Over at Downsizing the Federal Government, Chris Edwards has released an updated version of his “Plan to Cut Spending and Balance the Federal Budget.” The plan proposes spending cuts of more than $1 trillion annually by 2021, which would balance the budget without resorting to damaging tax increases. Federal spending would be reduced to 18 percent of gross domestic product by 2021 under the plan, which compares to President Obama’s projected spending that year of 24.2 percent of GDP.

Some key points:

• No sacred cows are spared. Defense, domestic, and so-called entitlement programs are all cut.

• The plan recognizes that the scope of federal activities must be curtailed. It would begin the reversal of decades of federal expansion into hundreds of areas that should be left to state and local governments, businesses, charities, and individuals.

• Instead of viewing federal spending cuts as a necessary evil, the plan recognizes that the cuts would shift resources from often mismanaged and damaging government programs to the more productive private sector, thus increasing overall GDP.

• The plan doesn’t achieve budget balance by increasing taxes. Under current tax policy, federal revenues as a share of GDP will gradually return to levels considered normal in recent decades. It is federal spending that has reached abnormally high levels. It must be reduced in order to get the government’s spiraling debt under control.

Updated Cato Budget Plan is a post from Cato @ Liberty - Cato Institute Blog

The George W. Bush administration ushered in a new era of big government. The Obama administration has built on Bush’s profligacy, and the president’s new fiscal 2012 budget proposal would further cement the trend.

Spending as a percentage of GDP has increased dramatically since the surplus years of the late 1990s. As the chart shows, the president’s budget once again seeks a permanently high level of federal spending as a share of the economy:

While the numbers drop from their stimulus- and recession-induced highs, it is not because the president has suddenly decided that he desires a less active government. Rather, optimistic economic assumptions largely account for the slight retrenchment.

Tax increases and optimistic economic assumptions explain the projected rise in revenue as a share of the economy. While the president would like us to believe he’s found religion on spending cuts, he’s actually relying on a rosy economic forecast and sucking more money out of the private sector to reduce annual deficits.

Taking more money from the productive private economy to maintain destructively high levels of federal spending is not a recipe for economic growth. Therefore, this budget proposal is as dangerous as it is disingenuous. Fortunately, it’s also dead on arrival in the Republican-controlled House.

New Era of Big Government is a post from Cato @ Liberty - Cato Institute Blog

Thanks to decades of reckless spending by European welfare states, the newspapers are filled with headlines about debt, default, contagion, and bankruptcy.

We know that Greece and Ireland already have received direct bailouts, and other European welfare states are getting indirect bailouts from the European Central Bank, which is vying with the Federal Reserve in a contest to see which central bank can win the “Most Likely to Appease the Political Class” Award.

But which nation will be the next domino to fall? Who will get the next direct bailout?

Some people think total government debt is the key variable, and there’s been a lot of talk that debt levels of 90 percent of GDP represent some sort of fiscal Maginot Line. Once nations get above that level, there’s a risk of some sort of crisis.

But that’s not necessarily a good rule of thumb. This chart, based on 2010 data from the Economist Intelligence Unit (which can be viewed with a very user-friendly map), shows that Japan’s debt is nearly 200 percent of GDP, yet Japanese debt is considered very safe, based on the market for credit default swaps, which measures the cost of insuring debt. Indeed, only U.S. debt is seen as a better bet.

Interest payments on debt may be a better gauge of a nation’s fiscal health. The next chart shows the same countries (2011 data), and the two nations with the highest interest costs, Greece and Ireland, already have been bailed out. Interestingly, Japan is in the best shape, even though it has the biggest debt. This shows why interest rates are very important. If investors think a nation is safe, they don’t require high interest rates to compensate them for the risk of default (fears of future inflation also can play a role, since investors don’t like getting repaid with devalued currency).

Based on this second chart, it appears that Italy, Portugal, and Belgium are the next dominos to topple. Portugal may be the best bet (no pun intended) based on credit default swap rates, and that certainly is consistent with the current speculation about an official bailout.

Spain is the wild card in this analysis. It has the second-lowest level of both debt and interest payments as shares of GDP, but the CDS market shows that Spanish government debt is a greater risk than bonds from either Italy or Belgium.

By the way, the CDS market shows that lending money to Illinois and California is also riskier than lending to either Italy or Belgium.

The moral of the story is that there is no magic point where deficit spending leads to a fiscal crisis, but we do know that it is a bad idea for governments to engage in reckless spending over a long period of time. That’s a recipe for stifling taxes and large deficits. And when investors see the resulting combination of sluggish growth and rising debt, eventually they will run out of patience.

The Bush-Obama policy of big government has moved America in the wrong direction. But if the data above is any indication, America probably has some breathing room. What happens on the budget this year may be an indication of whether we use that time wisely.

