The U.S. Economy Is Becoming Reliant on Government Fixes

Friday, May 29, 2009
Michael Boskin

It is still too soon to gauge the full economic impact of President Barack Obama’s implemented and proposed policies, but a preliminary read indicates limited short-term benefit at large long-term cost. The administration is exploiting a crisis atmosphere to enact a vast agenda that would reengineer the American economy, from autos and financial services to health care, energy, and the distribution of income.

Obama outsourced the details of the $787 billion fiscal stimulus package to Congress, and, no surprise, the old barons of the House stuffed it with pork and social engineering. Ten months later, less than a quarter of the funds has been spent. The federal government has even browbeat state governments–for example, demanding that California rescind a small pay cut for some unionized workers or lose $7 billion in stimulus funds. (Intervening in contractual relations ex post facto to enforce union demands is an emerging characteristic of the administration.) There has been little impact on consumption, the shovels are still in the shed, and the administration’s claim of jobs gained or saved is wildly exaggerated.

The foreclosure relief plan got off to an even slower start, and, although many more homeowners are now enrolled, a small fraction has thus far had permanent loan modifications. Further, if successful, it risks inducing a lot more delinquencies.

So score the stimulus an expensive, largely wasted opportunity. Instead, Obama could, for example, have suspended the payroll tax for a year, getting money directly into people’s pockets quickly and decreasing the need for firms to lay off workers. That would have saved a large multiple of the jobs putatively attributable to the stimulus.

Obama’s long-run budget calls for higher spending, higher taxes, and an explosion of debt that will crowd out borrowing in capital markets by private companies, state and local governments, and developing countries. Obama would add $6.5 trillion to the United States’ national debt, more than all previous presidents, from George Washington to George W. Bush, combined.

Those trillions are in addition to explicit tax hikes on income, capital gains, and dividends and implicit ones on energy via cap and trade and so on. It appears that the Obama strategy is to “stuff the beast” (the mirror image of the tax-cutting “starve the beast” philosophy attributed to some of President Ronald Reagan’s advisers), that is, to initiate massive spending and hide the true cost from citizens. The large deficits will eventually force much higher taxes, such as a national value-added tax similar to those in Europe or gigantic increases in everyone’s income taxes.

Large deficits will eventually force higher taxes.

The Federal Reserve lowered its target federal funds rate to zero before Obama was inaugurated and initiated many programs to try to revive credit markets, with mixed results. (The commercial paper facility has helped, whereas some others have gotten less sanguine results.) The Fed’s independence is a key component of its anti-inflation credibility; a key test for Obama will be to support the Fed’s efforts to withdraw the liquidity before substantial inflation pressures assert themselves.

The Obama administration also seems to be heading toward regulating derivatives and financial institutions deemed too big to fail. America does need a clearinghouse for derivatives, and a much higher percentage of derivative trading should take place on exchanges, rather than bilaterally over the counter. Any institution that is—or could quickly become—too big to fail needs to have adequate capital (rising with size) and real-time continuous monitoring of risk, but such measures should be implemented without overbearing micromanagement.

Unfortunately, the Obama administration’s decision to put the unions ahead of secured debt holders in the orchestrated Chrysler bankruptcy risks rupturing the basic fabric of credit markets. But Treasury secretary Timothy Geithner’s much-ridiculed bank “stress tests” made sense (although one can argue that sufficiently dire scenarios were not included or that too much was negotiated with the banks, etc.). Determining the size of likely losses is necessary to decide whether banks’ retained earnings from profitable ongoing operations and their ability to raise private capital will allow them to work down their toxic assets over time. If not, more draconian solutions will be necessary.

I support Geithner’s plan to cooperate with private investors in dealing with the banks’ toxic assets because investors make better business decisions than government bureaucrats. But even the low-interest, nonrecourse loans to buy up toxic assets have yet to result in a stampede of participants. Will banks be willing to part with the assets at low enough prices to attract private investment? And would doing so force larger write-downs, requiring banks, in turn, to ration credit—and thus harm the economy?

Obama has been better than feared on international trade. He was famously protectionist during the primaries, declaring he would unilaterally rewrite the North American Free Trade Agreement. But, although he has maintained a softer tone since the election, he has not even bothered to ask for fast-track trade promotion authority, let alone tried to pump new life into the Doha round of global trade talks.

Obama is implementing a large part of his agenda. Unfortunately, the numbers don’t add up, and he is laying twin time bombs with the explosion of federal government debt and inefficient government micromanagement of the economy. His call for immense deficits—even once the economy is back to normal, funds are returned from the financial bailouts, and the United States is out of Iraq—is simply irresponsible.

The Fed’s independence is a key component of its anti-inflation credibility.

The American economy will likely show a return to growth beginning in the second half of 2009 and into 2010, especially with the monetary and fiscal stimulus (though this probably would have occurred without it), but it will still be an economy on government lifelines. The big questions left unanswered are how far Obama wants to push the United States toward a European-style social welfare state, how he intends to pay for it, and how much long-term economic damage will result.