Back To The Basics

(Cross-posted at Heritage)

In the New York Times today, David Brooks has a column in which he describes two theories about the financial crisis: “greed” and “stupidity.” The “greed” theory is not what you might be thinking—it is not the simplistic notion that Wall Street is just full of greedy capitalists that swindle the people out of their money. It is a little bit more sophisticated than that, because it involves the government bailing out the banks. They do this, of course, because politicians earn handsome rewards for it. This theory has some merit.

The second theory, “stupidity” is also more sophisticated than it sounds. Wall Street did not know that it was engaged in such risky behavior. The theory as presented blames the complex financial instruments, but one could as easily blame monetary policy, subsidies, bailouts, or policy uncertainty, for creating this ignorance.

Government certainly had a hand in creating this crisis, yet now these same leaders are attempting to blame free markets, and resurrect socialism. Right before our eyes we are seeing the pattern: even as government spending backfires, we cede more control to it, and the love and faith in politicians grows. Even free market economists forget the basics.

Now more than ever, we need to return to the fundamentals. We need to relearn our Adam Smith, our Frederic Bastiat, the roots of liberalism and the morality of freedom. Only if the people understand these basic principles do we have a chance. Then we can see through the politicians, and not let them take our freedom and control our lives.

Changing Places: Europeanization as a Good Word

(Cross-posted at Heritage)

The financial crisis has exposed a trend that has been in the works for some time. Since the fall of communism, some of the more socialist countries have learned lessons from the Soviet collapse: free markets work, and government planning does not. Meanwhile, the capitalist countries have slept through these lessons, and have been slowly becoming more socialist.

The financial crisis has made this crystal clear. For example, US car companies, and now auto parts dealers, have received bailout money. Sweden, every liberal’s favorite social-democratic country, has let their signature car company, Saab, fail.

While the US Federal Reserve has been finding creative ways to print our way out of this financial mess, the European Central Bank has resisted this doomed inflationary policy. The European Union is actually concerned about high taxes, inflation, and excessive spending.

From the formerly communist Czech President of the European Union, we have a warning that Obama’s spending frenzy is a “road to hell,” but from the formerly free market United Kingdom, we have the Prime Minister calling for a Global New Deal.

It seems that, in the 21st century, “European style economy” might come to mean “free market” and “American style capitalism” might be a new term for “socialism.”

The Real Danger of World Government

(Cross-posted at Heritage)

Even more than rent-seeking and government expansion here at home, the greatest danger of a left-leaning Obama administration may be the danger of capitulation to a new world government.

In the past, “One World Government” has been seen as a rallying cry of a fringe group, not something that many in the mainstream would either fear or desire. But, suddenly today it is on the lips of world leaders. The recent financial crisis is being blamed on a lack of world government.

The Financial Times reports:

Jacques Attali, an adviser to President Nicolas Sarkozy of France, argues that: “Global governance is just a euphemism for global government.” As far as he is concerned, some form of global government cannot come too soon. Mr Attali believes that the “core of the international financial crisis is that we have global financial markets and no global rule of law”.

But, the financial crisis was not caused by a lack of international regulation. Financial crises in the past have tended to occur more due to intervention than due to lack of regulation, and each of the banks that failed in this crisis was regulated by at least one country. Monetary policy was a major cause of the 1929 stock market crash and is implicated in just about every other crash.

In addition to dangerous monetary policy, one of the underlying causes of the Asian financial crisis of the late 1990s was government industrial policy, “As part of their industrial policy, governments have directed funds toward favored industries at low rates of interest… This leads to excess lending to the companies that are well-connected and who may have bought influence with government officials.”

This is the same kind of corruption and rent-seeking we’ve been seeing back here at home, with Fannie Mae and Freddie Mac, and in other areas of government. Extensive government reach into markets is what causes crashes and recessions – not a lack of even more expansive government reach.

These leaders want not only to abandon capitalism as we know it, but they want to force these ideas upon all countries by regulating companies at the international level. This kind of anti-market world governance would not make peace more likely, nor would it make free trade more possible or financial crises less frequent.

It Will Never Be Enough

(Cross-posted at Heritage)

A Christian Science Monitor article this morning argues that Roosevelt didn’t spend enough to jolt economy into recovery. Only when spending skyrocketed for World War Two did the economy recover (unemployment finally dropped, of course this was because everyone was mobilized either as soldier or to support the war effort – creating things which were then destroyed in fighting the war). The Article claims that “One big reason is that President Roosevelt didn’t spend enough to really boost the economy, historians say.”

