POLITICS GETS IN THE WAY OF PRUDENT ECONOMICS
PART 1 – A SHORT LOOK – POLITICS AND THE RELEVANT HISTORY OF ECONOMIC THOUGHT
The basis for the proper implementation of prudent economics for individuals, businesses and industries (i.e. microeconomics) is logical and relatively straight forward. First, make a plan that encompasses all of the goals and restrictions that define the environment in which the individual, business or industry functions. This plan must consider present income, future income based on realistic investment opportunities, all costs both short and long run including external impediments, and spending decisions that reflect the specific goals established in the overall plan. Optimization of the path to achieving the established goals, such as the maximation of profit or maximization of sustainable net income over time requires adjustment of the operating plan as changes in the economic environment warrant such actions. The real-world rewards a good plan and prudent fiscal behavior with success in achieving and maintaining goals over time and irresponsible fiscal activity leads to bankruptcy.
For the country as a whole, the success of a macroeconomic plan does not simply depend on the aggregate fiscal success of all entities functioning as consumers or businesses in various markets and submarkets. However, there is another player in the national market place that is capable of being a catalyst for economic success or a disaster that draws all of the oxygen out of the economy – the government. From the viewpoint of a free-market economist, the most efficient economic structure that maximizes total social welfare is pure competition, driven by the goal of individual advancement (identified by Adam Smith’s as “the invisible hand”). In this case, the government functions as a referee and not a player. On the other end of the market structure spectrum is the socialist (or communist) model where the government is effectively the only player in the market place. This is a social structure model with little to no prospect of economic success over time. Karl Marx and Friedrich Engles established the Marxist concepts of the communist state postulating a bottom-up social upheaval quickly displacing the free-market systems that were evolving out of the 18th century industrial revolution emanating in England and spreading throughout Europe.
America’s founding fathers were staunchly on the side of individual freedom, free markets, and a minimal government that supported the property rights of citizens not only as individuals but also as players in the free market. The success of the American economic system has negated the push of socialist (or communist) left to uproot the free market and the right of private ownership of capital via a Marxist style bottom-up revolution that would lead to a quick transformation. The pattern of the Far Left’s efforts in America to transform the free market into a collectivist structure has adopted a more complex incremental cumulative sociopolitical pattern of change postulated by an earlier German philosopher Georg Wilhelm Hegel. In other words, the cultural revolution of the American political left has been to chip away at the free market over time, in an incremental manner with government activity replacing free market activity.
For the purposes of this paper, there is no need to deal with all of the complex machinations and divergences between Keynesian, Neo Keynesian, Classical, Neo Classical, Monetarist, Supply Side, etc., economic theories that, as a whole, has created the overall public impression of economics as the “dismal science” that somehow approaches wizardry. It suffices to view the primary difference between Keynesian and Classical (including Supply Side) theories as being that Keynesian theory postulates that economic growth is primarily demand dependent and Classical theory places more emphasis on supply factors. Keep in mind that Keynesian theory was developed to theoretically explain and formulate policies that would address the economic devastation created by recessions and depressions such as the “Great Depression” of the 1930s, following the 1929 stock market crash. The aspect of Keynesian theory relevant for this discussion is its’ premise that government stimulatory spending during a downturn will drive overall national consumption and, consequently, economic growth. Note that government spending is a component of Gross Domestic Production which means that an increase in government spending from a static viewpoint, without considering the negative dynamic aspects of doing so, will translate into economic growth.
