2017: Reaping What We’ve Sown

After a tumultuously good, bad, and ugly 2016, the arrival of 2017 brings with it new opportunities, new challenges, and – perhaps most importantly – a fundamental shift in domestic and international policy landscape, the likes of which we have not seen in decades. After the infamously shocking upset by Donald Trump in his bid for the presidency, the United States will on January 20th have a unified Republican government for the first time in eleven years. Rather than serving as a refreshing concreteness about the direction of policy and its implications (in contrast to the past several years of gridlock), however, in some ways things are more unstable and uncertain than ever. Although a unified GOP agenda is gradually materializing, many of Donald Trump’s proposals departs from established Reagan-era Republican ideology, and much of his behavior departs from norms that transcend partisan boundaries. Even for Mr. Trump alone, inconsistencies and repeated u-turns in his policy stances make for a very uncertain 2017.

My worries for this year and the years that follow are many. Top concerns include:

  1. Trade wars. Mr. Trump has taken a uniquely protectionist stance that threatens the post-World War 2 American-lead global consensus on generally free trade, vowing to renegotiate treaties (some of which are Reagan-inspired, like NAFTA) while slapping tariffs ranging from 35-45% on imports from China. Not only will such measures, if enacted, reduce the benefits America receives from the laws of comparative advantage (e.g. lower consumer prices, employment opportunities, etc.), but they threaten counter-measures and reprisals that could spiral into full-blown trade wars. Such a scenario could prove catastrophic – our last set of big trade wars, during the early 1930s, greatly exacerbated the Great Depression. Were another round to occur, the economic and political  ramifications could easily upend the current international order.
  2. The disintegration of domestic and international norms. Mr. Trump does not demonstrate a knowledge or respect for established norms and practices, such as honoring NAFTA commitments, not engaging in a nuclear arms build-up (which, unlike conventional warfare tactics, will do nothing other than provoke an arms race; such weapons derive power from strategic positioning, not quantity), the cultural repulsion of Japanese towards maintaining their own nuclear weapons, the implications on U.S.-China relations of indirectly recognizing Taiwan as an independent state, and a dangerous habit of immaturely lashing out at critics, to name a few examples. This lack of knowledge and respect and the resulting breakdown will make the world more unstable and less secure as institutions weaken and the historic anarchy of states reigns with greater freedom. Such institution-weakening globally will reflect our institutional deterioration at home, where the electoral process has been repeatedly undermined with false accusations and uncertainty regarding the peaceful transfer of power.
  3. An enormous exacerbation of our fiscal sustainability issues. Mr. Trump’s plans to cut taxes aggressively whilst preserving entitlement (Medicare, Medicaid, Social Security) and defense spending will wreak havoc on a debt situation that is, in the long run, already quite unsustainable. Deficits will not only jump sharply in the short run if such plans are followed through with, but will stay higher permanently (in other words, the structural deficit will grow). It is highly likely a follow-through with his plans will entail a near continuous expansion of debt at growth rates that exceed that of GDP growth, an unsustainable situation in the long run (and a dangerous one in the short-run with an economy that is already operating close to full employment – think inflation). How plans to cut taxes will be reconciled with also strong desires to reduce deficits is a key question as the administration prepares to take power.
  4. Regression on healthcare. Don’t get me wrong, the Affordable Care Act is an incredibly flawed piece of legislation. Its weak individual mandate, combined with minimum benefit standards has placed great upward pressure on premiums (and, especially, deductibles) without much relief from subsidies (yes, the subsidies are too low and stingy) whilst still leaving millions uninsured. The deterioration of the insurance risk pools has become so acute that many insurers have been fleeing the ACA’s state exchanges for the past year. Not only that, but the regulatory burden imposed by the ACA on employers (such as stringent definitions of full-time employees, the employer mandate, filing requirements, new taxes, etc.) have generated a large amount of waste, inefficiency, and consternation. Yet, it is my belief that a repeal of the act (and the resultant loss of insurance of 20 + million Americans) would, in the long run, be to the detriment of the United States if an adequate replacement is not implemented. The availability of health insurance is correlated (in a causal way) to better health outcomes, something of which is crucial for worker productivity (and thus, living standards).  Not only is good health and the associated productivity benefits good for the recipient themselves, but the positive spillover effects and externalities of workers having health insurance can benefit businesses as well (e.g., the associated productivity gains and their impact on the corporate bottom line). Like education, health insurance is a good/service that markets have a tendency to inadequately supply at levels below those that would be optimal for society (especially for those who need it), but which governments can help bring to optimal levels via intervention. As such, repeal of the law without an adequate replacement will contribute to deteriorated health outcomes (especially if preventative care cannot be accessed), lower productivity, and lead to continuing high levels of medical bankruptcy that have placed large dents in consumer spending and has financially devastated families, to the detriment of everyone. Not only that, but the experiments the law has initiated (for example, to pay providers in bundled payments) to save costs could prove instrumental in efforts to cost-save down the road. Finally, the repeal of the law will not automatically root out many of the structural causes of healthcare cost growth that the public has complained about, such as an aging population, the inability of insurance to compete across state lines, the monopolization of hospitals, the adoption of costly high-tech medical technology, insufficient price negotiation with drug providers, continued disequilibrium in the tax treatment of healthcare, overuse of uncompensated care in emergency rooms, medical malpractice litigation, and poor diet/exercise habits, to name a few factors. As such, if the law is repealed without a good replacement, expect the number of uninsured to grow greatly while, after an initial slowdown or decline, costs resume their march upward.

The Faint Silver Lining

2017’s uncertain outlook isn’t entirely bad. In the short run, at least, the likely passage of some form of tax cuts and infrastructure spending (and resultant fiscal stimulus) will likely boost economic activity by mid-year 2017, further lowering unemployment and closing what remains of the output gap. Granted, the irony of more deficit-financed fiscal stimulus after years of Congressional resistance shouldn’t be lost upon us, and it is rather late in the business cycle for such measures, but there is an argument to be had for a bit more stimulus still. Besides, if it is well-invested (especially on maintenance, not the creation of new projects), infrastructure spending could be a boon to long-run productivity growth, the engine of long-run economic expansion. Additionally, corporate and/or general tax reform and simplification could be beneficial by lowering the amount of time and resources needed to comply with the tax code (and instead directing such resources towards more productive uses), further boosting growth and incomes.

The question is, will the beneficial impacts of our new policy regime outweigh the dangerous risks listed above (especially in the years beyond 2017)? We’ll have short-run fiscal stimulus, yes, but with (likely) permanent marginal tax rate cuts, higher structural deficits will also be permanent, not short-term. The boost to growth will likely occur in 2017, yes, but will trade wars or the Fed’s concerns about the inflation outlook lead them to raise interest rates, sinking (or, worse, cratering) growth in the years that follow? And what about the effects of new policy stances on healthcare, foreign policy, and – perhaps most concerning – the health of our defining norms and values as Americans?

I’m not particularly optimistic about the overall prospects of our uniquely uncertain direction as a country. Hopefully, my bleak outlook can be proven wrong.

