Economic Theory, Reality and President Obama

Dangerous disconnects and hatred are endemic.

When in college, I majored in economics and enrolled in the honors program. That required that I write a paper on an aspect of economics. My field was micro-economics, how business works, and I elected to write my paper about the automotive replacement parts industry. My faculty adviser was Arthur Okun, then also a senior economist with President Kennedy’s Council of Economic advisers. He later served as the chairman of the Council of Economic Advisers between 1968 and 1969. While serving as one of President Kennedy’s economic advisers, he developed “Okun’s Law,” to the effect that

for every percentage point that the unemployment rate falls, real GNP rises by 3 percent. Okun’s Law is based on data from the period between World War II and 1960, and he cautioned that the law is good only within the range of unemployment rates—3 to 7.5 percent—experienced in that time period.

With an unemployment rate now far higher, a real one percent decrease (not a fictitious decrease based on greatly increasing numbers of unemployed people no longer looking for work and hence not counted as unemployed) might have a similar or even greater positive effect on the Gross National Product.

Like many economic laws, Okun’s is an observation of an empirical (real-world) regularity that is not based on any strong economic reasoning. Nevertheless, it has held up well, within the appropriate range of unemployment rates, since Okun discovered it. Yale’s James Tobin, who was Okun’s colleague both at Yale and on President John F. Kennedy’s Council of Economic Advisers (CEA), called Okun’s Law “one of the most reliable empirical regularities of macroeconomics.”

The words “empirical (real-world)” are delightfully refreshing to read now in anything dealing with economics.

Okun discovered the law while he was a senior economist with Kennedy’s CEA. The CEA wanted to convince Kennedy that the economy-wide gains from lowering unemployment from 7 to 4 percent were greater than previously imagined. Okun’s Law was a major part of the empirical justification for Kennedy’s tax cuts. At the end of President Lyndon B. Johnson’s administration, Okun was chairman of the CEA. (Emphasis added.)

Okun believed that wealth transfers by taxation  from the relatively rich to the relatively poor are an appropriate policy for government. But he recognized the loss of efficiency inherent in the distribution process. In Equality and Efficiency, the Big Tradeoff Okun introduced the metaphor of the leaky bucket, which has become famous among economists: “The money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich” (p. 91). Okun attributed these losses to the administrative costs of taxing and transferring, and to incentive effects. The poor who are receiving welfare or other transfer payments have less incentive to work because their transfer payments are reduced as they make more money. The rich have less incentive to work because high marginal tax rates take a large fraction of their additional income (top tax rates were between 50 and 70 percent at the time he was writing). The relatively rich also have more of an incentive to spend on tax-deductible items and on tax shelters as a way of avoiding taxes. “High tax rates,” wrote Okun, “are followed by attempts of ingenious men to beat them as surely as snow is followed by little boys on sleds.” For these insights, Okun can be considered one of the original supply siders (see supply-side economics). (Emphasis added.)

According to a summary at Wikipedia,

Supply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created by lowering barriers for people to produce (supply) goods and services, such as lowering income tax and capital gains tax rates, and by allowing greater flexibility by reducing regulation. According to supply-side economics, consumers will then benefit from a greater supply of goods and services at lower prices. Typical policy recommendations of supply-side economists are lower marginal tax rates and less regulation.[1]

Supply side economics must be Republican Voodoo economics, like workfare, now gutted by the brilliant Obama Administration:

Nobel prize winning economist Paul Krugman published a book dedicated to attacking the [supply side] theory, and Reaganomics, under the title “Peddling Prosperity.” (Insert added.)

Later, while at the Brookings Institution, Mr. Okun also “invented” the “misery index,” calculated by “adding together the unemployment rate and the annual inflation rate.”

During the Richard Nixon administration (1969-74), the “misery index” rose as high as 13.61.

The peak during the Gerald R. Ford presidency (1974-77) was 19.9, and was a major factor in his defeat in the 1976 Presidential election.

During Jimmy Carter’s presidency (1977-1981), the “misery index” hit 21.98, and was at least partly responsible for his defeat in the 1980 election.

Since our unemployment figures (even though persistently high) are now fictitiously low and our inflation index (based on the Consumer Price Index) is rather subjective in composition, there is no simple way to calculate a meaningful misery index today.

Mr. Okun’s field was macro-economics, the study of how the economy works as a whole, often with governmental intervention. He was also well versed in micro-economics and managed to take full account of it in dealing with macro-economics. During our discussions I came to understand why in a free capitalist society macro-economics is dependent on micro-economics. Unless the private sector economy functions adequately (in the micro-economic sphere), there can be no viable macro aspect if for no other reason than that the private sector produces the funding needed for governmental intervention, when necessary, in the macro-economic sphere.

