State of the Union Reactions, Part 2

I was talking last time (Part 1) about my immediate reactions to the State of the Union Address, particularly from a political lense.  Now I’d like to focus on the major problems the President wishes to tackle and the strength of his domestic policy recommendations, in order as they come up in the address (though, because of the length of the address, I won’t be hitting every point).

Obama is right to place heavy emphasis on equality of opportunity.  Unlike the concept of income inequality, an opportunity agenda is something that has broad support across the political spectrum and is a shared value nation-wide.  One of his best recommendations is an overhaul of the tax code, whose loopholes cause precious time and resources to be diverted away from productive activities as individuals and companies seek to minimize their burdens.  Running at an estimated cost of at least $250 billion/year in lost economic output and at least $1 trillion/year in lost revenues, the tax code is an abomination.  This lost output translates into lost job opportunities and slower job creation.  If the President fails to reform it (e.g. by cutting loopholes and lowering marginal rates), it will assume the title of Obamination.  His proposal to use some of the savings to help rebuild the nation’s infrastructure is also not a bad proposition, as the American Society of Civil Engineer’s 2013 Infrastructure Report Card estimates that America would need to allocate an extra $1.6 Trillion just to upgrade our infrastructure to a state of “good repair”.  If we continue to fail to maintain the nation’s physical capital, our competitiveness will deteriorate and the sluggishness in productivity growth that has been the norm since the 70’s will drag on.  Additionally, his idea of further connecting businesses and universities via regional hubs is also laudable.  Universities are a critical source of research and discovery; connecting them with businesses can help transform those ideas and discoveries into useful, productivity-enhancing goods and services.  All of these ideas will bolster American opportunity.

From there, his message starts to deteriorate a bit.  He mentions that his administration has made more loans to small businesses than any other, and wants to do still more.  Is this really a good thing?  State-directed lending (à la China) has had mixed results both in the past and present.  Although sometimes successful, loans tend to be politically driven and may not exhibit much, if any, return on investment.  As such, they tend to distort the market and allocate resources inefficiently, propping up businesses, ideas, and methods that aren’t economically viable in the long-run.

The address then turns back to embracing the market with his sound advocation of patent-reform and the ongoing natural gas/fracking boom.  Indeed, both are important issues; litigation has gotten out of control in many parts of the country, adding needless transactions burdens on thousands of businesses; a sounder process that reduces frivolous litigation would be welcome.  Streamlining the permitting process and reducing red tape for natural gas is also a long-needed reform; it’s good that the administration is finally realizing that fossil fuels still hold massive potential in both creating jobs and lowering American energy costs (which have dramatically increased our competitiveness relative to other developed nations, such as those in Europe).  At the same time, his mentioning of reducing fossil fuel subsidies is good as it produces problems similar to the problems small business loans produce.  Republicans would be smart to firmly stand with the President on this issue and work to get rid of the subsidies once and for all.  Corporate welfare almost never works – we have far better uses for our money.

After talking about the usual climate change mantra, he then shifts to immigration.  Personally, my views contain a mix of both Republican and Democratic thinking.  I agree with the Republicans that “blanket amnesty” would have some serious harmful effects on the country.  Specifically, I think granting illegal immigrants citizenship status who broke the law without penalty would undermine the rule of law, something that has already been undermined during this administration (think federal drug enforcement).  Not only that, it isn’t really fair to those who took the time and effort to come here illegally.  At the same time, Democrats are right in that deporting millions of illegal immigrants isn’t practical (or smart policy) either.  Not only is it extremely costly in fiscal terms, but it is damaging economically.  Like it or not, immigrants add to our GDP, lower costs for businesses and allow other citizens to specialize in higher value-added jobs.  Deporting them would raise costs, disrupt economic activity and ultimately slow growth.  Additionally, many illegal immigrants now have children – the so-called “Dreamers” – who came to this country through no fault of their own.  Deporting them or, worse, splitting up families via deportation is emotionally traumatizing and morally questionable.  As such, I think the best solution is to grant them citizenship status only after a) thorough background checks have been conducted b) high penalties (for breaking the law) have been applied, including perhaps putting them at the end of the line behind other immigrants that are attempting to get naturalized status.  Also good would be to streamline the naturalization system in a way that maintains our national security.  The President didn’t lay out the terms of his desired reform package in his address, though I’m sure that whatever he supports will contain lots of needed naturalization and far too little penalization.