I hate to sound like a deficit hawk, but…

I’d like to elaborate on this post more soon with more detail (and fun graphs), but the topic of fiscal policy and continuing federal budget deficits has been on my mind lately. My thoughts are:

  1. The economy is operating close enough to full potential that any Keynesian deficit-financed stimulus would potentially be counterproductive at this point. Similarly, continued annual deficits increasingly run the risk of crowding out private sector spending as resources are used to fuller capacity. If crowding out were to occur, interest rates would almost certainly rise, hurting growth. Though economic slack does remain, we should be increasingly cautious about running large-ish deficits in the coming years.
  2. Our long-term debt sustainability issues (which are our actual problems) certainly are not helped by short-term debt accumulation. Though acceptable in times of economic downturn and during recovery, short-term debt accumulation is less acceptable when an economy is both growing and has almost returned to near full operating capacity. If we continue to run structural (e.g. cyclical = 0) deficits, as we have for the past four decades, even in good times, our capacity to deal with the coming surge of entitlement spending will be greatly diminished. In many ways, though, we’re already too late on this regard.
  3. It might even be optimal to try to run a balanced or even more than balanced (e.g. surplus) budget for a few years. Normally, the rule-of-thumb is that, in the long run, annual debt growth (which roughly equal annual deficits) must be equal to or less than annual economic growth in the long-run (indicating that even balanced budgets are technically required for sustainability). Though this is now the case at the moment, our current deficit of around 3% of GDP is only small enough to about stabilize our debt/GDP ratio of around 75%, not reduce it. And arguably, reductions in debt/GDP would be preferable soon to give us more room for the coming entitlement spending and any future recessions we might encounter (and also to reduce the risk of a debt crisis).
  4. At the very least, we should continue to try to reduce our structural budget deficits while promoting long-term government investments (for example, in infrastructure, R&D, etc.). At the present time, further fiscal stimulus would seem inappropriate; the window for action has passed.
  5. Reduction of budget deficits is not only about timing, but rates of change (which is where the calculus comes in). Any plan must not just offer targets and amounts, but how quickly those targets and amounts are to be achieved and any feedback loops that might ensue
  6. None of the presidential candidates offers a viable long-term deficit reduction/debt stabilization plan, which is appalling. Indeed, many (especially Trump and Sanders) would dramatically increase our rate of debt accumulation in a very unsustainable way. Though many candidates offer proposals for productive spending, both that spending and, more crucially, the coming increase in mandatory program spending should be at least partially paid for, via tax increases or spending cuts. None elaborate on such a plan.

In my world, the government would:

  1. Enact reforms to mandatory programs (e.g. Social Security, Medicare, Medicaid) that progressively reduced benefit growth and raised more dedicated revenue (for example, by increasing the payroll taxes’ income cap)
  2. Reduce wasteful spending in the form of corporate subsidies (e.g. agricultural, fossil fuel), DOD procurement waste, redundant programs (for example, many overlapping government assistance programs)
  3. Raise general revenue (via reductions in excludability of health insurance from taxation, gradual phase-out of mortgage interest deduction, caps on deductions/deductability of some items, etc.)
  4. Modestly raise spending on direct R&D and R&D tax credit, transportation (highway) funding, job training programs

A more detailed discussion of the fiscal situation and solutions I would endorse will follow soon. But I thought it would be good to write down my general thoughts on the matter.

The Case for Pragmatism

Politics in America is broken. We all know that; we all feel it. Congress can barely legislate; families and individuals disagree sharply on almost every issue imaginable. And yet, despite the recognition, it keeps getting worse. Not only have political parties sorted themselves almost completely by ideology, but extremism is on the rise on both the left and the right. Indeed, things have become so contentious that that almost every fact-based article likely will not help towards resolving the unproductive tensions that plague our discourse; rather, it will probably serve to further exacerbate them. But I just can’t take it anymore. I’m sick of the puritanism, the all-in-one position packages people accept to be a part of their liberal or conservative tribes. I’m tired of the feel-good rhetoric that spouts simplistic messaging that caters to the predispositions of people, oftentimes without basis in truth. Whatever happened to American thinking and intellectualism? Whatever happened to solving problems, to recognizing trade-offs, to thinking critically about each issue and doing the research to determine the facts? More importantly, whatever happened to an emphasis on the unbiased and objective determination and analysis of facts?  Politics has turned much too much into a basic football game, with teams and fans cheering or sneering at the players. It’s a feel-good game that people participate in to feel included in their team, instead of recognizing that the entire stadium is on fire. It’s time to grow up and get past our differences to put out the fire; not only that, but to actually do things that will actually put out the fire, not make it worse.

As a country, here are the things we ought to agree on and base our actions on:

  1. Almost all of us like freedom. It’s defining it and the extent it should be allowed that becomes challenging
  2. Our civic values are what unite us as a nation. Not religion, not race, not even culture. Rather, it is our core beliefs in Western values.
  3. There is an important role for government, albeit a “limited” one. Defining limits is tricky and subject to different, reasonable arguments.
  4. Proper policies should favor the inputs of data and context over ideology. Different situations and results call for different actions/non-actions.
  5. There are many problems, some of them serious. But in myriad ways, America has never been “greater”. No matter what Trump, Clinton, or Sanders think, things are actually pretty good.
  6. All sides have something to offer. There is not one set of “correct” solutions that should be implemented puritanically. Rather, a mix of solutions that is dependent upon context and data are necessary.
  7. Never believe everything you hear; rather, challenge everything (appropriately). 

These points of (what should be) agreement naturally call for cautious and thoughtful debate and consideration of each problem and possible solutions to lay out a program of gradual reform. In other words, the exact opposite of what we actually have.

 

 

Hello 2016

It has been awhile since I last posted in mid-2015. To say a lot has changed since then is, quite simply, a vast understatement. In economics, the Fed raised interest rates while Japan adopted negative rates, China is slowing, Europe is recovering, oil prices are at historic lows, and the IMF recently issued a surprise recommendation that the world’s developed economies adopt coordinated expansionary fiscal policy to prevent global growth from stalling. In world affairs, ISIS is slowly being weakened while Islamaphobia rises, Russia has intervened in Syria, a nuclear deal with Iran was signed, US relations with Cuba continue to thaw, the Trans-Pacific partnership has made progress, and plans to close Guantanamo Bay have emerged. In US politics, Paul Ryan succeeded John Boehner as Speaker of the House, Bernie Sanders has emerged as a surprisingly strong presidential candidate to Clinton’s left, and the Republican Party is collapsing into anarchy as Donald Trump is poised to win the GOP nomination. So much more has occurred, and so much more will occur, as we progress through this pivotal 17th year of the 21st century.

Going forward, I intend to post more regularly on daily/weekly happenings as well as broader subject areas of importance. In terms of the latter, I will lay out what I think should be the key priorities for US domestic and foreign policy, an analysis and argument for the policies I favor, and how this all relates to the 2016 presidential election. Additionally, an analysis of domestic and global economic trends and policies will also be offered regularly. However, in a break from historical precedent, I hope for the blog to include a greater number of spontaneous daily reflections on an even broader variety of subject matters. As such, postings should generally become shorter and more to the point. This will accommodate me much better as I simultaneously seek to finish the remainder of my post-secondary education.