Which Nation Will Be the Next European Debt Domino…or Will It Be the United States? is a post from Cato @ Liberty - Cato Institute Blog

The financial crisis and global warming have reinforced an age-old criticism of our traditional ways of measuring wealth, and a number of alternative indexes have been proposed that would instead measure people’s well-being and environmental sustainability.

There are problems with using GDP. It involves an incredible amount of guesswork; and even if it were perfect, it would be bizarre to use production of goods and services as the only yardstick to evaluate our societies. But finding problems is one thing; it is something completely different to find an alternative that is better. Any sort of well-being index would require agreement on what well-being is, and there is a risk that governments would be tempted to find a one-size-fits-all standard and try to make us all wear it.

In a new paper I examine some of the proposed alternatives and they all beg the question about well-being by defining it as the result of the particular kinds of policies that they happen to prefer. Bhutan’s famous National Happiness Index, for example, defines it partly as a strong, traditional culture, and has used it to oppress minorities. And the Commission on the Measurement of Economic Performance and Social Progress, created by French president Nicolas Sarkozy and led by economist Joseph Stiglitz, selectively chooses measures to show that France is richer in relation to the United States than it would otherwise be.

The advantage of GDP is precisely what it has often been criticized for — that it is a narrow and value-free measure. It does not even try to define well-being, and so fits liberal, pluralistic societies in which people have different interests, preferences and attitudes toward well-being. It tells us what we can do, but not what we should do; and since it measures what we can do, it also correlates with most of the things most people want from life: better health, longer lives, less poverty and even happiness. The latest research shows not only that people in rich countries are happier but also that countries grow happier as they become richer.

Read the paper here. Read Will Wilkinson’s Policy Analysis on happiness research here.

On Happiness is a post from Cato @ Liberty - Cato Institute Blog

I’m understandably fond of my video exposing the flaws of Keynesian stimulus theory, but I think my former intern has an excellent contribution to the debate with this new 5-minute mini-documentary.

The main insight of the mini-documentary is that Gross Domestic Product (GDP) only measures how national output is allocated between consumption, investment, and government. That’s useful information in many ways, but if we want more output, we should focus on Gross Domestic Income (GDI), which measures how national income is earned.

Focusing on GDI hopefully would lead lawmakers to consider ways of boosting employee compensation, corporate profits, small business income, and other components of national income. Focusing on GDP, by contrast, is misguided since any effort to boost consumption generally leads to less investment. This is why Keynesian policies only redistribute national income, but don’t boost overall output.

You may recognize Hiwa. She narrated a very popular video earlier this year on the nightmare of income-tax complexity.

The Consumer Spending Fallacy behind Keynesian Economics is a post from Cato @ Liberty - Cato Institute Blog

A Washington Post editorial today discusses the National Academy of Sciences “Fiscal Future” study. The NAS report modeled four possible tax and spending paths for the nation over the next 70 years.  I was one of the NAS report’s co-authors.

The Post focuses on the “low spending and revenue” path, which would keep federal revenues below about 19 percent GDP and keep spending below about 21 percent of GDP. The Post argues that both tax hikes and spending cuts will be needed to fix the government’s budget problem because the “pain and sacrifice” would be too large if we just cut spending, as under this “low” path. But the Post’s conclusion is based on faulty one-sided accounting, only considering the recipients of government largesse.

The reality is that every dollar the government spends imposes ”pain and sacrifice” on current or future taxpayers. Thus, spending cuts may impose temporary pain on people whose benefits are withdrawn, but they create equal or greater pain on the taxpayers who foot the bill. Indeed, standard economic theory suggests that the economy gets a “free lunch” when spending and taxes are reduced in tandem because the deadweight losses caused by government coercive actions are reduced.

Note that I say “temporary” pain because to a substantial degree, benefit recipients will adjust their lives as subsidies are withdrawn, and most people will prosper without government help, as we saw following welfare reform in 1996.  Misguided government spending programs–like welfare–cause damage to society and the economy, so that reducing spending doesn’t increase pain, it ultimately reduces it. Consider how government housing subsidies ended up causing widespread damage, including for many people who initially benefited. For a guide to damaging federal programs, see www.downsizinggovernment.org.

The Post is right that the NAS study’s “low spending” path would require “broad areas” of federal spending to be cut, such as K-12 school subsidies and other state aid programs. But that would be a good thing for citizens, the economy, and for responsible government. Federal spending on properly state and local activities has been a giant failure, and it should be ended whether or not there is a budget deficit. 