Funds to develop a new or to expand an old business have to come from somewhere. If an entrepreneur has enough money, he can of course use his own. He can also sell stock to raise money, giving investors an equity share in the business in exchange for their funds. He can seek loans in exchange for bonds; the potential return on bonds is usually fixed and may be lower than the return on equities but should the business go bankrupt the bond holders normally stand first in line for repayment. There are various classes of stocks and bonds, each having its peculiar characteristics. Our Government, unwisely, has over the years become expert not in business but rather in crony capitalism, whereby the Government provides funds private citizens are unwilling to invest. Often, the purpose of Government in making such “investments” is not to make money but to advantage politically well connected campaign donors who, rather than invest in their own schemes, had made, and are in the future expected to make additional, large campaign donations. Often, their campaign donations are thus returned to them many times over.

The Government gets involved in business formation in other ways. Regulation of the securities market by the Securities Exchange Commission is one way. Acting as an exchange for federally issued debt is another. The latter can depress or increase market rates of interest while simultaneously increasing or decreasing the quantities of money in circulation. Since most funds are created and spent electronically, this does not require running the presses to print more paper money. Currently, Quantitative Easing III is in effect, to keep interest rates low. Since interest rates on such notes are already close to zero, QE III is unlikely to push market rates down further. It may help the banks, but seems unlikely to help industry or consumers. Nor is QE III likely to induce entrepreneurs to invest in businesses to produce or to sell goods or services for which adequate demand does not exist or when what they would like to do is hindered by burdensome and frequently changing government regulations. As noted here,

In a Speech before the Harvard Club of New York City, bank President Richard Foster publicly restated his opposition to the Fed’s recent decision to launch “QE3,” its third attempt in three years to use monetary policy to stimulate the economy. Foster began his speech noting that “with each program we undertake to venture further in that direction (in the direction of using monetary policy as stimulus), we are sailing deeper into uncharted waters. We are blessed at the Fed with sophisticated econometric models and superb analysts. We can easily conjure up plausible theories as to what we will do when it comes to our next tack or eventually reversing course. The truth, however, is that nobody on the committee, nor on our staffs at the Board of Governors and the 12 Banks, really knows what is holding back the economy.” (Emphasis added.)

Perhaps they might look at the economy, the general failure of business creation and the resultant high employment from a micro-economic perspective.

Later in the speech, Mr. Foster noted that our economy “is already flush with $1.6 trillion in excess private bank reserves owned by the banking sector and held by the 12 Federal Reserve Banks. Trillions more are sitting on the sidelines in corporate coffers. On top of all that, a significant amount of underemployed cash—or fuel for investment—is burning a hole in the pockets of money market funds and other non-depository financial operators. This begs the question: Why would the Fed provision to shovel billions in additional liquidity into the economy’s boiler when so much is presently lying fallow?”

Might it be lying fallow because of excessively intrusive governmental regulatory activity and uncertainty over what the regulators will do next?

The economy is being held back despite trillions of dollars “lying fallow,” and the highly educated experts at the Federal Reserve can’t figure out why. Mr. Foster deserves our thanks for being so truthful – yet we should all be concerned about his observations.

Of course, it was only three months ago when Chairman Ben Bernanke admitted that he had “no idea” why our economy is so “fragile.” This is the man who has overseen the lending of more than $3 trillion American taxpayer dollars to foreign banks; the rapid-fire acquisition of the former giant Merrill Lynch by the gargantuan Bank of America; the multi-billion dollar taxpayer bailout of Wall Street; and – although he craft legislation or sign bills in to law, he nonetheless supported the $800 billion “economic stimulus bill” from the Congress and the Obama Administration. (Note: there seems to be a syntactical garble in the last sentence and I haven’t been able to figure out quite what is intended.)

Maybe biting off the heads of roosters, as I once saw done at a Voodoo ceremony in Haiti, might work. That would be real Voodoo economics.

During President Obama’s first three years in office,

106 new major federal regulations [meaning that each had an expected economic impact of at least $100 million per year] added more than $46 billion per year in new costs for Americans. This is almost four times the number—and more than five times the cost—of the major regulations issued by George W. Bush during his first three years. Hundreds more regulations are winding through the rulemaking pipeline as a consequence of the Dodd–Frank financial-regulation law, the Patient Protection and Affordable Care Act, and the Environmental Protection Agency’s global warming crusade, threatening to further weaken an anemic economy and job creation. Congress must increase scrutiny of regulations—existing and new. Reforms should include requiring congressional approval of major rules and mandatory sunset clauses for major regulations.

