After falling rather sharply in 2008 and early 2009, American GDP grew at a good pace in the fourth quarter of 2009, but has slowed down during the second quarter of 2010. Unemployment declined to 9.5% from its peak in November 2009 of 10.2%, but has been stuck around its current level for several months. This has led to growing fears of a double dip recession, and to a call for still greater fiscal stimulus. I do not believe that either of these is correct, and that the federal government should be concentrating on providing a good economic environment to encourage businesses and entrepreneurs to invest, hire, improve productivity, and raise longer-term economic growth of the US.
More than 60 years ago, Arthur Burns- former head of the NBER and Chairman of the Fed- and Wesley Mitchell-founder of the NBER- together wrote a classic study of business cycles called “Measuring Business Cycles”. They divided business cycles into several stages, such as the economic peak, economic decline, trough, early recovery, late recovery, and then a peak again. They clearly show that business cycles are of uneven length, depth, and severity, and that recoveries do not always proceed smoothly. A recession ends after the trough is passed, but they recognized that during recoveries an economy takes a while before it reaches and then surpasses its earlier peak. So from this perspective, the troubles the American economy is experiencing are not unprecedented, or even unusual.
Nevertheless, I agree with Posner that something is rotten about this recovery from the so-called great recession. The Federal Reserve was slow to react to the financial crisis, but on the whole the Fed’s policies since then have been decent, given the many unknowns as it tried various old and new monetary approaches to stem the financial crisis. The financial picture was quite bleak as banks greatly increased their ratio of debt to assets during the boom years, and consumers rapidly expanded their debt to income ratios during these years. So even with the best of responses the recovery probably would have been slow and uneven.
But both the Congress and the administration of President George W. Bush, and especially the Congress and President Obama since his election in 2008 made the main mistakes after the crisis hit. Instead of concentrating mainly on fighting the recession and promoting faster economic growth, the Congress elected in 2008 believed they had a mandate to radically remake the American economy. Aside from repeated attacks on American business, especially banks-some of them deserved- they not only passed various stimulus packages (that did not stimulate much), but also tried to promote a vast legislative program that had nothing to do with fighting the recession. This program was aimed at reengineering the American economy. It included radical changes in the health care system, proposed taxes on carbon emissions by companies, much larger subsidies to alternative sources of energy, such as wind power, proposals to raise taxes on higher income individuals and on corporate profits, and to raise the taxes on capital gains and corporate dividends. It also includes a movement to make anti-trust laws less pro-consumer and more protective of competitors from aggressive and innovative companies. It has as its centerpiece a financial reform bill that was a complicated and a politically driven mixture of sensible reforms, and senseless changes that had little to do with stabilizing the financial architecture, or correcting what was defective in prior regulations.
In previous posts I have laid out some of the major defects in the financial reform act, the healthcare changes, and the unemployment extension bill (see my posts for 7/25 on unemployment, 7/11 on financial reform, and 3/28 on healthcare reforms). To single out a few points of these arguments, I criticized the financial reform bill for, among other things, neglecting to do anything about Fannie Mae and Freddie Mac, two major corporations that were important factors in causing the financial debacle, and for adding an excessive amount of discretion to financial regulators who did not use wisely the discretion they had prior to the crisis. I suggested that a proper unemployment bill would eliminate most unemployment benefits for persons during the first couple of months of their unemployment, and then use the savings from that to extend unemployment benefits during bad times to a year. The most desirable reform of health care should have been to increase the out of pocket share of medical expenses borne by older persons and other individuals with various illnesses- as in countries like Switzerland- but nothing much was done about this in the new law. My detailed criticisms are available in these posts.
Perhaps the new Congress elected after November will try to reverse some of these mistakes. I would like also to see a radical reform of the tax system that returns it to the income tax structure that resulted from the Tax Reform Act of 1986 promoted by President Reagan, and Democrats Senator Bill Bradley and Representative Richard Gephardt. This Act had a maximum personal income tax rate of 28%, except for a “bubble rate” for a few families that hit 33%.
To compensate for any loss in tax revenue from these changes, and to help face the growing debt problem of the US, I would support a value added tax, but only as part of such a comprehensive reform of the tax structure. Value added taxes have many attractive incidence features that can be a valuable way to raise tax revenue in a system with low personal and corporate income taxes. However, VAT taxes also have the potential to be rather easily increased over time without close controls over such increases (see my discussion of VATs in my post on 4/25).
Government spending rose a lot during the last year of the Bush administration, and rose even more so during the year and one half of the Obama administration. Instead of introducing additional stimulus packages and further raising the cost of doing business, Congress and the President should try to create an environment where companies, both large and small, and entrepreneurs are recognized as crucial forces in a dynamic economy. Their activities can help the American economy not only grow out of the economic slowdown, but also raise its economic growth in the future that will greatly improve the well being of future generations, and help meet a dangerous future debt burden.