The Post is on sounder footing with its observation that many Republicans do not seem to grasp the magnitude of spending reforms that are needed in the years ahead. The GOP does need to “get specific” and push for particular cuts. Let’s have national debates on federal involvement in K-12 schools, raising the Social Security retirement age, and cutting the corporate welfare programs mentioned by the Post. Let’s start that “adult conversation” right now, because as the NAS report warns, the longer we wait, the more the federal debt monster grows.

For the record, the NAS report did not endorse tax hikes or any other particular fiscal solution. It simply provided four possible combos of future tax and spending levels as starting points for discussion. It also usefully described how to overhaul the income tax and replace it with a much simpler and flatter tax system, as I’ve described here.

WaPo’s Fiscal Truths is a post from Cato @ Liberty - Cato Institute Blog

What had been a recurring story line buried in the business pages has now burst onto the front page: “Economic growth slowed by trade gap,” the Washington Post reports this morning in an above-the-fold headline.

The lead sets the stage for a story long on generalizations: “A widening U.S. trade deficit has become a substantial drag on economic growth as the country’s exports struggle to keep pace with the swelling sums that Americans are again spending on imported goods.”

The half truth in the story line is that exports fell by $2 billion in June compared to the month before, and that this has a negative effect on overall GDP growth. In our more globalized world, the rising wealth of our trading partners translates into more production in our own economy, and vice versa.

The fatal flaw of the story line (as I tackled recently here and at greater length here) is that it assumes that rising imports slow economic growth. That assumption, in turn, rests on a simplistic Keynesian view that if a portion of domestic demand is satisfied by spending on imports, that means less demand for domestically produced goods, thus less output and lower employment.

That view neglects the supply-side role of imports. More than half of what we import consists of goods consumed by producers—capital machinery, raw materials, parts and other intermediate inputs. Those imports help us produce more, not less. The Keynesian view also confuses cause and effect: Imports usually grow in response to RISING domestic demand. Consumers more eager to spend “swelling sums” on imports typically buy more domestically produced goods as well.

The bean counters at the Commerce Department “subtract” imports from GDP, not because those imports are a drag on growth, but to avoid double counting. If we want to count the number of widgets and other goods added to the economy in a quarter, we would obviously not count those that have been imported. But this does not mean the economy would have been that much larger if the widgets had not been imported.

The Post story adds to the misunderstanding by claiming: “At a basic level, trade deficits represent a loss of wealth for a country—money flowing abroad for goods and services produced elsewhere, supporting businesses and workers in other countries.”

This betrays a basic misunderstanding of wealth that Adam Smith exposed two centuries ago in The Wealth of Nations. Does wealth consist of money—pieces of green paper or blips on a computer or, in Smith’s day, bars of gold—or does it consist of the actual stuff that people produce to make their lives better, all those goods and services that we consume each year? Smith argued it was the latter. And in that case, a trade deficit at a basic level represents an inflow of wealth from the rest of the world—a cornucopia of cool stuff arriving everyday at our ports and stocking the shelves of our stores.

Of course, even if you think that dollars are the ultimate measure of wealth, obsession with the trade deficit ignores the fact that those dollars spent on imports quickly return to the United States. If they are not used to buy our goods and services, they are buying our assets—real estate, stocks, Treasury bonds, and so on. The “loss of wealth” supposedly represented by the trade deficit is almost exactly offset every year by a “gain of wealth” represented by the net inflow of dollars in the form of capital investment from the rest of the world.

Besides being wrong in its basic economics, making the trade deficit the scapegoat for slow growth poses a double danger for economic policy:

Danger no. 1 is that it tempts politicians to reach for the snake oil of protectionism to create jobs. If only we could stop the flood of imported goods, Americans would make more of those same goods themselves, creating millions of jobs. In reality, higher trade barriers impose a host of offsetting costs on the economy, resulting in lower output.

Danger no. 2 of blaming the trade deficit is that it diverts attention from policies that are far more plausible culprits in dampening growth. Politicians find it much easier to blame imported consumer goods from China for slower GDP growth than huge looming tax increases, expensive new health care mandates, a depressed housing sector, and a generally anti-business climate in Washington.

The trade gap should be the least of our worries.

Is the Trade Gap to Blame for Slowing GDP Growth? is a post from Cato @ Liberty - Cato Institute Blog

From January 2009 to the present, President Obama and his team have repeatedly made grandiose claims about the economic benefits of shoveling money at shovel-ready projects or green jobs.  “It is largely thanks to the Recovery Act that a second Depression is no longer a possibility,” said the President.   He also claimed that lavish spending alone (not Federal Reserve actions or bank bailouts) is what prevented the unemployment rate from “getting up to . . . 15%.”