2016 promises to be a new chapter, both for myself and for the world at large. In almost every single way, life is transforming rapidly and unpredictably. This year will have outsized importance in determining the trajectory of things to come. Yet as always, the paradox of path dependency looms prominently. No matter how much things change, just as much stays the same, and history can offer a compelling guide as to how the repeated narrative plays out, and what we should do about it. It’s up to us to utilize history and critical analysis to try to mold the future to create optimal outcomes for the greatest number. The question is, are we willing to embrace a new-found pragmatism in the face of unrelenting ideological irrationality and entrenched policy paralysis? If we are, then the future looks very bright indeed. If this blog can contribute to that those developments, no matter how insignificantly, then I will consider it to have succeeded in one of its core missions.

So with that, I say: hello 2016. And welcome to the Pragmatic Revolution.

A Spring Cleaning for American Monetary Policy

The past several months have witnessed profound transformations in the state of America’s economic outlook. Output growth has accelerated, with annualized GDP growth rates of 4.6%, 5.0%, and 2.2% in Q2, Q3, and Q4 of 2014, respectively.  This has been accompanied by similarly impressive gains in the pace of job creation, with a full year’s worth of monthly net employment gains of over 200,000, and an unemployment rate increasingly dipping into “natural rate” territory (estimated to be between 5.2 & 5.5%, though recently revised to around 5.1%).  Oil prices have plunged since late 2014, helping to spur aggregate demand.  And the FY 2016 budget released by the Obama administration in early February continued the turnaround in federal fiscal policy, with large increases in proposed discretionary spending initiatives promising to accelerate (if implemented) the transition towards a more accomodative policy stance.

Real GDP Growth has trended upward in recent quarters.  Photo courtesy of the Bureau of Economic Analysis.

Real GDP Growth has trended upward in recent quarters. Photo courtesy of the Bureau of Economic Analysis.

Monthly net payroll growth has steadily increased as output growth has accelerated

Monthly net payroll growth has steadily increased as output growth has accelerated

The U3 unemployment rate measure is slowly converging towards the estimated natural rate of unemployment (NAIRU).

The U3 unemployment rate measure is slowly converging towards the estimated natural rate of unemployment (NAIRU).

All of this points towards an economy that is rapidly strengthening and should continue to do so as the year continues.  The impacts of oil & natural gas price declines have yet to fully ripple through the economy in the form of increased manufacturing competitiveness and higher consumption.  Firming employment figures should boost aggregate demand as more earnings are recycled into discretionary household purchases.  Higher stock and housing prices will continue to translate into “wealth-effect” consumer spending.  And rising retail sales should further spur investment, boosting current and long-run growth in the process.  Ceteris paribus – all else held equal (such as geopolitical happenings) – and there is little reason to expect for strong economic growth not to continue.

With the arrival of Spring on March 20th and the accompanying wave of household cleaning, as well as this unexpected barrage of good economic news, it is a good time to take stock of the current policy trajectory.  Considering it is in the news so much, and bears so much direct import on the macroeconomy, of primary concern is the stance of monetary policy.  How soon should the Fed tighten?

Currently, the main policy tool that is modulated by the Federal Reserve, the Federal Funds Target Rate, is set in a range from 0 – 0.25% – the lowest levels in its history.  This has been the case since late 2008, and the 6+ years since then has likewise marked the longest period of accomodative policy in history.

This is set to change.

Rumor has it that a long-awaited hike in interest rates (read: Fed Funds Target Rate) will proceed by the middle to late-middle of this year, though the rate of increase will be fairly gradual, perhaps around 50 basis points to .75% by late this year.  This has been the assumption of investors for awhile now, and seems to be the likeliest course of action.  But is it a good course of action?

My views are mixed, but side with pessimists who feel that even these gradual steps are too rapid.  First among my concerns is that the American economy is still no where close to “full employment”, one of the key elements of the Fed’s dual mandate.  The Economic Policy Institute estimates that U3 rates closer to 4.0% (instead of 5 – 5.5%) are more consistent with NAIRU (n0n-accelerating inflation rate of unemployment).  This would make sense, for though unemployment is now within reach of the Fed’s estimates for NAIRU, inflation has continued to trend down (turning into outright deflation in recent months as lower oil prices feed into general prices), and wage growth remains stagnant (at 2% nominal growth, real wage growth is too low to feed into wage-push inflation).

fredgraph

Rates of inflation are well below the Fed’s 2% annual target

 

Nominal Wage Growth Tracker

As demonstrated by the Economic Policy Institute’s Nominal Wage Tracker, wages are rising too slowly to be consistent with target wage and inflation growth.

 

We would expect wage growth to strengthen as we near the natural full rate of unemployment.  Rising demand for workers while the labor supply becomes more scarce boosts the bargaining power of workers to negotiate higher wages.  This wage growth is partially a pre-requisite for higher rates of inflation (closer to the 2% target).  Higher wages means that prices usually must be increased for businesses to maintain profits, and these higher prices then necessitate further wage hikes, creating a positive upward spiral that feeds into rising inflation.  Since both nominal wage growth and inflation rates are well below target, it appears that full employment has not yet been reached.

Some will argue that the existence of monetary policy impact lags (how long it takes for a policy change to have an effect) would justify a rate increase now, as several months from now, it may well be that full employment is reached and wage and price increases are accelerating, to the point that tighter policy is needed to mitigate.  However, even if it were so that we reach full employment on current trajectory (which, if EPI is right and NAIRU is closer to 4.0%, will be a ways into the future), I still think holding off on an increase is justifiable.  For one thing, wage growth has been subpar for many years – allowing it to catch up back to pre-recession trends wouldn’t be a bad idea.  This is especially true if the Fed is worried about the sustainability of the expansion.  Wage increases are necessary for increases in consumer spending (the driving force of the U.S. economy) to be sustained.  Allowing for months, if not a few years, of above-average wage & inflation growth might not be a bad thing for the sake of sustainability.

Given the existence of multiple tools to combat inflationary pressures and to prevent higher inflation rates from being too ingrained, I think the biggest drawback of this proposal of delayed tightening is that the Fed risks overshooting its employment target (meaning that unemployment is below its natural rate for an extended period of time).  Technically, this would be a violation of its dual mandate.  However, invoking the argument about this policy helping to produce long-run economic sustainability (to maintain full employment and stable prices), a temporary overshooting of the dual mandate targets might be statutorily justified.  It all depends on the timeframe the Fed chooses to create policy, which historically has been rather short (within months/a few years).  This is the difficult balancing act the Fed must consider, and which is statutorily ambiguous.

