take over much of the infrastructure funding in the United States. To quote the bill, the “AIFA shall provide direct loans and loan guarantees to facilitate infrastructure projects that are both economically viable and of regional or national significance, and shall have such other authority, as provided in this Act.” The AIFA’s board consists of seven members, no more than four of whom can be from any one party (guess which?). In addition, the chief executive officer of the AIFA is appointed by the president, subject to Senate confirmation, for a six-year term, which means that the Obama appointment would keep his or her sensitive political position for the entirety of the next administration, be it Democratic or Republican. This governance structure is highly politicized from the start.

Moving money from the private to the public sector will kill more jobs than it creates.

The effect of this Financing Authority is to bypass, to some uncertain extent, the well-established federal-state programs that have been used to allocate federal funds to various state infrastructure projects. Once again, let this precedent get embedded, and the line between sensible infrastructure improvements and political pork will be quickly erased.

The fourth indictment is perhaps the most salient. Come what may, Obama’s ambitious program of job creation cannot work, even if we strip it of its other obnoxious features so that it becomes a pure stimulus program.

At the close of the debate, Rouse, to evident audience approval, put the case for the jobs program this way:

[A]s Mark has said very carefully, we really do risk falling into another recession which will be just devastating for all of us.

Might doing nothing make a difference? It might work. But I've got to tell you, I'm not a gambling girl, and I'm just not willing to make that gamble for 42 million workers who are out of work and the millions more who are really suffering economically.

Her remarks make for stirring rhetoric. There is no one who doubts the risk that we may fall into another recession. It is a risk that is obvious to everyone on both sides of the debate. Nor is there any disagreement that a recession is bad news for the 42 million people out of work.

But the question is what to do about this. On this point, Mitchell and I advanced a large menu of needed legislative reforms that the audience silently passed over in favor of the jobs bill. Despite Rouse’s aversion to gambling, the Obama jobs plan is not a risk-free operation. Indeed, even if we put aside its many long-term structural flaws, it is likely to fail as a stimulus program even in the short term.

The $450 billion dollars that it wishes to devote to its cause of job creation must come from somewhere. A look through the bill shows that the evident sources of funding are all controversial. Section 401 places a maximum cap of 28 percent on charitable deductions, which will reduce private giving and increase the control of the central government over various charitable activities. It also contains a proposal to tax all carried interests in real estate partnerships as ordinary income, reducing the incentives for new investment. It has extensive changes in the rules to “repeal oil subsidies,” and changes some of the rules on foreign investments. These changes must be argued for on their own merits. If they make sense, they should be put in place even in the best of economic times. If they do not, then they should not be implemented, even in the worst of times.

Yet that is not the strategy of this jobs plan. Rather, it is to take money out of the private sector and put it into government. The substitution will not be on a dollar-for-dollar basis, because the bill’s transitional tax provisions will impose large costs on the economy. The upshot is that there is in fact a huge chance that the loss of private sector capital caused by this bill will see the elimination of more jobs than this dubious stimulus program can create.

When it comes to creating jobs, this bill is a huge gamble rather than a safe bet. Let us hope that the popular sentiment throughout the nation on this bill is not what it is in New York City. Legislative gimmicks will intensify social dislocations. Only a thorough reform of the tax, regulatory, and labor policies of the United States can offer the hope of an immediate and lasting recovery.  

Paris, 1793: Historical Parallel?

The most interesting point about this essay, unfortunately, is not what Professor Epstein writes about economic policy. On that matter he is, as always, both wise and eloquent. No, the interesting point, and the alarming one, is his report on the mood and behavior of the audience. For some reason I am reminded of another time and place entirely: 1793, Paris.

---Owen Hughes

My Experience as a Business Owner in Canada

As a Canadian business owner, every point Professor Epstein makes about the impact of government policy on American business is sadly true. We have put aside plans for our clients to partner with American businesses or to sell into the U.S. When Canadian corporate tax rates are far lower than American tax rates, this is a signal. American business owners are despondent. Who is speaking for them? Thank goodness for Prof Epstein.

---Jacoline Loewen, Loewen Partners, Toronto