If any of that were remotely close to being true then, as a matter of simple accounting, rising federal spending would have shown up as a huge offset to falling GDP in 2009, and also as a major component of the modest increase in GDP growth in early 2010.   On the contrary, the table below shows that the increase in federal nondefense spending contributed only two-tenths of one percent (0.2) to the change in GDP in 2009.  That was no better than 2008 when the Recovery Act did not exist.  If nondefense spending had not increased at all in 2009 (unlike 2008) then GDP would have fallen 2.8% rather than 2.6% — scarcely the difference between a recession and a “second Depression.”  If nondefense federal spending had not increased at all in 2010, the economy still would have grown at a 3.6% pace in the first quarter, 2.1% in the second.  Cutbacks in state and local spending were a trivial damper on GDP growth last year, contrary to recent speculation, and real state and local spending rose significantly in this year’s second quarter (unlike the first).

This is just an exercise in crude Keynesian accounting, not economics.  Yet it nonetheless makes the stimulus bill look like a huge waste of money.  The reason Keynesian accounting is no substitute for economics is that governments can only spend other peoples’ money.  To claim that such spending is a net addition to “aggregate demand” is to ignore those other people — namely, current and future taxpayers.

Nobel Laureate Robert Lucas put it this way:

If the government builds a bridge . . . by taking tax money away from somebody else, and using that to pay the bridge builder — the guys who work on the bridge — then it’s just a wash.  It has no first-starter effect.  There’s no reason to expect any stimulation.  And, in some sense, there’s nothing to apply a multiplier to.  You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge.  And then taxing them later isn’t going to help, we know that.

Even Keynesian Accounting Can’t Find All That ‘Stimulus’ is a post from Cato @ Liberty - Cato Institute Blog

It was a good idea to get science and democracy from the ancient Greeks. It’s not such a good idea to get fiscal policy from the modern Greeks.

But that’s the way we’re headed.

Greece has a budget deficit of 13.6 percent. We’re not in that league — ours is only 10.6 percent, the highest level since 1945.

Greece has a public debt of 113 percent of GDP. We’re not there yet. But the 2009 Social Security and Medicare Trustees Reports show the combined unfunded liability of these two programs has reached nearly $107 trillion.

Under President Obama’s budget, debt held by the public would grow from $7.5 trillion (53 percent of GDP) at the end of 2009 to $20.3 trillion (90 percent of GDP) at the end of 2020. It could rise to 215 percent of GDP in 30 years. Welcome to Greece.

Here’s a graphic presentation of the official debt and real net liabilities of various countries, including the United States and Greece at the right. (From the Telegraph, apparently based on Jagadeesh Gokhale’s report.)

And here’s a Heritage Foundation chart on where the national debt is headed in the coming decade:

Paul Krugman wrote, “My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.” Now he was writing in 2003, when a different president was in office, but he was also warning about the possibility of a ten-year deficit of $3 trillion. Presumably the same warnings apply to today’s much larger deficit projections. And he was absolutely right to fear that government would turn to inflation as a supposed solution.

The Greek Model is a post from Cato @ Liberty - Cato Institute Blog

Perhaps I am a little confused, but didn’t the Obama Administration tell the American public only months ago that TARP was turning a profit?   But now the same administration is proposing to assess a fee on banks to cover losses from the TARP. Maybe President Obama is coming around to the realization that the TARP has indeed been a loser for the taxpayer. He appears, however, to be missing the critical reason why: the bailouts of the auto companies and AIG, all non-banks. This is to say nothing of the bailout of Fannie Mae and Freddie Mac, whose losses will far exceed those from the TARP. Where is the plan to re-coup losses from Fannie and Freddie? Or a plan to re-coup our rescue of the autos?

If the effort is really about deficit reduction, then it completely misses the mark.  Any serious deficit reduction plan has to start with Medicare and Social Security.  Assessing bank fees is nothing more than a rounding error in terms of the deficit.  Let’s put aside the politics and get serious about both fixing our financial system and bringing our fiscal house into order.  The problem driving our deficits is not a lack of revenues, aside from effects of the recession, revenues have remained stable as a percent of GDP, the problem is runaway spending.

The bank tax would also miss what one has to guess is Obama’s target, the bank CEOs.  Econ 101 tells us (maybe the President can ask Larry Summers for some tutoring) corporations do not bear the incidence of taxes, their consumers and shareholders do.   So the real outcome of this proposed tax would be to increase consumer banking costs while reducing the value of bank equity, all at a time when banks are already under-capitalized.

Obama Bank Tax Is Misguided is a post from Cato @ Liberty - Cato Institute Blog

Why blame only media and politicians for the public’s confusion about imports and trade deficits? Surely economists deserve some scorn. Some of the misunderstanding can be traced to the famous National Income Identity, which expresses gross domestic product, as: Y = C + G + I + (X-M). That is, national output (Y) equals personal consumption (C) plus government spending (G) plus investment (I) plus exports (X) minus imports (M).