PART 2 – POLITICS IN THE WAY – THE KEYNESIAN ROLE IN GROWING A BLOATED GOVERNMENT
For many years the political left in America had been using Keynesian economic theory as cover to slowly increase the government’s footprint in the national economy whether or not an economic slowdown has warranted government stimulation spending. Starting with the Obama Administration in 2008 and peaking with the Biden Administration (2020) the Democrat party took a sharp turn to the left and when they had control of the Legislature in addition to the Presidency, radically increased the footprint of the federal government. The definition of Gross Domestic Product is GDP=C+G+I+NX where C is private consumption, G is government spending, I is Investment and NX is net exports. The abuse of Keynesian theory by far-left politicians to increase the size of the federal government has pushed the level of G to an unsustainable level, racked the country with crippling inflation and backed out free market consumption (C) and Investment (I). Net exports (NX) have been negative since the 1970’s and post 1995, as the globalization of the world economy and misaligned trading terms led to a staggering negative NX figure of over 1 trillion dollars. A sleepy voting public kept voting for politicians who were content for the American economy to lose much of its industrial base and move toward a consumption economy with a bloated federal bureaucracy.
The cadre of Keynesian economic gurus that projected positive economic outcomes for increased government spending along with a cast of left leaning journalists, lulled the voting public to sleep while the country moved further and further away from the free-market economy that made this country so special. The overwhelming dominance of demand side, government growing policies may have appeared to keep GDP in a favorable state, but free market investment lagged optimal levels. Sustained economic growth over time is not possible unless productive capital grows, and excessive government spending and a bloated bureaucracy does not, in any form or fashion, constitute productive capital. The future path towards a dominantly consumption economy is not the path that any economy wants or needs if sustained growth and increasing prosperity over time is its primary goal.
Keynesian macroeconomic models have consistently overestimated the effects of government spending (decision making) via static projections based on imbedded biased assumptions while consistently underestimating the dynamic effects of supply side tax policies. See “Hard Core Keynesian Wizardry” and “A Keynesian Thumb On The Scale” posted in georgeeconomics.com for a more detailed examples of this issue. Artificial Intelligence (AI) modelling, if not constructed with a Keynesian bias, can shed a lot of light on this problem. Keep in mind that the Federal Reserve is a Keynesian animal whose tools are restricted to demand side functions and their decisions regarding interest rates are generated with a Keynesian analysis thumb on the scale. In an ideal economy, where divergent politics are not an issue, fiscal policy (government spending, taxation, etc.) and monetary policy (control of the money supply and inflation) should work in a balanced manner, that supports optimal economic growth and wellbeing of all consumers of over time.
As operationally established in the United States the political party in power controls fiscal policy and an independent Federal Reserve is charged with the task of keeping inflation and unemployment under control. For most of the past four decades my basic reaction has been – Good Luck and keep dreaming! Only a few times has the economy been in “Goldie Locks” situation where the Federal Reserve was not in a position of having to be in corrective mode. Note that Jerome Powell, Chairman of the Federal Reserve, referenced the pre pandemic period, toward in the second half of the first Trump Administration, as such a period.
Up to this point this paper has concentrated on the overall damage done to the American economy by the deceleration of its productive capital base below the growth level needed to avoid becoming a totally consumption-based economy, and the growth of government and the political march to the left (supported by the use and misuse of Keynesian analysis). A prime example of politics having a devastating effect on optimal economic policy is the “over the top” agenda driven spending by the Biden Administration that created the highest inflation in over forty years which forced the Federal Reserve to reverse course from its horribly wrong left-wing rhetoric that inflation was only transitory to aggressively using its only real tool, the target interest rate, to slam the brakes on the economy and slow down inflation. The bottom line is that if fiscal and monetary policy really should be controlled in a unified manner that aligns prudent demand and supply side policies, in an inflation neutral manner, rather than one having to counter the other. The economy would not be burdened with a federal Reserve, restricted to Keynesian demand side tools that can only counter out of control fiscal policy with economy crushing interest rate hikes.
PART 3- POLITICS IN THE WAY – TARIFFS AND INTERNATIONAL TRADE – TAX POLICY
Another example of political inflicted damage on the economy is playing out in front of us right now with the Trump Administration attempting to undo decades of politically induced economic malpractice relating to international trade with aggressive trade policies within a constricted period of time (due to the limited time Trump perceives to be able to politically effectuate “leveling of the playing field” tariff policy). In effect, he has established a dynamic, non zero sum game related to tariffs to force America’s trading partners, both friend and foe, to respond to the game he has set up. They have no choice but respond because the United States is the consumption behemoth in the world that cannot be ignored without substantial economic suffering by the myriad of players dependent on the purchase of their export dependent production.