Most such regulations have made doing business more difficult and costly while providing few necessary protections to consumers or others.

Some governmental regulation is necessary; by way of analogy, we need sensible efforts by the police to prevent crimes and to capture the perpetrators of crimes they did not prevent. People also need to learn not to make themselves vulnerable to criminals by, for example, leaving valuables where they can be stolen easily. Although we need sensible governmental regulation of business, a common public attitude of “buyer beware” is in many cases more useful; instead, successful litigation producing outrageously high settlements or judgments seems unlikely to make buyers more cautious when buying and using stuff: they might get lucky enough to win a Darwin Award as well as enough in damages to last a lifetime. The practice of tort law is quite lucrative, and the plaintiffs bar makes substantial political donations, principally to Democrat candidates.

Mr. Okun was quite helpful and we consulted frequently as I wrote my paper. He offered suggestions for my paper, approved it and seemed to like it. He offered to recommend me for a job in Washington in the field of economics should I pursue the subject in graduate school. I wanted to pursue the law instead and didn’t take him up on his gracious offer.

Mr. Okun died on March 23, 1980, at the young age of fifty-one. I wonder what he would say were he still alive about President Obama’s macro- and micro- economic policies. President Obama seems to have done his best to retard rather than to advance the private economic sector and his policies to that end have been quite effective. He has lost sight – if he ever had any – of how the micro-economic sector works and why it works best with the minimal governmental interference necessary coupled with preventing predatory conduct as long prohibited by our substantially unenforced antitrust laws. Those laws, the Sherman Antitrust Act and the Clayton Anti-Merger Act, should be but are not a principal foundation of our national economic policy.

In 1966, during a short period of employment following law school while I awaited the call to active duty as an Army JAG officer, I worked at the Antitrust Division of the Department of Justice. I was hired by Don Turner (PhD, Economics, Harvard; LLB, Yale), the Assistant Attorney General in charge of that division, who had presided as a judge at an antitrust moot court competition in which I had argued. He put me to work in my own little corner of the Evaluation Section analyzing the antitrust implications of the “ethical” (prescription) drug industry. Based to some extent on my work there, a section was thereafter created within the Antitrust Division to prosecute patent and other antitrust abuses in that industry. Turner, a strong proponent of antitrust enforcement left the Division in 1968. When I returned briefly to the Antitrust Division in 1970 following my four years of active duty with the Army, the place seemed to have much less vitality. I sensed that the private practice of antitrust law would not be profitable and so found employment as an associate, later partner, with a communications law firm in Washington. Although I have not recently followed the subject with the intensity I once did, antitrust enforcement currently seems weak and to have been so for quite some time.

Were our antitrust laws enforced as they should be, they could obviate the need to deal with corporations “too big to fail” which, like General Motors, were bailed out under President Obama in a manner avoiding the proper application of our bankruptcy laws and instead designed to protect the autoworkers’ union – a big supporter of President Obama – at the expense of the bondholders who had invested in the company. Businesses need investors to purchase their private debt and our bankruptcy laws are intended to give them primacy over others when things cease to go well. Now, following its bailout, General Motors still is not doing well.

President Obama is proud of his bailout of General Motors.  That’s good, because, if he wins a second term, he is probably going to have to bail GM out again.  The company is once again losing market share, and it seems unable to develop products that are truly competitive in the U.S. market.

Right now, the federal government owns 500,000,000 shares of GM, or about 26% of the company.  It would need to get about $53.00/share for these to break even on the bailout, but the stock closed at only $20.21/share on Tuesday.  This left the government [i.e. the taxpayers] holding $10.1 billion worth of stock, and sitting on an unrealized loss of $16.4 billion. (Insert added.)

The flamed famed Chevy Volt is not doing well, even though it may have saved or created some firefighting jobs.

Should the Government ever disengage from General Motors, the taxpayers will take a hit not unlike the hits taken by the bondholders, stockholders and the pension funds that had invested in General Motor’s bonds and equities. Now, Osama bin Laden is dead and General Motors is on life support. Solyndra? It died while on life support provided by the Obama Administration even after earlier help didn’t work.

Senior Obama Administration officials decided to restructure the government’s half-billion-dollar loan to the California solar energy firm Solyndra even after government analysts had concluded it would cost taxpayers far less to allow the company to fail, according to a newly released report on the investigation into the Solyndra matter by House Republicans.