The expression clearly lends itself to the wrong interpretation. The minus sign preceding imports suggests a negative relationship with output. It is the reason for the oft-repeated fallacy that imports are a drag on growth. Here’s why that conclusion is wrong.

The expression is an accounting identity, which “accounts” for all of the possible channels for disposing of our national output. That output is either consumed in the private sector, consumed by government, invested by business, or exported. The identity requires subtraction of aggregate imports because consumption, government spending, business investment, and exports all contain, in various amounts, import value. Americans consume domestic and imported products and services, the aggregate of which shows up in Consumption. Likewise, Government purchases include domestic and imported products and services; businesses Invest in domestic and imported machines and inventory; and, eXports often contain some imported intermediate components. Thus, the identity would overstate national output if it didn’t make that adjustment for iMports. After all, imports are not made on U.S. soil with U.S. factors of production, so they shouldn’t be included in an expression of our national output.

To reiterate, it is a simple matter of accounting: as an expression of national output, the National Income Identity subtracts imports only because imports are that portion of consumption, government spending, investment, and exports that are not produced on U.S. soil with U.S. factors of production. If we did not subtract an aggregate import value, then national output would be overstated.

But what unnecessary confusion that identity has created. Economists are often indecipherable, but here was an opportunity to actually connect with the public and describe a relatively easy concept in relatively easy terms. Why has it not been commonplace to use notation that conveys in no uncertain terms that C and G and I and X include some amount of imports? Maybe something like this:

Y=C(d)+C(m)+G(d)+G(m)+I(d)+I(m)+X(d)+X(m)-M,

where (d) connotes domestic; (m) connotes imported; and M=C(m)+G(m)+I(m)+X(m).

Again, imports are subtracted, not because they are a drag on output, but because imports are included in the other constituent elements of the identity. I’ve always found it misleading that the parentheses go around X-M – which isolates the expression “net exports,” but in the process can obscure the fact that imports are subtracted from the whole expression.

Finally, if the description above makes sense, then you’ll agree that imports have NO impact on national output. Regardless of how large or small, the import value embedded in the four constituent elements of national output is fully deducted by subtracting M. Thus, imports are neither a drag on GDP, nor can they cause GDP to rise. That conclusion may sound like it contradicts one of my assertions in yesterday’s post—that imports are pro-cyclical—(at least that was the claim of a NBER economist responding my post yesterday), but I think the conclusions are harmonious. To say imports are pro-cyclical means that they rise when the economy is growing and fall when the economy is contracting. It says nothing about causation.  That pattern has been amply and consistently demonstrated through expansion, recession, and recovery.

Another Reason Imports Get a Bad Rap is a post from Cato @ Liberty - Cato Institute Blog

The expansion in government and poor state of the economy got me thinking about how government growth is reflected in measured gross domestic product. So here is a wonky look at the treatment of government in the Bureau of Economic Analysis GDP data.

Data notes: By “government,” I mean total federal, state, and local. For 2009, I’m using the average of second and third quarter data. All data from BEA Tables here.

GDP measures total production. In 2009, government production was 20.7 percent of U.S. GDP.  Government production is roughly the sum of government value-added (the stuff it produces itself) and government purchases. The first item, government value-added, was 12.4 percent of GDP and mainly consists of employee compensation. For example, the Pentagon produces output by adding together fighter pilots, which it hires, and fighter jets, which it buys.

A more commonly cited measure of government is total government spending. In 2009, that was 38 percent of GDP. The difference between this number (38 percent) and the production number (20.7 percent) is 17.3 percent, and represents the sum of government interest payments and transfer payments to individuals and businesses.

Figure 1 shows how the three measurements of government size have changed over time. Government production has remained fairly stable as a share of the economy, but total government spending has soared. The growing gap between these two lines mainly represents the massive growth in transfer (or subsidy) programs, such as Social Security.

How Does Government Growth Affect Measured GDP?

Consider how the recent rise in government spending might have affected measured GDP. First, let’s look first at the production part of government spending. The important thing here is that we don’t know how much government workers actually produce because their output is generally not sold on the market. As a consequence, the BEA measures their output as the sum of their compensation amounts. Also, we know the dollar value of the things the government buys, but we don’t know how much those intermediate goods actually produce when in the hands of the government. So the government production portion of GDP seems kind of shaky, despite the superb efforts of the BEA to assemble all the data.

Anyway, let’s say the government adds a new worker with pay of $100,000, the BEA measures GDP being boosted by $100,000. But it might be that the worker doesn’t actually produce anything useful, and he adds zero to the economy’s actual output.