If it were to think more of the possible long-run consequences of its policies (especially as it relates to the dual mandate), an already difficult task suddenly becomes much, much more complex.  Further thinking and a cleaning of its future policy stance is in order…

TBC

Building a New Era of Governance – Part 2

6) Continue with efforts to reform the healthcare system.  Love it or hate it, the Patient Protection and Affordable Care Act (PPACA, e.g. Obamacare) is here to stay (sorry Project 2017); at the very least, the law will not in its entirety be repealed.  The myriad subsidies, tax credits, and benefit requirements are far too popular; to repeal them would be political suicide.  What Congress needs to do now is to focus on modulating and improving upon what already exists.  Obamacare goes a ways towards addressing the pre-existing deficiencies in the system (although in an arguably inefficient and potentially self-defeating, if not destructive, manner).  These deficiencies are not hard to identify.  American healthcare is outrageously expensive (see below), and too few people have access to the system (anomalies which are very much related, via the effects of adverse selection).  Those who do have access (especially those on employer-sponsored plans) then face rigidities such as a lack of portability and increased dependency upon a single employment setting.  Obamacare generally does a pretty good job at addressing the lack of access to care; already, it has significantly boosted insurance rates via expansions of Medicaid and the provision of individual and business tax credits/subsidies.  The renewed ability of individuals to purchase insurance has also addressed the portability issue.  However, its record on holding down long-run costs appears to be more mixed.  It has provisions that simultaneously place downward and upward pressure on costs.  For the former, the individual mandate should help by increasing the pool of healthy individuals contributing to the system (countering adverse selection), offsetting the costs of newly-enrolled less-healthy individuals.  Additionally, the law contains numerous “experiments” designed to hold down costs, such as the creation of “bundled payment plans” as opposed to the traditional fee-for-service payment model (which rewards doctors on quantity, not quality, of services rendered).  At the same time, the law contains many expensive provisions, such as the prohibition of lifetime caps on benefits and new restrictions on varying premiums based on certain risk factors.  Thus far, costs have leveled off in recent years; then again, we did go through a massive recession that put a dent in demand for health services, and spending growth has been rising as of late, albeit very modestly.  Regardless of Obamacare’s impact on cost growth in particular, an ageing populace and the continued existence of marketplace distortions calls for continued efforts to make health spending more efficient and cost-effective.  I think that Republicans in Congress can pursue policy options that are both effective and politically sustainable.  They include the following:

In both relative and absolute terms, the United States spends far more resources than other countries on healthcare (source: vox.com)

 

The growth in healthcare expenditures has slowed in recent years, though its permanence has yet to be determined

The growth in healthcare expenditures has slowed in recent years, though its permanence has yet to be determined

PPACA has had a dramatic impact on the nation's uninsurance rate

PPACA has had a dramatic impact on the nation’s uninsurance rate

a) Repeal the Cadillac Tax, replace with a gradual phase-out of the tax exclusion on employer-sponsored insurance premiums.  While FDR’s World War 2 wage and price controls arguably created the present-day Employer Sponsored Health Insurance (ESHI) system, this policy has no doubt been greatly aided by the Federal government’s decision to exclude employer sponsored insurance from taxation (and kudos to Ike for making it open-ended in 1954!).  By excluding fringe benefits from taxation, the federal government has virtually subsidized the provision of employer-sponsored insurance.  From both an employer and employee perspective, $1 in healthcare is much more cost-effective than an additional dollar in wages.  This has led to costlier plans, and an increasing proportion of overall compensation being dedicated to benefits (as opposed to wages).  Adding insult to injury, the same tax benefits do not apply to individual plans, which are typically purchased using after-tax income (although Obamacare has implicitly equalized this a bit via the provision of subsidies and tax credits for individual plans).  To try and further “equalize” treatment, the authors of PPACA included the phase-in of a 40% tax on “Cadillac” insurance plans, specifically the cost of plans that exceed pre-determined thresholds (about $10,200 for individual coverage and $27,500 for family).  I see this tax as very arbitrary – 40% on randomly selected amounts, that has no guarantee of “equalizing” tax treatment between ESHI plans and individual plans.  The thing is, we already have taxes in place (federal income & payroll taxes) that could apply to these premiums; it’s just that the government has exempted them completely.  In addition to its failure to equalize treatment and how unnecessary it is, it also does not raise anywhere near as much revenue as a hypothetical full repeal of the ESHI tax exemption would.  The Cadillac tax is estimated to raise about $80 billion between 2018 and 2023 – a six-year period.  Meanwhile, the ESHI exemption in totality costs the federal government a whopping $250 billion every single year.

The tax exclusion of employer-sponsored health insurance is by far the most costly federal tax expenditure

The tax exclusion of employer contributions to ESHI is by far the most costly federal tax expenditure

I see this as a prime opportunity for Republicans to claim credit for killing a tax (the Cadillac tax) while simultaneously making the tax treatment of healthcare more sane and raising the government badly needed revenue.  What they could do is enact legislation that repeals the Cadillac tax in its entirety, but simultaneously places caps on the tax exclusion equal to the thresholds imposed by the Cadillac tax.  In this way, benefit amounts exceeding $10,200 for individual coverage and $27,500 for family coverage will be subject to normal taxable income.  Unlike other proposals, though, I would move for these threshold amounts not to be indexed to price changes whatsoever – be it a measure of inflation, a flat rate, etc.  In this way, more and more plans will gradually be subject to the tax (much like bracket creep of the 1970s) so that the discretionary impact of the exclusion can be tempered over time.  Better yet, have the thresholds lowered on an annual basis so that eventually all “fringe” benefits will be taxed, and there will be no implicit subsidization of ESHI.  Of course, an elimination of the biggest single tax break in the federal tax code would produce enormous backlash in and of itself; indeed, it would be rather hefty tax hike.  That’s why I think the Republicans should also consider using some of the revenue generated to lower marginal tax rates (one of their favorite pastimes); any potential revenue left over could be used to lower the deficit and perhaps expand insurance subsidies for the poor and middle-class elsewhere (which would be especially appealing to Democrats).  Combined with a repeal of the (more visible and unpopular?) Cadillac tax, I think this could be a politically palpable solution.  It will help eliminate artificial demand for healthcare and give the many types of insurance options equal – as opposed to preferential – treatment.

b)  Force (or nudge) states to dismantle barriers for the purchase of insurance across state-lines.  This is an area where federalism & devolution has failed – and the federal government ought to step in.  Other than for the appeasement of insurance companies, there is no reason states should restrict consumers from purchasing policies from out-of-state companies.  This has had the effect of creating localized insurance monopolies that have artificially driven up costs.  Sure, it will take time for interstate insurance provider networks to materialize; but it’s better to start now than to continue with the status quo.  Republicans really shouldn’t encounter as much resistance from Democrats with this measure; after all, Obamacare intentionally created state-level exchanges where consumers can “shop” for different policies, with the intent that (perhaps one day) a single national exchange or market could be created.  However, Republicans may run into arguments that this will cause a decline in benefit standards as consumers seek the most cost-effective policies; however, shouldn’t Obamacare’s minimum benefit provisions (that differentiate plans into bronze, gold, silver, etc.) create a floor on a substantial portion of policies?  And if not, Congress could always mandate a bare minimum of standards to create a floor under state floors (though this would probably lead to a conservative backlash; the party establishment must proceed with caution).

