President Obama and the Minimum Wage

Economic policy is not made only by economists.  It is made by a lot of people, many who lack economic knowledge and credentials.  Politicians often make economic policy, and despite their immense resources to get the best economic advice, they often make bad economic policy.  The rest of us make economic policy everyday as we buy and save, and when we buy, what we buy, and when we save, how we save.

For background, there are two basic types of governmental economic policy, namely fiscal and monetary.  Fiscal deals with the size of government, the size of the deficit, tax policy, transfer payments, and all sorts of minutia that deal with governmental programs and purchases that are usually wrapped up in governmental budgets.  Monetary policy deals with interest rates, bank reserves, governmental bonds and assets, and similar things. 

Our politicians deal with fiscal policy, and the Federal Reserve deals with monetary policy.  The Chairman, Presidents and the Governors of the Federal Reserve are supposed to be knowledgeable in economics.  The politicians? …. Not so much. 

One of the areas where our chief politician wants us to support him in revising economic policy is on the subject of minimum wage.  President Obama gave the State of the Union address, and in it he wanted the Congress to adopt policies that would lower unemployment and bring more manufacturing to the United States.  And then the President asked the Congress to raise the minimum wage.  

The problem is that in real life there are policy trade-offs and if we want to raise the minimum wage, we will have to compromise our goals of decreasing unemployment and expanding manufacturing.  Mike Konczal explained the relationshipwell.  When the minimum wage goes up, the costs of production goes up as well, which the entrepreneur will want to control by lowering overall employment.  So, unemployment will go up, not down, and manufacturing will not expand, at least not at the pace the President wants.  This is the equivalent in physics of, where, if I jump up, I expect to stay up without coming down.

Raising the minimum wage would have some negative effects on our economy that I do not think we want to experience.  It would encourage an increase in offshore manufacturing, and the President spent a lot of time in the State of the Union asking for policies that would repatriate manufacturing jobs to our shores.  It would hamper effects to decrease youth unemployment, notably black youth unemployment that is pegged at 37%.    It would also hamper efforts to increase hiring among recent college graduates who need more internships and entry-level job opportunities.

The President wants an intelligent jobs debate, but to suggest that trade-offs are not in the mix and that we can have all things economic is misleading.  

In all fairness, there is a blog entry in this series criticizing those on the right who advocate privatizing Social Security without adding to the nation’s debt.  Efforts to misrepresent economic thinking exist on both the left and the right.  Except in this case, it is the President of the United States who is supposed to educate us all and lift the quality of the debate by sticking to real economic possibilities. 

Obama, the Budget, and the Debt Ceiling

The recent agreement to raise tax rates on the upper end of the earning population postponed the fiscal cliff while avoiding any agreement on spending cuts.  Obama won on the key plank in his reelection platform, which was to raise taxes on higher income earners, and the House Republicans lost on their main plank, which is to cut spending.  Since President Obama won the election, it is fitting that he wins the tax rate debate.  But the House Republicans won reelection as well, and they have yet to win the spending debate.

Now we come to the debt ceiling decision.  In approximately one to two months, the government will out be of the ability to borrow funds above their current level since it has hit its ceiling in late December.  Obama wants the Congress to raise the ceiling without cutting spending.  The House Republicans want to cut one dollar in spending for every one-dollar increase in the debt ceiling.  Obama objects saying that the debt ceiling should be raised automatically to accommodate the spending that the House Republicans have already approved.  Not a bad argument, or is it?

To analyze the Obama argument requires some background on budgeting.  A budget is a document that sets forth the ‘sources and uses of funds’ for a specific period of time for an organization.   ‘Uses’ refer to the typical image that most people think of when they refer to a budget, which is a list of planned expenditures.  The billions for defense and health care are listed under uses of funds.   ‘Sources’ refer to the where the planned expenditure dollars will come from, namely taxes, fees, and debt. 

The problem with Obama’s argument is that there is no budget of the United States.  There has not been a budget for the Federal Government for three years, one year prior to the House Republicans taking control to cut spending.  In a previous year, the Obama proposed budget was presented to the Senate and was defeated by Obama’s own Democrats.   For the last three years, our Government has been operating mostly under Continuing Resolutions.

 A Continuing Resolution refers only to ‘uses’ side of the budget.  It does not refer to the ‘sources’ side.  It has nothing to do with debt.  Further, it is a default position for the Congress.  If the Republicans and Democrats cannot agree on budget, they issue Continuing Resolutions that reflect agreements from the first year of the Obama administration, or, in other words, an all-Democratic view of the budget.  Ever since, the Republicans in the House have sent budgets with spending cuts to the Democratic Senate and they get back Continuing Resolutions.  The Republicans have not been able to make progress on their main reason for being elected, which is to cut spending.  