If the government hires that worker away from the private sector, private GDP would go down by about $100,000. As a result, overall measured GDP would be unchanged. But that would be incorrect because the economy’s actual output fell by $100,000.

So let’s say the government spent $100 billion to hire a million new government workers. Let’s say half of those workers produced as much value as their salaries, but the other half produced nothing of value. The result of this government expansion would be that the BEA would overestimate U.S. GDP by $50 billion. (I am assuming that the government’s hiring doesn’t change the unemployment rate. I’m also ignoring the distortionary effects of higher taxes).  

Now let’s look at the transfer or subsidy portion of government, which equals 17.3 percent of GDP.

Let’s say the government increases transfers by $100 billion, perhaps by increasing Social Security benefits, and funding it by higher taxes on wages.

If there are no behavioral responses among taxpayers and benefit recipients, measured GDP would be unchanged, which would be the correct answer.

But of course there would be behavioral responses. The higher taxes would induce people to work less and the higher Social Security benefits would induce people to save less and retire earlier. The results would be that output would fall, and that would be accurately reflected in measured GDP.

In sum, my purpose here was not to explore how a growing government affects the economy, which is a huge subject. Instead, it was to explore whether measured GDP accurately reflects changes in the size of government. The answer appears to be that the transfer part of government spending (17.3 percent of GDP) would be accurately reflected in a shrinking GDP, but that the production portion of government spending (20.7 percent of GDP) may not be. If workers produce less output when they work for government than when they work in the private economy, the latter portion of measured GDP will be overstated.

Government and GDP is a post from Cato @ Liberty - Cato Institute Blog

In a recent post, I argued that while third-quarter GDP was positive, the underlying data revealed that U.S. private investment was still in the toilet. While government spending might be providing a short-term “sugar high” for the economy, U.S. business investment remains in recession. I speculated that Obama’s anti-business agenda is likely one cause of the problem.

For those observations, economist Brad DeLong called me an “utter fool.”

Let me draw your attention to an article in the Washington Post today entitled “Corporate giants sit on piles of cash.” Nucor Steel is sitting on piles of cash that it is unwilling to invest. Nucor’s chief executive Daniel Dimicco explains:

Everything is still on hold because we don’t have a lot of confidence that the right things are being done in Washington to reinvigorate the economy.

To story goes on:

Nucor isn’t alone. The balance sheets of large U.S. corporations are for the most part in good shape. Many big companies have piles of cash on hand and credit markets have thawed so that they can raise new funds… But most U.S. executives lack enough confidence in the economy to expand their businesses.

The article explains how big businesses are “jittery” for various reasons, such as memories of last year’s credit crunch. It doesn’t mention President Obama’s policies, but at this point in the economic cycle when world growth is returning, the lack of excitement by U.S. businesses regarding domestic investment is very curious.

Unfortunately, the Obama administration is giving them nothing to get excited about. The President is promising them higher health care costs, higher corporate taxes, more labor regulations, higher energy costs with cap-and-trade, and a lack of interest in further trade agreements.

The Post article says that some U.S. multinationals are using their hoards of cash to invest abroad, allowing them to avoid punitive treatment under the high-rate U.S. corporate income tax.

How do we get U.S. multinationals to start investing their “piles of cash” in the United States? Cut the U.S. corporate rate permanently to 15 percent, as I’ve described in Global Tax Revolution. With just about every other advanced economy having slashed their corporate rate in recent years, we are “utter fools” for not following suit, especially with the unemployment rate now topping 10 percent.

Big Business Not Investing is a post from Cato @ Liberty - Cato Institute Blog

The Bureau of Economic Analysis released third-quarter gross domestic product numbers yesterday, and overall real growth at 3.5 percent was pretty good.

But examining the components of GDP reveals a more disturbing picture. While consumption, exports, and the government sector were up, private investment has fallen through the floor.

Figure 1 reveals a dramatic collapse of private investment over the last two years. In nominal dollars, private investment in 2009 has only been at about the same level as the bottom of the last recession eight years ago (BEA Table 1.1.5).

Figure 2 has the same data in real 2005 dollars (BEA Table 1.1.6). It shows that private investment is stuck in a rut at about 17 percent below the lowest level reached at the bottom of the last recession.

The third quarter GDP numbers show that the economy is only starting to “recover” because of growing government and expanding consumption, which has been artificially inflated by large government transfers.

Business investment continues to be in a deep recession. Companies are simply not building factories or buying new machines and equipment.

Why not? I suspect that many firms are scared to death of higher taxes, inflation, health care mandates, increased labor regulation, and other profit-killers coming down the road from Washington. That is speculation, but I haven’t heard a better explanation of the death of private investment in America.

Data note: the measure of “government” here is government production as a share of GDP, not total government spending, which includes transfers.