Notice, that it isn’t economists that argued that the programs should have been bigger in order to boost the economy, but historians. This is like getting a philosopher’s opinion on astrophysics. It’s nice, but it shouldn’t be taken as expert.

The article goes on to point out that many economists do think that government spending can stimulate an economy. So, let’s examine this argument a little more closely. After 1929 and before World War Two, federal expenditures tripled as a percent of Gross Domestic Product. If we tripled federal expenditures as a percentage of GDP today, that would mean an additional 8.2 trillion dollars in government spending each year. That is because federal expenditures are already 20 percent of GDP.

Perhaps we don’t have to also triple the government’s role to have the same “stimulus” as Roosevelt. One might argue it is the amount of spending as a percentage of the economy that matters. Roosevelt added about seven percentage points overall of additional annual federal spending (bringing spending from about 3 percent of GDP to about 10 percent).

An additional seven percentage points of GDP today constitutes an additional $1 trillion per year. This is a lot less than 8.2 trillion, but it is still nothing to sneeze at. Yet, are we not already pouring in this much to the financial bailouts? This is the same amount of additional government spending already – hence the need for journalists to argue that FDR’s additional spending wasn’t enough.

The problem is that government spending will never be enough to stimulate the economy. Just think about it this way. We have GDP of about $42,000 per capita. The federal government spends about 20% of GDP. In England, government spends about 45 percent of GDP and GDP per capita is about $33,000. In Sweden, the government spends about 50 percent of GDP and GDP is only $32,000 per capita. In France, it is 53% and $30,000. As we all know, in countries where government spends approximately 100 percent of GDP hardly any output or value is created. This insight formed the basis for such respected indices as the Index of Economic Freedom.

So, the idea that injecting a jolt into the economy by having government spend more as a percent of GDP is highly suspect. If what Roosevelt spent was not enough – despite tripling the government expenditures at the time – we should wonder whether any amount will ever be enough.

The Efficient Muffin Hypothesis

During this financial "crisis" and subsequent bailout, some Austrian economists have surprised me with their optimism. Essentially, they argued that the market will pull through. Even if stupidity got us into the mess, and stupidity was going to compound the mess, so long as the market is allowed to chug along we will always ultimately "grow our way out." In the end, these Austrians argued, we would end up better off after the crisis and bailouts are all over (say, a few years hence) than we were before the whole thing started. We might have been even better off had we not passed some of the stupid policies, but we would only lose growth, we would not shrink in real terms.

Austrians also talk a lot about inflationary policy, or other kinds of foolish policies that governments engage in for a short term fix, despite having bad longer term consequences, as being like a drinking binge. They then argue that you can't cure a hangover with more drinking.

Now, if original hedonistic policy is like the binge drinking of a wild night, then the morning is the time for recovery. And if, in fact, if a semblance of protection for private property rights is all it takes to "grow our way out" then we can pretty much use whatever hangover cure we want, and be alright.

We can call this the "efficient muffin hypothesis," because the muffin we eat for breakfast manages, as it breaks down, to metabolize away the worst of the negative effects of our night of drinking. This theory says that we will make it through the hangover and to complete recovery fairly quickly. We can even have a mimosa with the muffin to take the edge off.

The inefficient muffin hypothesis, then, would state that in fact any old hangover cure may not work, the effects of these policies may compound each other, and we may never recover. In this scenario, the muffin cannot purge the poison, nor can time alone, and permanent damage may have been done.

Now, if the efficient muffin hypothesis is true this has significant implications. If, so long as the market is not completely banned, the wee market left can always "grow us out" of any idiocy of government policy, then we might have to take a second look at whether these policies are so bad. A night of drinking ain't a bad thing, sometimes.

The Charmed Circle

(cross-posted at Heritage)

Candidates running for president in recent decades have sounded in their speeches more like they believe they are running for the position “God” rather than the position “President of the United States.” John Stossel pointed this out in his recent special on 20/20.

Politicians claim that they can solve economic crisis, prevent natural disasters, keep the enemy at bay, create millions of jobs, and so on. Gene Healy argues in his book The Cult of the American Presidency that the executive has incredible power outside its original constitutional limits in part because we have fallen for this idea that the president can save us. The candidate we like we think can cure all our ills, while the one we dislike will destroy the country over night. But, he argues, in fact both are probably about equally destructive because the power given to the position and the scope of the government’s role is the core problem, not who sits in the office.