Now we come back to Obama’s argument to pay for a series of Continuing Resolutions that avoided negotiating with Republicans with an argument that the Congress should pay for its debts.  The real meaning is that the Congress should continue avoiding negotiating a budget agreement with the Republicans.  This is not consistent with the spirit of the Constitution, namely that the two houses and the administration actually negotiate a budget. 

In all fairness, the Government has operated under Continuing Resolutions in both Democratic and Republican administrations.  However, in the most recent election the electorate chose a Democratic President and Senate, and a Republican House.  There are many polls that show the electorate wanting both parties to work together despite this split in institutional control. 

The Obama argument, if successful, would require the House to abandon its constitutional responsibility to opine on the sources of dollars needed to fund our Government.  If there were a budget, then the House would have had its say. 

A negotiated budget representing the compromises that the electorate wanted when it elected a Democratic President and a Republican House is what the country needs.  If there were a budget, there would be no objection to a debt ceiling increase consistent with that budget.

Wealth, Equity, and The Recovery

This blog has had two previous discussions about the causes of the 2007 recession.  The first was a post on the merits of Keynes, Hayek, and Fisher in providing an answer to the question of what caused the 2007 Great Recession.  Despite the popularity of Keynes and Hayek in popular editorials, the forgotten Fisher provides the best answer.  Our country forgot the lessons of Fisher and encouraged a bubble in real estate that caused the debt-deflation cycle that we have experienced for the last five years.

The second discussion was a post on Roger Farmer on the role of wealth to create a productive society.  Citing Milton Friedman, Farmer provides the evidence that supports the view that employment tracks positively with wealth.  The more wealth we have as a country, the more employment we have.  With more employment comes more growth and more governmental revenues that provide more services and reduce deficits and debt.

My own research supports the Farmer position.  However, instead of talking about wealth, I use the term equity since I use an accounting view of the economy.  When I look at a statement on the Gross Domestic Product, I see something that is similar in large terms to a national income statement.  And if the country has an income statement, there must be a balance sheet.  I found some data and built a balance sheet going back sixty years.  I analyzed it and saw how equity dropped seriously in the 2007 recession and in the years following. 

Equity is important because it creates the leverage that enables all of us to buy houses and cars and other things.  How many of us postponed a great many purchases because we wanted to repair our own individual balance sheets following 2007?  Both Richard Koo and John Taylor termed this effect as a “Balance Sheet Recession” in their discussions of the Great Recession.  If, from a macro view, the national economy is a composite of our microeconomic behaviors, then our 2007 recession and recovery should reflect the goals of rebuilding our balance sheets.

This brings us to the Stimulus package.  If the cure to the recession is to rebuild our individual balance sheets, then stimulus should enable that to happen.  What did the Stimulus package do?  First, it was a limited series of tax cuts.  Most people used the extra money to pay down debt, which is good, but it failed to stimulate.  In other words, the money was used to rebuild individual balance sheets.  Second, the Federal government transferred money to the states to reduce program cuts.  The Stimulus reduced the number police and teachers that would have been laid off without the Stimulus.  While this is a good thing, it is not stimulative.  In short, this action did not create growth.  The third was a package of road and infrastructure improvements that took far longer to implement than was planned, and the growth effect was diluted.  The sum of these parts is that the Stimulus package did not stimulate very much.  

The reason why this happened is because the policy makers of the time from both parties, including many economists, just got it wrong.  The administration assumed that the recession was basically the same as before.  They did not ask if it was different, and the administration recommended that the medicine from before would cure it. 

The first economists who said otherwise were Carmen Reinhart and Kenneth Rogoff in their book This Time is Different.   They referred to 2007 as a financial recession but they did not offer a prescription for curing it.  We had to wait for people like Roger Farmer to offer a suggestion.

We should also note that as the recession continued, people on their own would improve their balance sheets, which has enabled them to begin buying again.  Once we get back to a national debt/equity leverage typical of the years leading up to 2007, then the economy will begin to approach pre-2007 growth levels.

If we knew then what some know now, the recovery would have been different. 

