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Economic downturn: Wrong diagnosis = Wrong remedy

Since 2008, there has been heated discussion about policies to foster economic growth. President Barack Obama and Democrats in Congress championed a “stimulus bill” made up of tax cuts, aid to state governments, additional spending for a wide variety of federal programs, and a very small allocation (approximately 10 percent of their $850 billion package) for so-called “shovel ready” construction projects. Predictably, Republicans uniformly opposed the plan. Republicans now decry Obama’s jobs bill as “another failed stimulus.”  Though their opposition appears more based on politics than policy, they may be right.

The Democratic approach follows a long-held view that the federal government must deficit spend in order to “jump start” a recovery. This is called “Keynesian economics,” named for John Maynard Keynes, whose writings influenced the response to the Great Depression. Harvard economist Ken Rogoff asserts that the Keynesian formula is not applicable today. Rogoff insists that recessions rooted in the collapse of financial institutions are different. His theory? We are experiencing a reset of our economy, which for too long was built on debt (excessive consumer debt, risky second mortgages, inflated housing prices, exotic debt-based financial instruments, etc.). If he is right, and I think he is, this implies that more debt (in the form of a federal stimulus) is not the answer. It also suggests that, unlike a typical recession, the reset will take time.

So what policies would produce long-term growth? The housing collapse was central to today’s financial meltdown. It is disappointing so little has been done to address this crisis. I believe we need something comparable to the Farm Credit restructuring legislation enacted in the late 1980s (which I helped to craft as a member of Congress). This would place a floor under home values, provide an incentive for borrowers and lenders to negotiate, and reward both borrowers and lenders for any future increase in home values. Without such action, bankruptcies and foreclosures will continue to depress this sector — and home values will remain too low for too long.

The role of trade and immigration
Trade and immigration are also important to economic recovery. And on these issues both parties are part right and part wrong. Democrats are anti-trade and pro-immigrant (including pro-illegal immigration). Republicans, conversely, are pro-trade and anti-immigration. Instead, we need a pro-trade and pro-immigration policy.

Tim Penny
Tim Penny

Given that American markets are already wide open to imports, every new trade agreement results in breaking down barriers in other countries that work against American exports. Obama is right to ask Congress to approve trade pacts with Colombia, Panama and South Korea, and he will get Republican support. As for immigration, the post 9/11 limits on HB1 visas and student visas have hurt our economy. Unfortunately, we issue only a third as many visas today as compared to a decade ago. Still, fully 68 percent of our nation’s doctoral graduates are born elsewhere — and, today, instead of staying here (as they once did) most go home. By making it more difficult for bright and ambitious foreigners to come here, study here, and contribute by working here, we are stifling our nation’s future growth.

Energy policy can also “fuel” our recovery. But it is time to move beyond the tired slogan of the conservative right — “drill here, drill now” — and the tired dogma of the liberal left — “go green.”  We need instead an “all of the above” energy strategy that allows us to responsibly develop our own energy reserves (off-shore oil, clean coal and natural gas) while developing non-carbon alternatives (wind, solar, ethanol, bio-mass, cellulosic, nuclear and hydro). The mix can and should be more “green” as time goes by, but we need our own reserves in the meantime. And, our economy will be stronger if we become more energy independent — sooner than later.

Tax code: overly complex, increasingly inequitable
Sensible tax policy is also tied to economic growth. The simplistic slogans being spouted by Democrats (tax the rich) and Republicans (no new taxes) are divisive. While in Congress, I proudly supported the bipartisan 1987 tax reforms fashioned by a Democratic Congress and signed into law by Republican President Ronald Reagan. Those reforms simplified the tax code and lowered rates — and were a factor in the economic growth our country experienced in the 1990s. Sadly, in the ensuing 25 years, the tax code has again become overly complex and increasingly inequitable. As in 1987, we need bipartisan tax reform designed to clean out the code’s loopholes while lowering overall rates.

Most economists warn that our growing government debt is a major threat to long-term growth. Addressing debt means getting control of our entitlement programs — the largest of which are Social Security, Medicare and Medicaid. Baby boomers will explode the cost of these programs over the next two decades. Already, Social Security is collecting less tax revenue than is needed to pay annual benefits — and that has been exacerbated by recent “temporary” payroll tax cuts. More worrisome, Medicare and Medicaid are increasing at three times the rate of inflation. In short, something has to change — and the sooner the better — or our debt will limit future growth.

Commit to early-childhood school readiness
Any forward-looking economic policy must invest in tomorrow’s work force. In that regard, early childhood education will pay huge dividends. Some economists estimate the return on this investment at a ratio of 13 to 1 due to the reduced need for remedial education, increased graduation rates, and increased prospects for gainful employment. Accordingly, we should make it a national priority that every young child enters kindergarten ready to learn — and is ready to read at grade level by third grade. We can achieve this by dedicating AmeriCorps’ 85,000 enrollees to early childhood success. Minnesota — to its credit — already allocates most of its AmeriCorps personnel to this purpose.