It wasn’t always this way. Although government was a tiny fraction the size it is today, Calvin Coolidge was a proponent of privatizing those concerns where the state had taken control and failed. There are so many time when these words would have been appropriate these past decades, but so few times when this sentiment was aired, and fewer when the action was taken:

If anything were needed to demonstrate the almost utter incapacity of the National Government to deal directly with an industrial and commercial problem, it has been provided by our experience with this property.

In that speech Coolidge mentions the “enormous debt” of $30 per person or $150 per 5-person household. Adjusted for inflation, $30 would be about $352 dollars today. Our per capita national debt today is about $35,000. Yet, he saw the debt as a serious concern, and vowed to reduce it. Just a few years later he was able to make these remarks – just imagine we could say this today:

We have substituted for the vicious circle of increasing expenditures, increasing tax rates, and diminishing profits the charmed circle of diminishing expenditures, diminishing tax rates, and increasing profits.

Four times we have made a drastic revision of our internal revenue system, abolishing many taxes and substantially reducing almost all others. Each time the resulting stimulation to business has so increased taxable incomes and profits that a surplus has been produced. One-third of the national debt has been paid, while much of the other two-thirds has been refunded at lower rates, and these savings of interest and constant economies have enabled us to repeat the satisfying process of more tax reductions. Under this sound and healthful encouragement the national income has increased nearly 50 per cent…

Notice that he spoke of the “national debt” not the deficit being paid off. What America needs today is not a president who promises hope and dreams, and to cure our ills with more spending, but a president that sees how far outside constitutional bounds we have come, and vows to get us on the path of that charmed circle of reducing expenditures, cutting taxes and increasing our private prosperity.

America Serves

(cross-posted at Heritage)

President-elect Barack Obama has quietly changed the meaning of the American Dream and introduced a proposal for American Serfdom. In America, what it means to serve one’s country is very clear. It is voluntary and for the purpose of defending the country during a time of war, or for the purpose of upholding the constitution by serving, for example, as a judge or on a jury.

Obama has reinterpreted the American Dream of “life, liberty and the pursuit of happiness,” as a collectivist ideology. He believes it is a dream about the collective happiness. He connects the notion of “service” to the American Dream, as he interprets it:

When you choose to serve -- whether it's your nation, your community or simply your neighborhood -- you are connected to that fundamental American ideal that we want life, liberty and the pursuit of happiness not just for ourselves, but for all Americans. That's why it's called the American dream.

Obama is wrong. It is called the American Dream because in America the individual is secured rights and liberty, and with those rights protected and liberty ensured anything is possible. The American Dream is an individual dream. It is the dream of each of us, not the dream of a collective hive, or a collective outcome. This is not to say that private charity in un-American. Private charity and civil society are very much part of the American spirit. But this is because they are private and voluntary.

But then Obama goes on to describe what it means to him to serve. He has a list of new “corps” to add to his expansion of the Peace Corps. Then he lists “a plan to require 50 hours of community service in middle school and high school and 100 hours of community service in college every year.” That is, 500 hours of mandatory community service.

Obama says that it is when “you choose to serve” that you are connected to the American Dream. But this quote is used to bolster support for a program which includes mandatory community service for every American child and college student. So, now mandatory community service is the American Dream. Now, it is not an independent pursuit of a better life but performing manual labor for the state that constitutes the American Dream.

Now to serve one’s country in America will have the taste of being a servant to the state, a serf, rather than the proud voluntary service of a free man.

The new New Deal

Cross Posted at Heritage

Could the current crisis usher in a new “New Deal”, with a new brand of corporatism to replace the free market system? Certainly European leaders are arguing that case. The current economic “crisis,” may itself have been caused by bad policy. Yet, is provides a great pretext for an expansion of government.

During the 1930s, as part of the New Deal, Franklin D. Roosevelt nationalized banks, set prices, wages and work hours, and promoted public works programs to employ the unemployed. The New Deal, or the National Industrial Recovery Act (NIRA) to be precise, was supported by many industrial leaders, some of whom had helped draft the legislation. Cartels, inflated prices and subsidies were great perks for established business, especially those that would have trouble staying ahead in a free market.