Roger Farmer on Wealth and Unemployment

I heard a lecture this semester by Roger Farmer who is the Chair of the Economics department at the University of California, Los Angeles.  Dr. Farmer is different from most economists in that he is attempting to address the 2007 recession from a new perspective.  In a previous post I mentioned that there are the Keynesians, and the Hayekians.  There is also Irving Fisher who explained the 1929 depression in terms of a debt-deflation cycle.  Dr. Farmer explains Fisher by pointing us to look at the end result of Fisher, which is wealth.  It is wealth that is lost once a debt-deflation cycle occurs.  This is equity on the balance sheet, and in financial terms, it is that residual value in our own individual financial structures that allows us to borrow in order to buy things.  It is the basis for our own personal leverage.

When the 2007 Great Recession hit lots of personal wealth was wiped out.  Some estimates put it as high as 40%.  This restrains consumption from a Fisher perspective.  However, Farmer makes wealth a more central part of his economic argument.  He bases much of his argument on Milton Friedman, whom he described as a Keynesian.   Friedman stated that consumption is based on wealth and not income, which is counter to a traditional Keynesian argument that wealth is based on income.  I know what you are thinking, but I am just reporting what I heard.

Dr. Farmer presented several graphs that brought his argument into focus.  He traced unemployment through the 1930’s and showed how growth in employment marched hand in hand with the value of the stock market.  He then used this information to build a model of the relationship between the S&P and unemployment over fifty plus years.  He used the first have of the years to establish a foundation of data for the model.  He then used those years to predict unemployment from the 1980’s to more recent years, and the model was incredibly accurate.  He demonstrated that wealth and unemployment move together, and wealth can be used to predict the level of unemployment.   

What are the policy implications of this?  Dr. Farmer proposed a solution that could be received as a “big brother” type of method to stabilize the economy.  He proposed that the Federal Reserve establish an indexed fund of stocks.  The term “index fund” means to buy a set of stocks from the market that mirrors the overall market.  The idea is not to buy a set of winners over loosers.  The fact that the Federal Reserve would buy an indexed set of stocks to stabilize asset values in down cycles would also protect employment from moving to the downside in the proportions that it has in the last five years.

My own personal recommendation is not to tax capital, because taxing capital would retard its growth.  If you want employment to grow, wealth should grow.  

Dr. Farmer has a little book that I recommend to anyone who wants to understand the economy, but who has not the time or the patience to suffer through a college course on the subject.  The book is How the Economy Works and it is available on most bookseller web sites.  Dr. Farmer’s own web site with his mathematically based technical working papers is linked here as well.

The idea that wealth relates closely to unemployment is not a new idea, but Dr. Farmer has been able to put together persuasive evidence that the relationship is real.  

President Obama and Executive Responsibility to Mitigate Risk

Every modern day executive is concerned about selecting the right policy for the organization.  Associated with policy selection, planning the implementation of policy and mitigating risk associated with that policy is an equally important responsibility.  In other words, if a plan is at risk of not going well, the executive has to ask what can be done to put the policy back on track?  When a policy is adopted and not after, good executives ask what can go wrong.  They then ask how to place corrections in place at the time the policy is adopted, not later when things go wrong.  Good executives anticipate what can go wrong and insure against it at the onset through their actions.  This happens before things can go wrong.

This is a skill that President Obama has not exhibited in his first term in office.  He should have asked a series of “what-if’s” with each new policy he put before Congress and implemented in the bureaucracy.    What could be done if the Stimulus Program failed to stimulate?  What could be done if Obamacare failed to contain costs?  What could be done if gas prices double?  And there are other policies where mitigations were not identified.

One of those policies is President Obama’s mid-east policy that was announced in Egypt in 2009.  When he adopted it, an obvious and foreseeable question to ask at the time is what should happen if the mid-east perceives the policy as weak?  One obvious and foreseeable mitigation is to strengthen US embassies in the area.  Any executive of any worth would have protected the policy from any potential risk to the downside at the time of the decision.  When requests for increased security from the field were received would be too late. 

A potential risk that awaits us in the future is what happens when China no longer wants to buy our debt.  When China transitions from an export economy to a consumer economy, there is a good possibility that they will need an inflow of cash from their investments.  There is also the possibility that China may use our debt as a strategic weapon in case we need to compete with them in the Pacific for influence over some critical issue.  This type of risk analysis is sufficient cause us to restrain our growth in fiscal debt.  The question is what mitigations should be put in place to deal with this risk.  This is a President Obama question.

Dealing with uncertainty through risk mitigation is an executive responsibility.  It’s basic.    