c) Medical malpractice reform.  Yup, it’s a relatively small part of the overall cost picture, but even Democrats have to admit that $45 billion a year in defensive medicine is a bit much (even if a portion of it is “worthwhile”.  Although it might work better at a state-level, federal policies such as enacting caps on total payouts, raising the thresholds to file suit and concepts such as “loser pays” could all do their bit to reigning in excessive medical malpractice costs.

d) Promote cost transparency.  Obamacare has already done a wonderful thing by mandating that employers report insurance costs on employee’s W-2 forms.  This has helped in the process of getting employee’s “skin in the game”, so that they are congnizent of costs that otherwise feel disconnected  from them (what a revolutionary concept).  Congress ought to expand the variety of benefits that require W-2 reporting, and could try to find additional means for cost information to reach consumers directly.  Of course, it must be mindful of the unintended consequences of such mandates, as reporting consumes time & resources in and of itself.  Again, since transparency provisions already passed Obamacare in its original form by an overwhelmingly Democratic Congress in 2010, I don’t see why further transparency provisions can’t be a bipartisan effort.

e) Temporarily increase Disproportionate Share Hospital (DSH) payments to hospitals.  Right now, hospitals across the nation are straining to provide uncompensated emergency care for millions of uninsured Americans, care that the federal government partially pays for via DSH payments.  Unfortunately, these payments are usually not enough, forcing costs onto general insurance premiums.  As Obamacare expands and insures more people, this problem should theoretically ease somewhat, and the strains on DSH should ease.  Nonetheless, this insurance expansion in incomplete (especially since not all states are on board with expanding Medicaid), and may not be enough to substantially reduce the strains on the already overburdened DSH payment system.  So why would conservative Republicans have an incentive to increase federal spending?  Quite simply, higher DSH payments could indirectly ease insurance premiums for millions of people (allowing for less private-level “redistribution” from the insured to the uninsured”, and costs could be lowered for the federal government too in a way that offsets the increased spending on DSH.  Expanded DSH would also be appealing to Democrats, as it would serve to benefit one of their core constituencies (the uninsured poor).  It is one of those times when less requires more.

f) Loosen federal restrictions on Health Savings Accounts (HSAs).  I see HSAs as a part of the solution to get people to have skin in the game when it comes to healthcare spending.  When combined with high-deductible health plans, HSAs establish a connection between medical spending and personal savings that can help to curb the consumption of excess medical care.  The Federal government should lift existing statutory contribution limits and abolish all taxes that apply to HSA withdrawals, including for so-called “non-qualified” withdrawals.  The latter option, in addition to being more fair, would help to eliminate distortionary tax-minimizing behavior that could actually inflate health spending.  HSAs go along with the conservative notion of individual responsibility (which might explain their strong support by Republicans), and certainly Democrats shouldn’t be opposed to an increase in savings accounts (especially considering Obama’s proposed myRA retirement accounts).

g) Eliminate the Employer Mandate.  One of Obamacare’s most controversial provisions is that employers with 50 or more “Full Time Employees” (FTEs) provide them with health insurance or pay a penalty.  An FTE is defined as someone who works 30 hours or more.  This has lead to huge disagreements over the provision’s impact on the labor market, with critics claiming that this provision is weakening the 40-hour workweek by incentivizing employers to cut back on workers’ hours to avoid the mandate and associated penalties.  Proponents have countered that most workers already work more than 40 hours a week, and thus are at little risk having their hours drastically cut to below 30/week.  In response to a recent bill to move the threshold from 30 hours to 40 hours, these proponents have also said that this bill makes cuts in workers’ hours much more likely, as so many work 40 hours (or a little more) per week.  Both sides have points; but really, it almost doesn’t matter.  The employer mandate, like much of Obamacare, creates arbitrary thresholds that threaten to severely distort the economy and strangle business decisions.  The 50 FTE threshold has already led to an increase in “49er” businesses, who artificially limit their employee count to less than 50 to avoid the mandate and payment of penalties.  Additionally, I feel the employer mandate exacerbates an existing major problem with American healthcare: the very fact that so much of it is provided by employers!  This 4th-party payment system is incredibly non-transparent and non-portable, disregarding the economies of scale it provides via pooling, and explains a major part of the cost dilemma.  As such, I think the mandate deserves repeal.  Since Republicans will obviously fail at repealing the law, they might as well go after a single provision of it to incrementally enact positive change.  Although repeal of the mandate is also likely to fail, it is still worth a shot, especially considering how the new 114th Congress has already decided that targeting the mandate will be one of its first legislative acts.  Perhaps this will also give some Democrats who are weary of the net impact of Obamacare to finally demonstrate their political independence from a surprisingly unpopular law.

Essay on Neoliberalism and the Global Financial Crisis

My apologies for not posting in a while, it’s been a busy month and a half.  Although I will continue to be very busy until early May, I thought I would at least post some of the material I’ve been working over the past several weeks.  The following is an essay I wrote for my International Political Economy class regarding the ideological roots of the financial crisis.  I write it from a structuralist and constructivist perspective.  Although it does not necessarily reflect my actual views/opinions on the origins & genesis of the financial crisis, it does bring up some key points that I think are worth mentioning.

NEOLIBERALISM AND THE GLOBAL FINANCIAL CRISIS

Abstract

This paper explores the complex subject of what the main contributors to the recent global financial crisis were, specifically by asking what governmental policies and ideas either contributed to or failed to mitigate the crisis.  Upon careful analysis, several conclusions were reached.  First, an ideology of neoliberalism was instilled in states by non-state actors in reaction to the economic developments of the post-war period.  These states moved not only to adopt neoliberal policies themselves but also to impose such ideas and policies on other states via international institutions and organizations.  Ultimately, it is argued that the adoption of neoliberal economic policies stemming from the development and transmission of neoliberal ideas via state and non-state actors allowed for pre-crisis economic imbalances to form.

 Introduction

 Beginning in the summer of 2007, signs of distress in global financial markets began making first appearances.  By the end of the next year, the world found itself engulfed in the worst financial crisis and resultant recession since the Great Depression.  The inability of policymakers and analysts to forecast the coming of this calamity and to identify its many contributors beforehand is alarming, and by itself provides ample justification for an in-depth analysis of what ultimately went wrong.  Specifically, it is asked in this paper what the underlying structural causes of the financial crisis were, and how government policies and prevailing ideologies either helped contribute to or failed to mitigate such causes.  Finding the answers to these questions will be crucial in helping governments to rethink dominant economic ideologies and to craft better policies that can help to prevent financial crises in the future.  Additionally, this research topic is pertinent to the study of the International Political Economy (IPE).  The policies enacted by governments are all related to how scarce resources are allocated in the global economy.  It is this interaction between the political and economic that solidifies this issue as being relevant to IPE (Balaam & Dillman, 2014).

Pre-crisis Economic Imbalances: A Historical Overview 

There were a wide variety of underlying economic contributors to the global financial crisis that had been incubating well in advance of the crisis’ systemic phase that began in mid-2007.  These took the form of a variety of irregularities in sectors ranging from trade to investment to disparities in income and wealth.  The key theme that runs across all causal factors, however, is the notion of imbalance.