The Death of Private Investment is a post from Cato @ Liberty - Cato Institute Blog

Republicans made many big mistakes when they controlled Washington earlier this decade, so picking the most egregious error would be a challenge. But continued American involvement with the Organization for Economic Cooperation and Development would be high on the list. Instead of withdrawing from the OECD, Republicans actually increased the subsidy from American taxpayers to the Paris-based bureaucracy. So what do taxpayers get in return for shipping $100 million to the bureaucrats in Paris? Another international organization advocating for big government.

The OECD, for example, is infamous for trying to undermine tax competition. It also has recommended higher taxes in America on countless occasions. And now it is suggesting that Iceland impose high tax increases – even though Iceland’s economy is in big trouble and the burden of government spending already is about 50 percent of GDP:

Both tax increases and spending cuts will be needed, although the former are easier to introduce immediately. The starting point for the tax increases should be to reverse tax cuts implemented over the boom years, which Iceland can no longer afford. This would involve increases in the personal income tax… Just undoing the past tax cuts is unlikely to yield enough revenue. In choosing other measures, priority should be given to those that are less harmful to economic growth, such as broadening tax bases, or that promote sustainable development, such as introducing a carbon tax.

Using Gasoline to Douse a Fire? OECD Thinks Higher Tax Rates Will Help Iceland’s Faltering Economy is a post from Cato @ Liberty - Cato Institute Blog

• Jack of all trades and master of none: What happens when the government gets so big that it fails to fulfill its most important role.

• The hard truth about end-of-life care in America.

• If current trends continue, the U.S. government will soon spend a greater portion of GDP on Medicare and Medicaid than Canada now spends on its entire single-payer government-run system. Here’s a way to fix that.

• How about a little honesty from time to time in the tobacco policy debate?

• More drug-related chaos along the Mexican border.

• Go North Young Man! Will Wilkinson becomes “forever Canadian.”

Weekend Links is a post from Cato @ Liberty - Cato Institute Blog

Last week Conor Clarke at The Atlantic blog , apparently as part of a running argument with Jim Manzi, raised four substantive issues with my study, “What to Do About Climate Change,” that Cato published last year. Mr. Clarke deserves a response, and I apologize for not getting to this sooner. Today, I’ll address the first part of his first comment. I’ll address the rest of his comments over the next few days.

Conor Clarke: 

(1) Goklany’s analysis does not extend beyond the 21st century. This is a problem for two reasons. First, climate change has no plans to close shop in 2100. Even if you believe GDP will be higher in 2100 with unfettered global warming than without, it’s not obvious that GDP would be higher in the year 2200 or 2300 or 3758. (This depends crucially on the rate of technological progress, and as Goklany’s paper acknowledges, that’s difficult to model.) Second, the possibility of “catastrophic” climate change events — those with low probability but extremely high cost — becomes real after 2100.

Response:  First, I wouldn’t put too much stock in analyses purporting to extend out to the end of the 21st century, let alone beyond that, for numerous reasons, some of which are laid out on pp. 2-3 of the Cato study. As noted there, according to a paper commissioned for the Stern Review, “changes in socioeconomic systems cannot be projected semi-realistically for more than 5–10 years at a time.”

Second, regarding Mr. Clarke’s statement that, “Even if you believe GDP will be higher in 2100 with unfettered global warming than without, it’s not obvious that GDP would be higher in the year 2200 or 2300 or 3758,” I should note that the conclusion that net welfare for 2100 (measured by net GDP per capita) is not based on a belief.  It follows inexorably from Stern’s own analysis.

Third, despite my skepticism of long term estimates, I have, for the sake of argument, extended the calculation to 2200. See here. Once again, I used the Stern Review’s estimates, not because I think they are particularly credible (see below), but for the sake of argument. Specifically, I assumed that losses in welfare due to climate change under the IPCC’s warmest scenario would, per the Stern Review’s 95th percentile estimate, be equivalent to 35.2 percent of GDP in 2200. [Recall that Stern’s estimates account for losses due to market impacts, non-market (i.e., environmental and public health) impacts and the risk of catastrophe, so one can’t argue that only market impacts were considered.]

The results, summarized in the following figure, indicate that even if one uses the Stern Review’s inflated impact estimates under the warmest IPCC scenario, net GDP in 2200 ought to be higher in the warmest world than in cooler worlds for both developing and industrialized countries.

Source: Indur M. Goklany, “Discounting the Future,” Regulation 32: 36-40 (Spring 2009).

