Monday, December 16, 2013

Commentary: How to Kill an Economy!

"I'm sure everyone feels sorry for the individual who has fallen by the wayside or who can't keep up in our competitive society, but my own compassion goes beyond that to the millions of unsung men and women who get up every morning, send the kids to school, go to work, try and keep up the payments on their house, pay exorbitant taxes to make possible compassion for the less fortunate, and as a result have to sacrifice many of their own desires and dreams and hopes. Government owes them something better than always finding a new way to make them share the fruit of their toils with others." --Ronald Reagan

When I was an economics major in college, I was taught that Franklin Roosevelt saved capitalism using Keynesian principles. The unchallenged assertion was that the sole reason the Great Depression lasted a decade was because New Dealers were too timid in spending borrowed money. In many economists’ minds, skyrocket spending to win World War II proved conclusively that huge deficits were the cure for slow growth. To a large extent, this is a rewriting of history. It didn’t happen this way.

Instead of spending our way back to wealth, two phenomena saved the American economy. Impending war forced Roosevelt to cease bashing business and the 80th Congress elected in 1946 balanced the budget and undid the worst aspects of the New Deal.

Freedom’s Forge, How American Business Produced Victory in World War II by Arthur Herman does an excellent job of describing the shift from an anti-business bias to acquiescence of capitalism during Roosevelt’s third term. The new tolerance of a profit motive had a huge impact on the production of war materials. The United States manufactured two-thirds of all weapons and supplies used by the Allies, “yet the output of consumer goods was larger every war year than it had been in 1939, despite the restrictions and rationing. In 1945 Americans ate more meat, bought more shoes and gasoline, and used more electricity than they had before Hitler invaded France … total economic production in the United States had doubled; wages rose by 70 percent.”

Deficit spending is often referred to as demand-side economics. This is the concept that when demand is present, producers will automatically ramp up production to meet demand. Supply-side economics puts the focus on growing the private sector faster than the public sector by restraining government growth and encouraging profit making enterprises.

The government sector grew enormously during the war, but as the size of government grew, government regulatory and tax restraints were moderated. The profit motive was back big time. The problem with the demand side is that unless producers can make a profit, they don’t produce. Demand alone is meaningless. Ask Japan, where for the last two decades there has been enormous amounts of cash sitting on the sidelines along with massive worldwide demand. Government debt and public sector growth annihilated the late 20th Century powerhouse. 

The end of the war proved the case for supply-side economics. War time government spending suddenly collapsed and ten million men and women in uniform suddenly returned to civilian life. This was a dramatic shift. New Dealers were shouting from the rooftops that this would result in high unemployment and a return to a depressed economy.

Herman writes in Freedom’s Forge, “A report released by Senator James Mead of New York predicted massive unemployment and inflation in the war’s aftermath, as America’s fighting men would be returning to empty factories and empty store shelves … ‘There should be no mincing of words’ with the American people, the new head of the Office of War Mobilization and Reconversion, John Snyder, warned President Truman … The end of war production would mean the end of prosperity, and lead to eight million unemployed by the spring of 1946. Economist Leo Cherne thought that number wildly optimistic. It would be closer to 19 million, he asserted. Paul Samuelson, later the dean of American economists, warned that unless the government took immediate action, ‘there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has faced.’”

New Dealers insisted that massive government intervention was needed to avoid catastrophe. The American public had a different notion. In 1946, Republicans ran against “big government, big labor, big regulation, and the New Deal’s links to communism.” The elec­tions were a rout, with Republicans capturing the Senate and House for the first time since the start of the Depression. Republicans beat thirty-seven of sixty-nine liberal Democrats in Congress, which made the minority party more conservative as well. The Eightieth Congress passed the first balanced budget since the Great Crash, cut taxes, shreded regulations, overrode Truman’s veto of the Taft-Hartley Act—which restricted unfair labor practices—and shut down price controls. Opponents screamed that Republicans were driving the nation back into the Great Depression.

The naysayers were wrong. The country enjoyed more than two decades of prosperity.

You can’t be called an economist without a Ph.D., so they all consider themselves pretty smart people. Undergraduate work is about relationships between different types of economic activity. Graduate economics is about using these relationships to guide, nudge, and push the economy in a desired direction. Ronald Reagan and I only earned a bachelor degree in economics. We learned the basic theory, which is clear and noncontroversial. For instance: if this factor goes this way, how will this other factor react? A firm grasp of these relationships is what made Reaganomics so successful.

Why are economic computer models so often wrong and why do they frequently violate observable phenomenon? The answer is tens of thousands of variables, which leave plenty of room to skew a model toward a desirable outcome. Computer models have made a mash of things. Don’t be influenced by Ph.Ds. trying to elbow their way into a policy position by telling politicians what they want to hear. Common sense and your own eyes will work just as well.

If you feel you need more, Economics for Dummies by Sean Masaki Flynn will give you more insight than a doctorate. The world really does work the way it seems. There are no short cuts, and as Milton Friedman liked to say, “There’s no such thing as a free lunch.”

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