Click here to read part 1 of “Beyond the New Normal” by Wayne Winegarden and Niles Chura
For more than a decade federal policy has re-shaped the economy through a variety of activist policies. Taxes have risen, spending has increased, and the regulatory state has been empowered.
The Federal Reserve, through its zero-interest rate policy, distorted investment decisions, rewarded borrowers on the backs of savers, and exposed the corporate and public sectors to significant risk from rising interest rates.
The consequences from these policies are the current slow growth economy. But just as these misguided policies ushered in sub-par growth, a comprehensive policy fix can rejuvenate it.
Learning from these mistakes, the prime economic policy directives of the Trump Administration should be to undo the distortions caused by previous policies while minimizing volatility during the transition.
Starting with the tax and expenditure policies, the government raises money by either levying taxes or issuing debt. By definition, when the government levies taxes, the taxpayers can no longer spend this money. Similarly, when the government borrows money, private entities can no longer invest those funds. Therefore, for every dollar that the government spends, the private sector must spend one less dollar.
Consequently, government spending positively impacts economic growth only when the value generated by that spending exceeds a rigorous cost-benefit threshold. Unfortunately, the evidence indicates that government expenditures are not currently meeting this criterion. There are several reasons for this.
First, government expenditures remain around historical highs relative to the size of the private economy. A fundamental tenet of economics is the law of diminishing returns – the value of any good or service (including public goods and services) declines as we consume more of that good. Take hamburgers as an example. While the first hamburger you eat may create great value for you, the tenth hamburger will likely make you sick. The current size of government expenditure more resembles the tenth hamburger rather than the first.
Second, the composition of government expenditures is being directed away from traditional public goods and services toward transfer payments. While there are social benefits from such spending priorities, transferring income from one person to another does not grow the economy.
The persistent deficits, high tax burdens, and unaffordable government expenditures are a drag on the economy. The current Administration’s proposals to hold the line on spending and reform the tax code will remove these barriers and enable faster growth.
Another contributing factor to our current low-growth environment has been the Federal Reserve. Post the Great Recession, the Fed drove down interest rates and created trillions of new dollars directed at the capital markets. The result has been massive capital gains for those in the markets, but significant continued losses for savers.
Reminiscent of the housing boom and bust, the Federal Reserve’s efforts to maintain artificially low rates has dangerously misallocated capital and enabled the excessive borrowing by the federal government – deficits are on a trajectory to again exceed $1 trillion per year according to the Congressional Budget Office.
While monetary policy is complicated, and drastic movements can be destabilizing, the Fed would best promote long-term economic growth by abandoning its attempts to manage the business cycle and simply focus on a core mission of price stability.
Then there is the regulatory assault.
Regulations on the health care sector (e.g. the Affordable Care Act) raised taxes, increased costs, and decreased competition for many health care consumers.
Sweeping mandates were imposed on the financial industry (Dodd-Frank) that diminished the incentive for banks to lend (particularly to small businesses) and increased systemic market risks.
The energy sector has faced regulatory barriers such as the rejection of the Keystone Pipeline and the EPA’s unprecedented power grab over the nation’s power generation sector.
This hyper regulatory environment created an unprecedented burden on businesses and the economy, and diminished the incentive to work, save, and invest. These regulatory assaults need to stop. Positively, the current Administration’s recent greenlighting of the Keystone pipeline signals a reversal of these policies.
But, fixing just a few of the bad policies is insufficient. The correct stance for the new administration is to implement comprehensive policy reforms across all of these areas.
Toward this end, the recent withdrawal from the Trans-Pacific Partnership (TPP) trade deal is a step in the wrong direction. While not discussed above, expanded international trade opportunities are an important component of a pro-growth policy mix.
Properly implemented, comprehensive reforms that establish a pro-growth policy mix is the surest path to revitalizing long-term, and broad-based, economic growth.