The economic imbalances that predate the crisis are perhaps most clearly identified when first looking at international trade.  Starting in the 1980s, the United States and other developed nations started to log enormous annual trade deficits, reflected in an abrupt negative swing in their current account balances.  This essentially means that the value of goods and services being imported started to vastly exceed the value of exports.  After a mild retreat in the early 90s, the annual U.S. trade deficit ballooned, widening by approximately $740 billion from 1996 to 2006 (Wolf, 2008).  In order to finance current account deficits, a country must either borrow funds from abroad or sell assets to foreigners to maintain a net balance of payments.  The United States and other debtor nations did both, and foreigners (especially countries with large trade surpluses and huge capital reserves) flooded them with excess capital, helping to drive down interest rates and feed pre-crisis housing bubbles (Balaam & Dillman, 2014).  By 2007, multiple counties had become dangerously dependent upon speculative capital for economic growth (Sherman, 2011).  The presence of these debt-driven global trade imbalances was a key contributor to the crisis.

Trade did not just fuel massive current-account imbalances, however.  It also played a role in another major contributor to the financial crisis: growing income inequality within developed countries.  According to the Organization for Economic Development and Cooperation (OECD), the average Gini coefficient among OECD member nations increased from .28 in the mid-1980s to .31 in the late 2000s, indicating a more unequal domestic distribution of income (Growing Income Inequality in OECD Countries: What Drives it and How Can Policy Tackle It?, 2011).  Regardless of the causes of inequality, a growing consensus exists among economists that there is a positive correlation between income inequality, household debt, and bank failures (Noah, 2012).  Specifically, it is thought that a general stagnation in incomes for those in the lower and middle income brackets will cause them to borrow and take on debt to maintain or advance their living standards, a situation that is economically unsustainable in the long-run (Correa & Seccarecccia, 2009).

All of this combined to create a third major imbalance, elevated levels of consumer and commercial debt.  A surplus of credit and the resulting low interest rates in combination with a higher consumer need to borrow caused consumer debt levels to skyrocket.  Additionally, financial institutions took advantage of low interest rates to build up leverage, or the measurement of debt taken on to make investments (Hubbard, O’Brien, & Rafferty, 2014).

Finally, a key imbalance to consider is a lack of transparency and elevated concentrations of risk due to unconstrained financial innovation.  Major financial institutions would snap up mortgages made by mortgage lenders and repackage them into securities to be sold to investors.  The problem was that many investors did not know what the actual level of risk was of the mortgages that backed the securities they held.  Additionally, because lenders could sell mortgages to other actors quickly (and thereby issue more loans), they had little incentive to ensure that the loans they made were to creditworthy borrowers.  Thus, financial innovation greatly decreased transparency and increased risk in the financial system (Jarvis, 2011).

All of these imbalances finally began to unravel with the bursting of various housing bubbles in the summer of 2006.  Rising interest rates dampened incentives for consumers to borrow and for investors to invest in risky equities, such as mortgage-backed securities.  Mortgage defaults began to rise, putting further downward pressure on housing prices.  As mortgage payments evaporated, investors became even more reluctant to purchase mortgage-backed securities, causing their holders to suffer enormous losses as their value dropped.  Additionally, the resultant decline in financial institutions’ net worth made other institutions reluctant to lend to them.  It was this vicious cycle that nearly caused the collapse of the entire global financial system.  Although this outcome was ultimately avoided, the financial crisis still ended up morphing into the infamous “Great Recession” (Hubbard, O’Brien, & Rafferty, 2014).

The Impact of Neoliberalism: No Regulation, No Mitigation

When analyzing the history immediately preceding the financial crisis, it is not difficult to see a prominent ideological shift towards neoliberalism, or market-like rule, taking hold among various state and non-state actors.  Following the Great Depression, many countries entered an unofficial Keynesian “postwar compromise”, in which states became more economically interventionist to tame market forces via fiscal policies, monetary policies, and regulation (Duménil & Lévy, 2013).  This consensus lasted until the 1970s, when a combination of inflation, low corporate profits, low investment, and a perception that workers had too much bargaining power caused a rejection of governmental interventionism and a political and cultural shift towards neoliberalism (Friedman, 2009).  This shift towards and development of neoliberalism was aided in no small part corporate lobbying interests on behalf of the capitalist classes who were seeking greater profits and freedom from government meddling (Birch & Mykhnenko, 2010).  Other lobbying activities involved businesses creating political action committees and founding think tanks, all of which helped to embed neoliberal thinking amongst policymakers (Gallagher, 2011).  By the 1980s neoliberal ideology, which suggested that markets are always efficient and that government intervention should be minimized, had become very popular among the policy elite of America and, by virtue of its hegemonic clout, other states and intergovernmental institutions as well (Birch & Mykhnenko, 2010).  As will be demonstrated, it was ultimately the adoption of these neoliberal economic policies worldwide that permitted global pre-crisis economic imbalances to advance to unsustainable levels.

The acceleration of trade liberalization around the world was one notable facet of this emerging neoliberal ideology.  Beginning with the Uruguay round of trade negotiations, a more uninhibited version of trade in which protectionism was curtailed and remaining trade barriers were abolished became established institutional thinking (Balaam & Dillman, 2014).  The underlying rationale for free trade goes back to David Ricardo’s infamous law of comparative advantage, in which it was theorized that living standards rise when countries specialize in producing goods and services they are most efficient at producing (Krauss, 1997).  Trade barriers infringe upon this process by attempting to protect certain industries and workers, which leads to lower competitiveness and economic inefficiencies, theoretically harming living standards.

Ultimately, this neoliberal ideology was transformed into trade liberalization via two major routes, international trade agreements and IMF/World Bank loans.  Trade liberalization was actively advocated for via various American administrations, first through the General Agreement on Trade and Tariffs (GATT), then the World Trade Organization (WTO) (Balaam & Dillman, 2014).  Meanwhile, IMF and World Bank loans to developing countries became conditional upon the latter implementing various economic reforms, including trade liberalization.  Indeed, as recently as 2006, an estimated 26 out of 40 developing countries still had privatization and liberalization conditions attached to their IMF loans (Kovach & Fourmy, 2006).  In this way, trade liberalization became international economic policy.

Unfortunately, the liberalization of trade would allow for the buildup of several of the pre-crisis imbalances mentioned earlier.  In developed nations, the post-liberalization increase in competition with developing countries meant that the former experienced an erosion of low and middle-skill jobs, as developing nations had comparative advantages in such tasks (Dowd, 2009).  This contributed to rising economic inequality in developed countries and the resultant rise in unsustainable consumer debt.  Additionally, suppressed domestic wages in developed countries and the increased ability to import cheap goods due to free trade also lead to massive global trade imbalances in which some countries developed trade surpluses and other developed trade deficits.  Countries with trade surpluses invested their excess capital reserves into countries with trade deficits, and the latter then used these funds to finance their deficits.  Had trade liberalization not occurred, it is plausible that these unsustainable imbalances could have been mitigated (Correa & Seccarecccia, 2009).