The costs of climate change used to develop the above figure are, most likely, overestimated because they do not properly account for increases in future adaptive capacity consistent with the level of net economic development resulting from Stern’s own estimates (as shown in the above figure).  This figure shows that even after accounting for losses in GDP per capita due to climate change – and inflating these losses — net GDP per capita in 2200 would be between 16 and 85 times higher in 2200 that it was in the baseline year (1990).  No less important, Stern’s estimate of the costs of climate change neglect secular technological change that ought to occur during the 210-year period extending from the base year (1990) to 2200. In fact, as shown here, empirical data show that for most environmental indicators that have a critical effect on human well-being, technology has, over decades-long time frames reduced impacts by one or more orders of magnitude.

As a gedanken experiment, compare technology (and civilization’s adaptive capacity) in 1799 versus 2009. How credible would a projection for 2009 have been if it didn’t account for technological change from 1799 to 2009?

I should note that some people tend to dismiss the above estimates of GDP on the grounds that it is unlikely that economic development, particularly in today’s developing countries, will be as high as indicated in the figure.  My response to this is that they are based on the very assumptions that drive the IPCC and the Stern Review’s emissions and climate change scenarios. So if one disbelieves the above GDP estimates, then one should also disbelieve the IPCC and the Stern Review’s projection for the future.

Fourth, even if analysis that appropriately accounted for increases in adaptive capacity had shown that in 2200 people would be worse off in the richest-but-warmest world than in cooler worlds, I wouldn’t get too excited just yet. Even assuming a 100-year lag time between the initiation of emission reductions and a reduction in global temperature because of a combination of the inertia of the climate system and the turnover time for the energy infrastructure, we don’t need to do anything drastic till after 2100 (=2200 minus 100 years), unless monitoring shows before then that matters are actually becoming worse (as opposing merely changing), in which case we should certainly mobilize our responses. [Note that change doesn’t necessarily equate to worsening. One has to show that a change would be for the worse.  Unfortunately, much of the climate change literature skips this crucial step.]

In fact, waiting-and-preparing-while-we-watch (AKA watch-and-wait) makes most sense, just as it does for many problems (e.g., some cancers) where the cost of action is currently high relative to its benefit, benefits are uncertain, and technological change could relatively rapidly improve the cost-benefit ratio of controls. Within the next few decades, we should have a much better understanding of climate change and its impacts, and the cost of controls ought to decline in the future, particularly if we invest in research and development for mitigation.  In the meantime we should spend our resources on solving today’s first order problems – and climate change simply doesn’t make that list, as shown by the only exercises that have ever bothered to compare the importance of climate change relative to other global problems.  See here and here.  As is shown in the Cato paper (and elsewhere), this also ought to reduce vulnerability and increase resiliency to climate change.

In the next installment, I’ll address the second point in Mr. Clarke’s first point, namely, the fear that “the possibility of ‘catastrophic’ climate change events — those with low probability but extremely high cost — becomes real after 2100.”

Response to Conor Clarke, Part I is a post from Cato @ Liberty - Cato Institute Blog

The Heritage Foundation has a chart up on its blog, showing defense spending as a percentage of gross domestic product and declaring that “Obama plan cuts defense spending to pre-9/11 levels.”

This is a standard rhetorical device for defense hawks (see the Wall Street Journal editorial page, Mitt Romney and lots of others) so it’s worth pointing out that it’s misleading. The unfortunate truth is that Obama is increasing non-war defense spending this year and seems likely to increase it at least by inflation in the near future.

It’s true that defense spending will probably decline as a percentage of GDP, assuming the economy recovers. But that’s because GDP grows. Ours is more than six times bigger than it was in 1950.  Meanwhile, we spend more on defense in real, inflation adjusted terms, than we did then, at the height of the Cold War. The denoninator has grown faster than the numerator. 

By saying that defense spending needs to grow with GDP to be “level,” you are arguing for an annual increase in defense spending without saying so directly. That’s the point, of course.

To be straight with readers, charts that show defense spending as a percentage of GDP should either show GDP growth over time or include a line that shows defense spending in real terms. Otherwise they fail to demonstrate that the decline in defense spending as a percentage of GDP is a consequence of growing GDP, not lower spending.

Here’s a chart from the Congressional Budget Office’s report, “The Long Term Implications of the Current Defense Plans,” that does this.

The assumption in analysis like Heritage’s is that defense spending should be a function of economic growth, not enemies and strategies for defending against them.  It’s easy to point out that this is strategically and fiscally foolish. And it’s worth noting, as I have on many occasions, that we face a benign threat environment and can cut defense spending massively as a result.

But there is something weirder going on here that warrants mention.  Arguing that wealth creation should drive defense spending is to attempt to divorce the military from its strategic rationale. That’s an implicit acknowledgement that defense spending is not for safety.  High military spending in this worldview is either an end in itself or a partisan or cultural tool.  That’s not much of a revelation, I guess.

Misinformation from Heritage is a post from Cato @ Liberty - Cato Institute Blog