Businesses then, as now, cried to Congress about their need for a bailout, and the disaster which would be wrought by their bankruptcy. NIRA was eventually declared unconstitutional. The decision made the important point that “extraordinary conditions do not create or enlarge constitutional powers.”

Until then these laws were widely supported and considered critical to recovery from the economic crisis of the time. Yet intervention did more to cause and prolong the crisis than to aid recovery.

Although these measures were defended as being necessary during an emergency, and only temporary, many still exist today. For example the emergency farm supports created with the Agricultural Adjustment Act (AAA) have morphed into the current Farm Bill, which still pays farmers not grow food.

Like the New Deal period, we are seeing waves of nationalization, bailouts of unrelated industry, and expansion of central bank power. The nationalization of banks during the New Deal was actually smaller than what we are doing today – as a percentage of GDP it was the equivalent to about $500 billion. Today the state took shares in the largest nine banks and bailouts total well over a trillion dollars.

As John Goldberg points out, the stake that government now holds in these banks is actually greater than the stake it held in Fannie Mae and Freddie Mac, and it is quite likely that this temporary measure might too become the regular state of affairs.

If Obama is the next president, he would like to see a return to union domination and government mediation in wages and hours. Obama also favors public works programs to employ those out of work. He has already proposed at least two kinds of programs like this: his “transitional jobs” program which hires the unemployed, and his National Infrastructure Reinvestment Bank. With the excuse of an ongoing recession, he could easily roll these into New Deal sized public works projects.

But, prior to the New Deal we had small government. Prior to this new “New Deal” we already have enormous government and massive debt. The Deal we sign today would be for European style socialism, with European style unemployment and stagnation.

Mortgage Socialization

Cross-posted at Heritage.

Fannie Mae and Freddie Mac were created during the New Deal by the Roosevelt administration in order increase home ownership. With government backing and price controls, the supply of housing was artificially increased, with the funds coming from the taxpayer.

Even when Fannie and Freddie were made into government sponsored enterprises (GSEs) in the 1960s, they were still provided the financial support of the Federal Government. Because of their implicit government guarantees, these policy-based suppliers came to dominate the housing market.

As GSEs, Fannie and Freddie purchased 44% of subprime mortgage securities and were the biggest buyer of Countrywide loans. They became an industry duopoly, owning or guaranteeing about half the $12 trillion mortgage market. Risk was socialized, spread across all taxpayers through government guarantee, while profit was concentrated and private. This is a prototype case of government thriving on “concentrated benefits and dispersed costs.”

The ability to do this is what drives government expansion, taking from the masses and channeling the money to a minority – or special – interest. With these special interests, campaigns were launched, politicians entrenched and bureaucracy expanded. Hence Fannie and Freddie represent a massive rent seeking operation, to funnel money into the hands of officials at the expense of the taxpayer.

And yet none of this was sustainable, because it wasn’t profitable. Inevitably there would be collapse. Fannie and Freddie engaged in Enron-style accounting, and mafia-like corporatist tactics. It was their privileged status that led to the corruption, and that distorted the housing market and helped to inflate the housing bubble (also made possible by loose monetary policy).

The government takeover only makes all of these things worse. In the short run there is relief that a market collapse won’t occur imminently, but like the Soviet Union during perestroika, the fear of pain during reform can only lead to the delay of collapse and a more painful landing. Further concentration can only cause further waste, as competition, profit guidance and valuable price signals give way to bureaucracy, rent-seeking, inflation and misdirected investment.

As nationalized firms, Fannie and Freddie are government agencies, relying entirely on public funding. They have no reason to keep costs low, and every reason to allow short-term political objectives to guide their choices instead. Indeed, the Treasury has made it very clear that they will specifically move away from profit guidance. Treasury secretary Paulson said on Sunday that the entities “will no longer be managed with a strategy to maximize common shareholder returns.”

Paulson has promised that the fees they charge banks for loan securitization services will be examined “with an eye toward mortgage affordability,” even as they are neck deep in bankruptcy. This reminds me, again, of the logic of perestroika – instead of freeing prices up and allowing some market adjustment, so that the economy could finally get on track, a compromise was made. Prices would be “based on social costs,” companies were allowed to “take into consideration cost-effectiveness” but “speculative price increases aimed at excessive profit” were forbidden.

The logic of the expanding U.S. government is becoming just as warped. The socialization of risk caused the housing crisis, and the response is to nationalize. Risky lending driven by policy not profit caused the collapse and the “reforms” will reduce fees and shun profitability. If we keep moving in this direction, we’ll pass through our own reverse perestroika, and end up a socialist state.