The President then moves on to the importance of education, especially pre-K education.  It is true that early childhood education can improve cognitive development and boost achievement in a child’s academic career (and even later on in life), and is something the country needs to consider to bolster its human capital and even total factor productivity (the level of efficiency in turning capital and labor into economic output).  However, his advocation of “invest(ing) in new partnerships with states and communities across the country” to boost pre-K education should be approached with caution.  I believe that states and localities know best how to create competitive, high-quality educational programs.  Getting the federal government involved, even if it is “just” via funding, might not be a good idea.  Federal involvement can hinder local innovation and can make localities far too reliant on federal aid (something that can make states puppets of whatever the federal government wants – think Medicaid).  Increasing federal involvement since the 1970s, especially since the creation of the Department of Education by the Carter Administration hasn’t noticeably boosted educational access or progress; indeed, since the 1970s, progress on indicators ranging from reading and math proficiency to graduation rates have stagnated.  Let the states and localities do it on their own; no federal involvement is necessary.

Obama’s policy proposals then turn outright populist with his insistence that Congress raise the minimum wage, and lended support to Senator Tom Harkin and Representative George Miller’s proposal to raise the federal minimum from $7.25/hour to $10.10/hour.  On net, I think this is a very bad idea.  Let’s start with the usual neoclassical argument: assuming that the current minimum wage right now is at the “equilibrium” wage (which likely is not true), a raise in the price floor would lower business demand for labor while simultaneously increasing the supply of people willing to work.  This creates a labor surplus that would translate into unemployment.  Indeed, a Congressional Budget Office estimate of the proposal’s effect on employment projected that enacting the Harkin/Miller bill would reduce employment on net, with its central estimate at about a 500,000 decrease in employed workers.  Then we hear the counterargument by left-leaning economists, such as those at the Economic Policy Institute.  They argue that an increase in the minimum wage could actually increase economic growth and job creation, counteracting any job losses.  This would be due to the “multiplier” effect of raising the wage of millions of low-income citizens, whose marginal propensity to consume (according to Keynesian theory and many studies) is high.  In other words, the newfound income these people would have would be spent almost immediately, increasing aggregate demand and generating economic activity.  That is a possibility I suppose. However, we must remember that the equilibrium wage is vastly different across the nation – different states have different price levels and levels of competitiveness; for some, raising the minimum wage could theoretically increase job creation; in others, however, raising the minimum would place it far above the current equilibrium, increasing unemployment.  As The Economist has noted, places like Puerto Rico are already suffering from high labor costs due to the current minimum wage, and economists in general have long recognized the high minimum wages of many European countries as contributing to their high long-term unemployment rates.  In places like these, the costs of further increases would far outweigh the economic “benefits”.  Additionally (as The Economist also mentioned), let’s face it: many of the jobs minimum wage workers currently perform could easily and efficiently be done by technology and automation.  I believe that the only reason many of these jobs still exist is due to cultural norms, which have a tendency to get in the way of rational economic thinking.  Raising the minimum wage could accelerate the shift towards these technologies substituting for low & medium-skilled workers, hurting them in the short term.  No matter what, the minimum wage is a command-and-control solution to tackling the problem of poverty and low-wage work that will cause more harm than good.  Other ideas (such as an increase in the earned income tax credit that the President mentioned) that reward workers without distorting the market and disincentivizing them from working (or employers from hiring) are needed.  Additionally, wages are partially a result of overall cultural norms – change the norms, and perhaps we can change the wage. 

The last big thing I wanted to address from Obama’s speech is a commendable proposal, the MyRA.  Partially due to record-low interest rates, savings rates for Americans are at an all-time low.  This is very worrying.  Savings are crucial for a good retirement (which Social Security was originally meant to compliment, not substitute) and for consumption smoothing (look up the Modgliani life cycle hypothesis).   A lack of them can put further liabilities and pressures on entitlements.  Additionally, savings help the economy to grow by boosting available financial capital for investment.  Without them, long-term economic growth is put into jeopardy.  Helping workers to put away reliable savings, especially at a time when defined-benefit pensions are dissapearing in favor of less stable 401Ks is potentially a good idea for governmental involvement.  My only caveat: should it be federal?

Overall, the speech was good, with a mixture of good and bad proposals.  The nation now needs to prioritize and, when that is done, begin to have thorough debates on these critical issues.  Forget midterms; this is among the administration’s last good chances to finally leave a positive mark on American history.