Another notable tenet of neoliberal policy was the widespread removal of capital controls beginning in the 1980s at the urging of the United States and the IMF.  This process continued into the 2000s, as several bilateral U.S. trade treaties did not allow other countries to use them to mitigate balance of payments problems.  Again, the assumption was that markets would allocate resources (in this case, capital) efficiently.  Additionally, it was thought that the cost of credit could be lowered worldwide, promoting investment and consumption to propel economic growth.  What policymakers did not foresee, however, was that capital would be used speculatively and investment would become increasingly risky, helping to inflate asset bubbles worldwide (Gallagher, 2011).  The imposition of capital controls, such as taxes, price or quantity controls, or banning of trades in international assets, would have helped nations to deal with unstable and unsustainable asset bubbles (Neely, 1999). Instead, pressure from governments and major financial institutions ensured that the IMF continued to push strongly for the continued removal of capital controls on a global scale (Gallagher, 2011).

This removal of capital controls went hand-in-hand with another contributing trend, the deregulation of the financial services and banking industries.  A prime example of this is the repeal of the Glass-Steagall Act of 1933 by the Clinton administration.  This act separated commercial banking from investment banking, prohibiting institutions from having elements of both at once.  Since investment banking was largely unregulated at the time, as more and more institutions became hybrids, more and more of their activities became unregulated.  This meant that the use and development of risky and opaque (but high-yielding) financial instruments, such as mortgage-backed securities, became quite prevalent.  Additionally, in many nations, capital requirements to cushion potential losses were lowered, with America’s Securities and Exchange Commission going so far as allow firms to determine what was appropriate for themselves (Macdonald, 2012).  When combined with a lack of antitrust enforcement, these neoliberal policies of non-intervention resulted in the emergence of ‘too-big-to-fail’ financial institutions that took on excessive risk with ineffective safety nets (Stucke, 2010).  Similar spurts of deregulation occurred in other countries as neoliberal doctrine spread.  While this came via IMF/World Bank loan conditions for many developing countries, for developed countries the pressure came mainly from financial markets, business interests, and think tanks, both domestic and foreign in origin (Beder, 2009).  Had such deregulation not occurred, unconstrained financial innovation and its resulting lack of transparency likely could have been slowed or halted.

Although it is true that not all states liberalized at the same pace or to the same extent, the transmission of neoliberalism as an ideology between multiple state and non-state actors and its resultant liberalizing effect on policy is widely accepted to have occurred globally.  Nonetheless, an argument could be made that it was in fact too much governmental intervention, not too little, that helped to build pre-crisis imbalances.  For example, some argue that governmental agencies such as Fannie Mae and Freddie Mac in the United States helped to inflate the American housing bubble by buying, securitizing, and backing more than $1 Trillion worth of subprime mortgages, among other interventionist policies (Forbes & Ames, 2009).  However, this fails to explain why asset bubbles developed internationally and in countries without such agencies.  Nor does it an accurate representation of the situation, as the majority of risky subprime mortgages were made by private institutions, including 83% of subprime mortgages issued in 2006 (Goldstein & Hall, 2008).  The fact that private institutions held a majority of the riskiest assets (and primary contributors to the crisis) directly counteracts the central argument of neoliberal ideology, that private market actors will allocate resources efficiently and rationally.  Clearly, this was not the case.

Conclusion

Overall, it is clear that the development and transmission of neoliberal policies and ideas played a key role in the genesis of the global financial crisis.  In response to the perceived failures of state intervention in the economy during the 1970s, various non-state actors launched campaigns to embed an ideology of noninterventionism amongst the policy elite of different countries.  Additionally, several states placed significant pressure on intergovernmental and international institutions to both adopt neoliberal ideas and promote the spread of neoliberal policies on a global scale.  As a result, on the mistaken neoliberal assumption that markets are always rational and efficient, an array of economic imbalances and misallocations formed that could only be corrected by a near total collapse of the entire global financial system.  Although it is now known how neoliberalism as an ideology spread and how it played a role in the crisis, further research is necessary to determine why it was so difficult for different states to reject neoliberalism even as its many shortcomings became increasingly clear.  So as to ensure the maintenance of humanity’s economic well-being and security, it is vital that such questions are not left unanswered.

  Bibliography

Balaam, D. N., & Dillman, B. (2014). Introduction to International Political Economy. Boston: Pearson Education, Inc.

Beder, S. (2009). Neoliberalism and the Global Financial Crisis. Retrieved from University of Wollongong: http://ro.uow.edu.au/cgi/viewcontent.cgi?article=1220&context=artspapers

Birch, K., & Mykhnenko, V. (2010). The rise and fall of neoliberalism: the collapse of an economic order? London.

Correa, E., & Seccarecccia, M. (2009). The United States Financial Crisis and Its NAFTA Linkages. International Journal of Political Economy, 70-99.

Dowd, D. (2009). Inequality and the Global Economic Crisis. London: Pluto Press.

Duménil, G., & Lévy, D. (2013). The Crisis of Neoliberalism. In K. Yagi, N. Yokokawa, S. Hagiwara, & G. A. Dymski (Eds.), Crises of Global Economies and the Future of Capitalism: Reviving Marxian crisis theory (pp. 191-208). London, United States of America: outledge.

Forbes, S., & Ames, E. (2009). How Capitalism Will Save Us. New York: Random House.

Friedman, G. (2009). The Next 100 Years: A Forecast for the 21st Century. New York: Anchor Books.

Gallagher, K. P. (2011, February). Regaining Control? Capital Controls and the Global Financial Crisis. Retrieved from Global Development and Environment Institute at Tufts University: http://www.ase.tufts.edu/gdae/policy_research/KGCapControlsPERIFeb11.html

Goldstein, D., & Hall, K. (2008, October 12). Private sector loans, not Fannie or Freddie, triggered crisis. Retrieved from McClatchyDC: http://www.mcclatchydc.com/2008/10/12/53802/private-sector-loans-not-fannie.html#ixzz12xTyWY91A

Growing Income Inequality in OECD Countries: What Drives it and How Can Policy Tackle It? (2011, May 2). Retrieved from OECD: http://www.oecd.org/social/soc/47723414.pdf

Hubbard, R. G., O’Brien, A. P., & Rafferty, M. (2014). Macroeconomics. Boston: Pearson Education, Inc.

Jarvis, J. (Director). (2011). The Crisis of Credit Visualized [Motion Picture].

Kovach, H., & Fourmy, S. (2006, November). Retrieved from OXFAM Québec: https://oxfam.qc.ca/sites/oxfam.qc.ca/files/2006-12-06_Kicking%20the%20Habit.pdf

Krauss, M. (1997, May). How Nations Grow Rich : The Case for Free Trade. Cary, North Carolina, United States of America: Oxford University Press, USA . Retrieved March 30, 2014

Macdonald, R. (2012). Genesis of the Financial Crisis. New York: Palgrave Macmillan.

