“Government and Economic Growth”

Sydney M. Williams

Thought of the Day

“Government and Economic Growth”

September 25, 2012

Government is addicted to growth. Unfortunately it is addicted to the growth of its own bureaucracies, not the economy. It is the rare bureaucrat who desires to make his or her department smaller. There are a few examples. Demobilization always follows the conclusion of wars. In Germany, the Treuhandanstalt, which was established in 1990 (and for which my oldest son worked for a year and a half) to privatize East German industry, was that rare bureaucracy that was set up to last for a specific period of time. In 1990, it was the largest industrial firm in the world with 8500 businesses employing 4 million people. Five years later, its job accomplished; it did not exist. As Indiana Governor Mitch Daniels said in his response to the President’s State of the Union message last January, “…government is meant to serve the people rather than supervise them…” Every manager – public and private – has a desire to grow his department. But the government bureaucrat who does so too often inhibits the private sector, by imposing unnecessary rules and regulations.

A sense of waste is embedded in almost all governmental bodies. When I was a new Army recruit fifty years ago, I recall being ordered to rake leaves, but to rake them one leaf at a time.

Unlike a business that must depend on rising sales to enjoy the benefits of growth, the government worker relies on an ever-rising stream of tax revenues, or an increase in the level of debt to achieve the same objective. Government does not produce anything, apart from paper work. It is responsible for passing legislation and then administering rules and regulation; it protects our lives and property and defends us when we need defending; it has responsibility to teach our youth and to ensure laws are upheld. It prosecutes miscreants, and transfers wealth where and when it deems to do so necessary. And it does all this while being paid through the tax dollars we pay. It is a service industry with too little understanding of the concept of service.

For most of the past four decades, the federal government spent about one out of every five dollars in the entire economy. For the last four years it has been spending one out of four. An expanding government crowds out a struggling private sector. When the economy expands, so do tax revenues. But, when it shrinks or grows at a subpar level, tax receipts decline. When spending keeps on chugging along, as it is now in lean economic times, that means debt is expanding.

Recessions cause the traditional balance between the public and private sectors to be altered, at least temporarily. A lack of tax revenues causes debt to increase, but the goal should be to get the private sector re-energized as quickly as possible, not to permanently put in place government programs that cannot be easily disassembled. The Federal Reserve plays a key role in aiding an ailing economy, but encouraging business investment and consumer spending should be the motivating reasons – not making it easier for government to expand their reach, which is what this Fed has done.

With tax revenues at historically low levels, the response of the Administration has been to raise “fees” on everybody, increase taxes on the “rich,” and to increase borrowings to pay for expanded welfare programs. Cutting spending and reducing the size of government is considered an unacceptable form of austerity. Low interest rates have allowed government to expand without the penalty of paying for what has been reckless fiscal behavior. With a complaisant Federal Reserve, while having the world’s reserve currency, the consequences of the arithmetic have not yet been fully felt in the U.S. But that will not last. There will be a price to pay.

John Taylor, professor of economics at Stanford, recently noted that last year the Fed bought 77% of all new federal debt issuance. Their actions have kept interest rates at abnormally low levels. For example, last year federal debt amounted to 98.7% of GDP, and interest rates were 3.0% of GDP. In contrast, in 1989 debt was 53.6% of GDP, while interest expense was 4.4% of GDP. Another way of looking at the same numbers is to measure federal debt per capita and as a percent of per capita income. Using those measures, debt per capita as a percent of per capita income in 1989 was 85%. In 2011 it was 183% . If price controls on interest rates were lifted, interest costs would exceed what we now pay for defense. MSNBC, not a noted advocate for fiscal prudence, noted last year that interest costs on the federal budget in 2018 will exceed what we now pay for Medicare. Today, according to their report, interest costs are one half of Medicare expenses.

