Wednesday, June 08, 2011

Martin Peldstein misdiagnoses the reasons the economy isn't doing well.... and thus, his proposed cures won't quite fix what ails us.

The problem Feldstein has is the same that afflicts most professional economists: they view the economy as if it was an entity in its own right... rather than merely the aggregation of millions upon millions of people going about their lives and businesses on a day to day basis.

Thus, to influence the economy, one must look to influence the people who comprise the economy. And before you can do that, you must understand why the people are acting the way they are.

(Broken record alert) The underlying reason the economy isn't doing well is because (1) employers aren't hiring, (2) people with disposable income aren't spending what they have, and (3) the number of people with money to spend isn't growing.

And the reason this is happening is because we're are scared.

Employers are scared that not only will there not be an increased demand for their products but that the current level of demand won't last. They're scared about higher taxes (both corporate and on their own incomes) and regulations that constantly increase the costs of doing business. They're worried about how much more in the not-too-distant future it is going to cost them to provide health care to their employees. And scared employers bank their profits (as evidenced by ever-increasing piles of corporate cash), they don't hire and thus don't increase the pool of people with money.

People with money aren't spending it because they're scared, and for many of the same reasons. They're worried about higher taxes. They're worried that the source of their income isn't all that steady and secure. They're worried about the higher costs of gas and food. They're worried about having enough money for retirement and paying the ever-increasing costs for college tuition for their kids and health care for their parents.

And with people losing jobs and taking pay cuts and losing what value they thought they had in their home and retirement accounts, not only is there not an increase in the number of people with money to spend, there actually has been a decrease in this number (note: this may or may not be true on a quantifiable basis, but I argue it most definitely the case based on how people think of themselves and their finances).

Given the level of fear, any proposal has to start with eliminating the fear. It is actually that simple: get rid of the fear and the economy will grow. Businesses will hire and people will spend.

So how do we get rid of the fear?

We have to start by looking at the causes of the fear. Get rid of the reasons people are afraid and you get rid of the fear itself.

Let's start with the fear that taxes will go up. Eliminate that fear - and on a real basis, not merely temporarily so - and you've made a good first step.

Follow up by freezing and rolling back the regulations that make it increasingly expensive to run a business. Get rid of Sarbanes-Oxley and the recently enacted financial reform bill. Turn the tables on regulatory review, so that government has to prove their case (that something or the other is harmful) rather than requiring businesses to prove the absence of any harm.

Then come up with some ideas for reducing the costs of health care (not merely shifting the costs around, as is the case with Obamacare). Repealing Obamacare would be helpful, as most businesses would prefer the risks of the 'known' previous state than the potential damage from what they don't know about Obamacare.

Get rid of the uncertainty people have about the value of their house (note: the push to freeze foreclosures is actually doing more harm than good). Make it easier for people to get out of houses they can't afford.

Eliminate the fear businesses have of arbitrary and capricious bureaucrats coming in an ruining their businesses. Get rid of the so-called crony capitalism that leaves unfavored businesses feeling like the deck is stacked against them.

Yes, as Feldstein and the rest of the conservative side of the economist profession argue, we also need to cut the federal government budget down to size. But while it is a long term problem, it isn't the reason businesses aren't hiring now.

Fixing the 'economy' isn't all that tough... it just requires that one understand why things are the way they are.