The President's New Plan

It's getting close to the mid-term elections in the US and President Obama has a new plan for business tax breaks. Robert Reich gave a great commentary on NPR's Market Place and the commentary seemed to be based (with some embellishment) on the causal model above (click on the graphic for an enlarged view).

The president is proposing corporate tax cuts for R&D. Tax cuts will lead to the development of labor-saving technology that reduces jobs. Profits might also generate some investment (if there is demand). Otherwise, profits will be expended on CEO pay and Shareholder dividends which fuel the Stock Market casino (didn't that all start the Great Recession in the first place, that is, too much easy money sloshing around).

The problem we're having right now is inadequate demand created by the Great Recession (you can see the vicious circle in the graph: lack of demand leads to lack of sales leads to lack of production which leads to unemployment which decreases demand, etc.). Interest rates could be lowered by the Federal Reserve but they are almost at zero (the zero-bound) right now. Exports could be increased but the rest of the world is also in recession. Imports could be reduced (e.g., automobiles) but that requires demand for US products.

What remains is the Keynesian economic prescription: government spending. There is only one problem with increased government spending: it is being blocked by deficit hawks, fiscal conservatives, sound money evangelists, and bond vigilantes. The same dynamic played out during the Great Depression until WWII intervened.

So, the President's New Plan will be counterproductive (R&D tax cuts could decrease jobs), the Fed is at the zero-bound, and government expenditure will not increase unless we have another World War. What's going to happen?

Eventually, the markets will have their way and, in the words of Andrew Mellon (Herbert Hoover's Treasury Secretary), the markets will:

...liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.

For people that believe in markets and for people that do not, Mellon makes an important point. All markets will eventually adjust to bubbles created in other markets (e.g., housing and the stock market). The adjustments are brutal and painful if not necessarily swift. Subdivided ghost towns will be bulldozed or left to decay, jobs will be shipped to low-wage countries, companies will fail, people will drop out of the work force or take jobs below their skill level, and eventually there will be a new equilibrium.

The politics of all this are a little infantile: The US father figure (the president) is expected to fix the mess yet, at the same time that he is expected get out of the economy by reducing expenditure and regulation. I just heard another great Catch-22 in NPR Marketplace tonight: all the stimulus funds have not been spent because there are not enough federal workers to manage the contracts.