The Fed can keep the music going for a while, but at some point it stops. Senator Schumer (D-NY) recently stated, in an unacknowledged indictment of himself and Congress, that “the Fed is the only game in town.” Richard Fisher, President of the Dallas Federal Reserve Bank, at a speech last week at the Harvard Club said he would have answered Mr. Schumer (who is also his college classmate): “No, Senator, your colleagues are the only game in town. For you and your colleagues, Democrat and Republican alike, have encumbered our nation with debt, sold our children down the river and sorely failed our nation. Sober up. Get your act together. Illegitimum non carborundum (loosely translated as ‘Don’t let the bastards wear you down.’) Sacrifice your political ambition for the good of the nation…For unless you do, all the monetary policy accommodation the Federal Reserve can muster will be for naught.” I would add to the list of those guilty our President who has done very little, if anything, to jumpstart the process of reigniting the economy. Mr. Fisher’s speech can be accessed by going to www.dallasfed.com, and then looking for speeches by Mr. Fisher.

In the same speech, Mr. Fisher referenced a recent Duke University survey of 887 chief financial officers. Only 14.5% cited credit markets/interest rates among their top three concerns. In contrast, 43% listed consumer demand and 41% mentioned federal government policies. Third on the list were price pressures from competitors, and fourth was global financial instability. Eighty-four percent of the respondents said they would not change investment plans if interest rates dropped two percent.

As I noted in a piece last week, “The Fed Does What Washington Dares Not,” liquidity is not the problem. Banks have excess reserves of $1.5 trillion. Corporations have something like $2 trillion in cash on their balance sheets. As of last week, money market mutual funds held $2.578 trillion. Cash is not the problem. Confidence is. Mary Anastasia O’Grady had an op-ed in yesterday’s Wall Street Journal, in which she reviewed the miracle of commonsensical politics that saved Canada eighteen years ago. It is a story worth recapping. Paul Martin, who had been elected finance minister in 1993 in Jean Chrétien’s Liberal Party, faced a federal debt-to-GDP ratio of 80 percent. Interest costs were consuming about one third of the government’s revenues. Mr. Martin cut spending by ten percent over two budgets. Nothing was spared. In the 1997 election, the Liberal Party increased its majority in Parliament. Two tax cuts were implemented, in 1997 and 2000, including the largest cuts – both corporate and personal – in the history of the country. Again, in the next election, they won. The problem in Canada had been building for years. Over a two-month period in 1994, interest rates on Three-month Canadian Treasuries rose from 3.85% to 5.82%, providing a preview of what can happen in Treasury land. Federal spending, which was 15% of GDP in 1965, had risen to 23% by 1993. (Today, we are at 24 percent.) Canada turned the corner. Growth reignited. Taking the difficult steps to fix the problem did not hurt the Liberal Party in the subsequent elections. Of all developed countries, Canada weathered the recent economic downturn better than most. Countries can be turned around, but it takes bold ideas, determination and a willingness to be straight with the electorate.

More than anything, Mr. Obama should be using the power of his pulpit to restore confidence; and that means explaining the magnitude of the problem and that the best way to restore growth is to simplify both the tax code and regulation, as a means to encouraging businesses to invest.

A consequence of an expanding government – one that has increased rules, regulations – has been a decline of the United States in the Economic Freedom Index compiled by the Fraser Institute in British Columbia. Gene Epstein reported the results in last weekend’s Barron’s. On a scale of 1 to 10, the U.S. scored a 7.7, placing it 19 and behind such countries like Canada, Chile, Denmark, Finland and the U.K. In 1995, the U.S. was 2, and in 2000 it ranked 8.

Growth can only come from the private sector. Government needs to provide for those who for whatever reason cannot do so themselves, but bureaucracies getting big for the sake of getting big are not the answer. They encourage a lack of responsibility on the part of people, and complacency and arrogance on the part of government employees. Parkinson’s Law, which states that work will expand to fill the time available for its completion, is applicable to government, but not to private businesses that must produce a profit in order to survive and grow. As Mr. Daniels said in his response last January: “We do not accept that ours will ever be a nation of haves and have nots; we must always be a nation of haves and soon to haves.”

The philosophical difference is important. One says trust in government; the other says trust in one’s self and free markets. One breeds dependency; the other responsibility and self respect, and helps fulfill the aspiration of millions. One grows government; the other grows the economy.