Neely, C. J. (1999). An Introduction to Capital Controls. Retrieved from Federal Reserve Bank of St. Louis: http://research.stlouisfed.org/publications/review/99/11/9911cn.pdf

Noah, T. (2012). The Great Divergence: America’s growing inequality crisis and what we can do about it. New York: Bloomsbury Press.

Sherman, B. J. (2011). Globalization Policies and Issues. New York, New York, United States of America.

Stucke, M. E. (2010). Lessons from the Financial Crisis. Antitrust Law Journal, 313-341.

Wolf, M. (2008, September). Fixing Global Finance. Baltimore, Maryland, United States of America.

Feedback Loops & Entrenched Patterns

Simple_Feedback_02

For some reason, yesterday seemed to be a day all about feedback loops, where dependent variables impact the independent variables, impacting the dependent variables and so on. I just wanted to write down my thoughts about it quickly, before I forget.

Too many people assume that life is full of simple causal relationships. For example, many people place blame on their external environment if they are in a bad mood. In their minds, the environment directly caused their bad mood. However, even if it initially started out this way, eventually the bad mood of the person will impact their environment. The mood of others will deteriorate as a result of Person A’s bad mood, and their bad mood will cause Person A’s mood to deteriorate further. It is a feedback loop – a vicious cycle that, if you think about it, only the introduction of positive external variables (e.g. caffeine, another happy person, etc.) can halt.

There are countless examples of feedback loops in the real world.  Naturally the best examples I can think of have to do with the economy and the political system.  I had already been thinking about feedback loops yesterday when an article from The Economist threw another example at me: business lobbying and government intervention.  Think about it: more governmental intervention begets more lobbying, which begets more intervention, which begets more lobbying….and so on.  In fact, this vicious cycle has become so powerful it has become entrenched, contributing to the rise of an elite class of politicians and crony capitalists.  This is a big explanation for widening income inequality: it is caused by a combination of business interests and the government working for one another.  The resultant strength of the lobbying industry due to this vicious cycle has also lead to “democratic sclerosis” (coined by Jonathan Rauch), in which it is nearly impossible to eliminate certain rules, loopholes, and programs.  Feedback loops have begotten entrenchment.

The business cycle is another example of a feedback loop – in fact, many market forces exhibit feedback loops and thus do not always reflect “rational” behavior.  Take an economic expansion.  Rising consumer confidence results in higher consumer spending & investment, increasing short term economic growth & creating jobs, which raises consumer confidence more and results in still higher spending & investment, and so on.  Eventually, like all bubbles, reality finally sets in – and the feedback loop vicious works in the opposite way.  Consumer confidence falls, lowering spending & investment, which drags down economic growth and job creation, resulting in still lower consumer confidence.  Whether these boom-bust cycles are healthy or not is a matter of debate – on the positive side, the booms mean that things get done faster than they otherwise would.  The downside is that booms can lead to improper investment, meaning the busts can be painful and damaging.

I could go on with more examples, such as the feared health insurance “death spiral”, where young healthy people do not buy insurance, raising premiums and further driving young people away.  The basic point has been established, though.  Feedback loops are an integral part of our lives, and when intense enough over long durations, can cause entrenched patterns that are near impossible to get out of.  They are simply amazing – and terrifying – all at once.

Healing the Dismal Science

Perhaps the most obvious feature of modern-day macroeconomics is the great Keynesian-Neoclassical divide.  Although it is a subject that is sure to turn up in any econ 101 course, I’ll provide a brief (if not crude) summary of the basics of each theory here:

Keynesian Economic Theory

  • Demand-focused & “consumer-oriented”
  • Advocates for active fiscal policy to combat recessions (cut taxes/increase gov. spending to boost aggregate demand)
  • Believes there is a “multiplier effect” of spending, including government spending (e.g. active fiscal stimulus can produce self-sustaining virtuous economic growth)
  • Highlights notions of excess capacity and full employment

Neoclassical (Supply-Side) Economic Theory

  • Supply-focused & “business-oriented”
  • Advocates for limited government to boost economy (e.g. cut taxes/trim regulations to boost supply of goods & services)
  • Places emphasis on incentives to save & invest

For years, especially since the Great Depression, macroeconomists have been split as to which theory best explains macroeconomic behavior and produces the best macroeconomic outcomes.  Although there have been periods of “consensus” (e.g. the postwar “Keynesian Consensus” from the 40’s to the 70s and a neoliberal “Washington Consensus” from the 80s up until 2008), divisions have been apparent for nearly a century.

Having studied the economic history of the nation and the pros and cons of each theory, I am left wondering: why must we accept only one theory to explain all macroeconomic behavior and to implement rigid pre-prescribed solutions for every economic situation?  After all, in my opinion, both theories have substantial vices and virtues, and both work well in different situations and for different objectives.  For example, Keynesianism appears to well when there are significant demand shortfalls (accompanied with a large excess capacity or low inflation).  I view it as the “short-term” theory as well, because it intends to boost consumer & business demand immediately.  However, when it comes to structural issues in an economy and promoting long-term growth, neoclassical supply-side solutions seem to work well.    It helps to alleviate supply shortfalls (which are usually accompanied with little excess capacity or higher inflation).  I view it as the “long-term” theory, as by increasing incentives to save and invest, it boosts productivity, which grows the economy in the long-term.

Even when one theory is better suited to address a specific situation, I don’t see why both theories can be implemented simultaneously.  Take today’s economic situation.  Almost 4.5 years after the 2007-2009 “Great Recession” ended, the United States still remains mired with low aggregate demand and enormous excess capacity (accompanied with high unemployment and very low inflation).  I am of the opinion that, in general, continued Keynesian short-term stimulus might be a feasible economic prescription (disregarding the role of public debt, which I’ll get to later).  However, there is no reason why we can’t simultaneously institute supply-side reforms now to boost long-term growth.  For example, I am of the opinion (as are many economists) that the healthcare sector is incredibly over-regulated.  Barriers to the supply of health care services include state prohibitions to sell insurance across state lines, underfunding of Medicare/Medicaid reimbursements, the threat to doctors of medical malpractice suits and new ObamaCare health insurance regulations that mandate that plans cover “essential services”.  If we were to lift state prohibitions on the out-of-state sale of health insurance, moderately boost funding for Medicare/Medicaid reimbursements, implement medical malpractice reform and lower or repeal ObamaCare health insurance benefit mandates, we could help to solve some of the healthcare sector’s supply problems, lower premiums, and boost growth prospects for that sector and the economy as a whole.  And that’s just for one sector.

My point is, we need to stop this zero-sum mentality in economics that one theory must be right while the other is wrong.  Only then can the “dismal science” finally begin to heal.  

 

First Post

Congratulations!  You are currently reading the 1st of what will hopefully be several Leightonomics blog postings.  Although it is true that this blog will largely be dedicated to economics (hence the “nomics” portion of the blog name), I intend to talk about all sorts of issues plaguing the world and to either mention or propose solutions to these issues.  I am especially interested in the public-policy realm, so don’t be surprised to find me posting about governmental budgets, taxes, health care, education, finance and, of course, macroeconomics.  

Well, that’s about as much as I’m willing to dedicate to the blog’s intro.  Let’s get started!