The Future of Mandatory Service

(Cross-posted at Heritage)

Time magazine ran a story back in 2007 on “The Case for National Service.” The story described the positions of the candidates for president on expanding “public service” programs. Two of the Democrat candidates favored mandatory community service by all high school students. And two others — Hillary Clinton and Joe Biden — favored creation of a U.S. Public Service Academy for training civil servants.

Barack Obama has centered speeches around this idea of public service. He waxes sentimental about what we can each do for our country. All in one speech, he said that we must “answer a new call to service to meet the challenges of our new century” and that he “won’t just ask for your vote as a candidate” but “will ask for your service.” And he said that, in fact, this is the cause of his presidency.

Obama, though, is not listed as favoring this proposed academy. Instead, he proposes expanding AmeriCorps and the Peace Corps along with several other programs, and offering funding to students in exchange for community service. We can only hope that he isn’t convinced by his supporters and colleagues to change his mind on this.

Proponents of the academy argue that we’re facing a shortage of public servants, and such an academy could help. Of course, they do not mention that we could reduce the size of government instead of training our youth like soldiers to work for an ever expanding public sector.

It isn’t mere rhetoric to say they would be trained like soldiers. Supporters of the bill have called the proposed academy the “civilian counterpart to the uniformed service academies.” But we should not need a civilian counterpart to the military service academies beyond the police academies that already exist — because the civilian counterpart to the military is just the police officer corps.

Another scary thought is that the belief in mandatory community service for high school students, or mandatory military service as Rep. Charlie Rangel (D-NY) has proposed, could combine with this call for a Public Service Academy. In fact, Rangel himself suggested that under his proposal, “Recruits not needed by the military in any given year would be required to perform some national civilian service.” He argued that mandatory service would close the economic gap, in which the poor are forced to serve disproportionately. However, this gap is actually a myth.

The idea that America’s youths should train like soldiers to serve government on the domestic front is contrary to the freedom and independent spirit this country was founded on. Furthermore, such programs are reminiscent of Soviet youth programs and Soviet job programs, and would similarly incorporate propaganda beneficial to the government in power. A free economy founded on small government has no need for such things — and they set a dangerous precedent.

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Ask what you can do for your country? What happened to your civil servants serving you - the government as a service to us, to protect us, so long as we vote for it to do so, and no longer? How did this mutate into the ideal of citizens showing their love for government through potentially mandated terms of service?

A Race to the Bottom

Could it be that governments around the world are competing so hard for investment that they are actually going to bottom out on business taxation one day soon? This is the best sign I have seen in some time - since the big trend toward flat taxes by former communist countries - that indeed a small-government world is possible.

Note that I am not saying that tax trends overall have been good, but consider the evidence regarding business tax competition.

(1) Corporate income taxes are lower in all except four OECD countries than they were in 1986 -- unfortunately, overall taxes as a percent of GDP have gone up in every one. Seven OECD countries cut corporate rates between 2006 and 2007.

(2) The reduction in rates since 1986 and the low rates in OECD countries today are the result of conscious competition among countries for investment income. Because of this competition Germany, which has lagged other European Union countries in lowering corporate tax rates, wanted to force tax harmonization among member countries to prevent investment from fleeing. When this strategy failed, Germany was forced to start lowering its own corporate rate.

(3) The intent to compete ferociously, and without respite, is spelled out. In a testimony to the Canadian Senate Committee on Banking, Trade and Commerce, it was recommended that “the Canadian capital gains tax rate should be quickly be lowered to match the rate in the United States.”

The report then added that “the Committee also recommends that international competitiveness be the criterion guiding the choice of a capital gains tax regime, and that federal government be prepared to lower the tax until that criterion is met.” Canadians listened, and the current capital taxation in Canada is falling fast. By 2012 the federal corporate income tax rate will be 15% and the overall effective corporate rate will be the lowest in the G7 and, as the budget report gloats, it will be over 9 percentage points lower than in the US.

How low can they go? Maybe a little vicious competition can help bring a more reasonable tax system and lead to smaller government. Sadly, it may only be on the business side that government will care to compete. Yet "brain drain" does occur when individual income taxes are too high. As any anarcho-capitalist will tell you, competition is the best way to keep government in line. Let's hope we're beginning to see a trend toward tax competition.