This ‘game’ is not like checkers or chess. Game theory is a serious study of mathematical models of strategic interactions that simulate a bidding format for offering and accepting outcomes based on interdependent options available to each of the player. There are numerous recognized types of games, but for the purposes of his discussion, it appears as though the playoff of options for the players evolves in a manner that the total value of options can vary as each player makes choices (non-zero or variable sum game). The game at hand is dynamic, where each player has good knowledge of the other players options, the action is fluid, and the positions of each player can change continuously over time. Whether planned or not, the outcome of this tariff dust up will unfold in two steps. First, there will be a response of each of the exporting trade partners that will lead to quick agreements or confrontations that will lead to negotiations. Establishing the final tariff map may take months to evolve as the individual exporters adjust their positions, in a fluid manner, as they negotiate to find their optimal offer (which cannot ignore the positions of competing exporters that are also part of the overall “game”).
Once the final tariff map is established the next important factor to be determined, relating to American economic issues such as inflation, is the distribution of the of each the various exporting nation’s tariffs between the buyer (American importer) and the seller (foreign exporter). The advantage will go to the player that has more options. For example, if a foreign exporter has to compete with more sellers than it has American buyer options, then that seller may end up absorbing most if not all of the tariff total established by the negotiated tariff rate (which may or may not be a high total). Economists view this, conceptually, in a manner comparable to the price elasticity of demand or supply, depending on whose viewpoint the analysis is directed. Right now, “the jury is out” regarding each of the above refenced steps. It will take a while, but the results will be a harbinger telling us if Trumps’s plan to reverse decades of economic stupidity will a long-term success. or if it will be a lot of commotion that falls short of contributing to his vision “a golden era”. If American importers are truly in a monopsonist position, or at least in a position to have more options than most or all of the exporting trading partners, then the degree of success that will evolve from this endeavor could be substantial. I am curious, however, how he will address a country like Vietnam that has offered to go to zero tariffs. Though not a massive player, in their area of export products they do have a substantial labor cost advantage. Perhaps, a smaller “pay to play” tariff will result. Deals with small players like Vietnam could be used as prybars to deal with other bigger players. Major players, such as the European Union and larger Asian countries, should and will get a majority of the Trump Administration’s attention. China is an adversary and should be treated as such. China may drag out negotiations aiming to wait out Trump’s political window, but Trump has enough time to force their hand given that national security mandates a path to controlling their aggressive adversarial economic and military intentions.
Time is of the essence, because political windows have proven to be quite narrow and this push by the Trump Administration also depends on favorable tax legislation that will work in tandem with trade realignments to diversify and strengthen the American economy and American security. If the proposed tax cut legislation successfully passes Congress and the ultimate tax rate does not dip below Arthur Laffer’s optimal rate, then this will be complete win for the entire American population. His premise is that if existing tax rates are above the optimal rate, the lowering of taxes will actually increase total taxes collected until an optimal rate is reached, after which total taxes collected will decrease. Data following the Tax Cuts and Jobs Act, enacted during the first Trump Administration (2017), back up the credibility of his theory. The static view of tax cuts in Keynesian theory specifies a drop in tax revenues collected in contrast with Laffer’s (supply side) dynamic view of tax cuts considers the consequent expansion of free market activity that more than makes up for the lower tax rate. In reality, the proposed tax legislation (when codified into law), especially when coupled with deregulation and substantial cost cutting, is even more important to the economy than correcting the uneven terms of trade with our trading partners. Not only could total tax collections increase, the free market will be shielded from the constant attack by the political left and the “Golden Goose” will be free to spin its magic.