The decision appeared to be made at least in part out of concern with how it would look if Solyndra — the first recipient of government funds meant to spark growth in the nation’s production of cleaner burning fuels — went bust, according to the report, which quoted extensively from internal administration emails.

Opps.  Here goes another $190 million to another Solyndra.

LOS ANGELES — A tiny San Jose solar company named SoloPower will flip the switch on production at a U.S. factory Thursday, a major step toward allowing it to tap a $197 million government loan guarantee awarded under the same controversial program that supported failed panel maker Solyndra.

President Obama seems to view everything through the lens of politics and that lens magnifies the importance of campaign contributions and political loyalty while minimizing the importance of a sound private sector. He has no significant experience in the private economic sector and appears not to have studied it other than as based on his perception that it ranks among the worst enemies of his vision for society. Unless and until we have a President who has adequate experience in the private economic sector, views it as the nation’s means of support rather than as its enemy and considers the advice of others with similar views, our national economy will continue to go down the spiral drain.

If President Obama succeeds, we can bid a slow and tedious farewell to the benefits of free enterprise. As it dies, even recipients of politically useful Federal largess will gradually have to do without the benefits they now receive. Without a viable private economic sector, governments have no viable means to provide those benefits unless they usurp the place of the private sector — as in North Korea, China and other non-free, non-democratic states. If that is what we want for our nation, we should support President Obama and give him another four years to work his will, with “increased flexibility.”

Some things work pretty well, and some are basackwards. Thanks and a h/t to Dancingczars for this photo.

Was President Obama driving that car with the big Obama window sticker?

About danmillerinpanama

I was graduated from Yale University in 1963 with a B.A. in economics and from the University of Virginia School of law, where I was the notes editor of the Virginia Law Review in 1966. Following four years of active duty with the Army JAG Corps, with two tours in Korea, I entered private practice in Washington, D.C. specializing in communications law. I retired in 1996 to sail with my wife, Jeanie, on our sailboat Namaste to and in the Caribbean. In 2002, we settled in the Republic of Panama and live in a very rural area up in the mountains. I have contributed to Pajamas Media and Pajamas Tatler. In addition to my own blog, Dan Miller in Panama, I an an editor of Warsclerotic and contribute to China Daily Mail when I have something to write about North Korea.
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4 Responses to Economic Theory, Reality and President Obama

  1. Pingback: Opinion Forum » Economic Theory, Reality and President Obama

  2. Boeke says:

    Okuns law is not very convincing, it looks like the effect of happenstance as much as relationship. Anyone can cast around in a bunch of statistics and find a weak relationship that works over a small range and for a short time in history. It is NOT profound.

    Macro Economics is dominated by Demand-side effects and Supply-side economics is just a minor adjustment, in capitalist economies, where the customer rules (supplyside is more effective in Communist systems where planning is centralized and done by suppliers) . And WE are definitely in a consumer (customer) economy. Economic events are dictated by buyers, not suppliers. Supply-side analysis depends on continuous unchanging Demand.

    The reason $5-7trillion is sitting idle is because of NO DEMAND! No businessman is going to invest in an industry and go out and hire workers if there is no demand for his product.

    “Might it be lying fallow because of excessively intrusive governmental regulatory activity and uncertainty over what the regulators will do next?”

    No. Would you, as a businessman, idle your business and lose real money (and real marketshare) to competitors just because of regulatory changes? No. After all, the competition is subject to the same regulations, so it’s a wash.

    That money is lying fallow because of the great loss of income among the masses, and the subsequent diminished demand. The cure is to direct more money at the least paid among us, even if we must tax the richest. The “99%” have the highest Marginal Propensity To Spend and thus the highest Economic Multiplier.

    In fact, those trillions of dollars of idle capital represent a huge “redistribution” from the modest to the wealthy (as evidenced by the huge bifurcation of income and capital during the Bush years through tax advantages and administration policy).

    Regulations and taxes are just Bean Counting to a successful businessman.

    Talking about “real businessman” I have real reservations about Romneys qualifications as a businessman since he looks like Just Another Liquidator to me. He’s the guy you call in to burn the town down and sift through the ashes for peoples gold teeth. I don’t see where he’s ever built a product and built a company based on that product. He just makes money off other peoples misery. A business Undertaker.

    YMMV.

  3. Pingback: » Economic Theory, Reality and President Obama » Tea Party Tribune

  4. Mike says:

    Excellent.
    I continue to believe that Obama is an economically uneducated Socialist Radical. Bringing down the system Cloward-Piven style is not something he is afraid of. The problem with many if not most of our concerns is the premise we are building them on… we assume any person in their right mind would want things to get better.

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