Keynes, Hayek, and Fisher

Most people who follow economic events have some familiarity with John Maynard Keynes and Frederick Hayek.  Both economists were contemporaries at the London School of Economics in the 1930’s and have huge followings in economics and public policy to this day.  People associate the public policies of expanding government during recessions financed through public debt and a weak dollar with Keynes.  They also associate austere government programs and a strong dollar policy with Hayek.  While Barack Obama would be characterized as a follower of Keynes, Ron Paul would be characterized as a follower of Hayek or what is currently referred to as the Austrian school, which was Hayek’s home country where he grew up and first taught economics.   While these two people represent the extremes of contemporary economic thought, there is a third economist that should be mentioned when attempting to understand the major economic event of the last five years.

That person is Irving Fisher who was an economist in the United States in the 1930’s during the Great Depression.  He had a number of followers who elaborated on his work.  Among them was Charles Kindleberger.  These two economists described the mechanisms associated with great financial economic depressions that apply to today’s economics. 

A financial collapse, such as the ones that were experienced in 1929 and 2007, usually begin with an asset that can grow over time faster than the average asset.  Speculators begin to recognize the growth potential and borrow money to buy more of the asset, which in turn, causes the value of the asset to grow at a more accelerated rate.  Financiers begin to see the potential of financing the asset as a growth market and put more funds into the area.  Soon, credit requirements are lowered.  More speculators are enticed by the financing possibilities and more credit is put into the market.  This cycle continues until there are no more speculators that can be enticed into the market to bid up the value of the asset in question.  In other words, there is no more credit that can be drawn into the market to finance the asset.  Either way, the value of the asset will fall leaving vast sums of unsecured credit exposure.  There is a financial collapse and neither Keynes nor Hayek adequately addresses it.

Fundamentally, what do we have here?  Assume that the national economy can be represented by a set of financial statements that a company, whether big or small, would maintain.  There is a balance sheet, which is a snapshot statement of assets, liabilities and equities, and an income statement, which is a summary of revenues and experiences.  Note that the Fisher process focuses on assets and liabilities, or balance sheet items.  It does not focus on employment, jobs, and growth, which are income statement items.

The policy responses of a Keynesian would be to expand government to take up the slack in the GPD.  In short, borrow funds to keep people working, which is an income statement strategy.   It assumes that the income statement would correct the balance sheet, which is rarely the case.   The policy responses of an Austrian would be to assume that the capital markets heal themselves.  In short, the impairment to the capital markets will result in creative destruction.  The economy will heal itself faster though a great many more people being hurt in the process when compared to a Keynesian approach that will not grow the economy much while not hurting as many people.  Both sides of this continuum sound silly, don’t they?

The policy response of the Fisher approach is to repair the balance sheet.  Unfortunately, we cannot do that without betraying a lot of bedrock American principles.  We do not take over banks and forgive the debt of the American public.  We recognize “moral hazards”, and avoid forgiving rational people for rational decisions that ended up badly.   So, how do we get out of this mess?

One thing that should not have been done is to adopt the stimulus program that was executed.  It turned out to be a “make work” program to keep as many people working for as long as it could.  If the President recast it into acquiring assets that could be leveraged for growth, then we would have been better off.  He talked about improving the electrical grid, which would have lowered energy prices and help businesses and consumers operate with lower margins.   He also talked about solar farms and similar things that would have improved our competitiveness globally.  This did not happen and we are left with the debt and not much productive improvement to our base that can be used to pay it down.  The result is more burdens on all of us.  It turned out to be a bad investment.  It still does not answer the question of what we do now.

One thing that should not be done is to increase the taxes on capital, which would be the impact of the current tax plan advocated by the Democrats and President Obama.  Assets need to be leveraged for productive use, and taxing capital will reduce this country’s ability to acquiring productive assets that create jobs.  Tax fairness is a legitimate issue, but cutting off one’s nose despite the face is not the way to go.

The public wants an administration that will increase employment and lower the unemployment rate.   Government has proven itself incapable of achieving this goal.  The business sector is all that is left and that raises the question of how do we make business work without raising our risks of capital destruction in a Fisher asset bubble?  Not totally sure, but the two approaches we have in our major political parties are not producing answers to our problems.   What I am looking for is a pro-growth economic philosophy that includes not just protecting our capital assets but also leveraging them for growth.  So far, I have not seen anyone on the current stage that talks this stuff, though Romney comes closest.

My apologies.  I led you, the reader, through a number of economic alternatives that probably raised the hope of you reading a bunch of easy to remember policy prescriptions only to find out that I don’t have any  -- yet.  I only have a bunch of questions with some clues as to what those prescriptions should be, and the realization that the current crop of answers is inadequate.

Public policy is not easy.  Those who say it is are not being honest.