Finally, is there room for any “stimulus” deficit spending, as Democrats insist?  Maybe — so long as it is restricted to infrastructure (roads, bridges, etc.). This is a matter of generational equity in that it is only fair that future taxpayers obtain a benefit for the debt they must repay. Accordingly, much needed infrastructure projects should be the centerpiece (not a tiny piece) of any stimulus or jobs bill.

The bottom line? Washington policy-makers have misdiagnosed the current economic downturn. Implementing policies that produce economic growth is truly a long-term proposition. Yet our political system has produced only a short-term stimulus and rhetoric designed for short-term political benefit. At this crucial time, facing a reset second only to that experienced in the 1930s, we need better leadership than we are getting from Washington today. Only then will we get the results we seek.

Former U.S. Rep. Tim Penny is the president and CEO of the Southern Minnesota Initiative Foundation.

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Comments (13)

  1. Submitted by Richard Schulze on 10/21/2011 - 07:10 am.

    I have a very simple solution to the country’s budget deficit problem. Hit the reset button. Eliminate the Internal Revenue Code. Just set it on fire. Keep the existing progressive, hockey stick tax rates on income, but eliminate all deductions. And I mean everything; deductions for dependents, home mortgage interest, medical expenses, charitable contributions, the works. There are no sacred cows. My revised Form 1040 would have only three lines on it:

    Tax Rate
    Tax Due

    The budget deficit would disappear overnight. Government spending would shrink dramatically, because you could ditch most of the 100,000 who work for the IRS. Some 1.3 million auditors and CPA’s would have to hit the road in search of new work too. The amount of money that is wasted on tax collection in this country is truly staggering. This is not some pie in the sky concept. This is how taxation already works in most countries, and they seem to get along just fine.

  2. Submitted by Matt Lewis on 10/21/2011 - 08:46 am.

    I have several quibbles with your article. First, the things I agree with: yes, Tax reform is necessary (Sens Wyden and Gregg had a good proposal taking this task on). Yes, early childhood education is important. And I believe infrastructure spending is important regardless of its stimulative effect, so now is a good time to do it since borrowing costs are incredibly low as are materials and construction costs. Any stimulative effect (I believe it would have some) would be a bonus.

    Now where I disagree:

    America’s borders are not wide open to trade from other countries. That claim is laughable. Ask a Brazilian sugar cane farmer how open our borders are to imports. The tariffs on sugar cane are sky high to protect America’s corn farmers. There are many other places where America is far from a free trade country. Back in 2009, America and China got into a scuffle over increased tariffs on tires from China. Let’s just say free trade agreements will still cut both ways. That’s not a reason not to sign them, I’m actually all for free trade. But let’s not kid ourselves about the purity of America’s free markets.

    Finally, on Reinhart/Rogoff. The problem here is not with their historical analysis. They’re right, countries that suffer financial crises do take longer to recover than from normal recessions. But the leap most people make is that there’s nothing that can be done to help. And that’s just not true. What R-R really managed to prove is that governments in the past have done a really bad job of responding to financial crises. Unsurprisingly, that has resulted in long and slow recoveries. But that doesn’t mean that the US is doomed to this fate, it means we need to do a better job of responding! These days Rogoff has been saying that the best thing that could be done right now is for the Fed to target higher inflation. I’m all for that, though I don’t think that precludes a big chunk of infrastructure spending as well. 9% unemployment is unacceptable, throw the kitchen sink at the problem.

    And to Richard Schultze above: the IRS Budget is ~$13bn/yr. You could cut the whole department and the deficit would barely change. But again, I support simplifying the tax code. Not the way you described it, however, since I would keep the EITC to prevent tax reform from becoming a huge tax increase on the working poor.

  3. Submitted by Rachel Kahler on 10/21/2011 - 10:35 am.

    Mr. Penny, I respect your experience and your consideration on these issues. However, it’s my view that many of these solutions are naive to the actual complexity of the issues.

    One example: those foreigners getting 68% of the PhD’s in this country are not leaving because they can’t stay. Many leave because that was the initial plan–we have probably the best higher education in the world (opportunity and funding is a whole different story). We attract people from other countries because of HOW we learn, not just what we learn. It is prestigious in other countries to have a degree from the US, if nothing else for the practical experience with dealing with Americans and speaking English. We also teach our students to be creative and question the accepted solutions to problems. All of these things lead to an innovative mind set, something that many other countries have a hard time teaching. So, they send their best and brightest here so they can import it back into their native countries.

    A second reason PhD holders go back to their originating country is because we simply don’t have adequate jobs in this country for many of them because we are not investing in innovation, even if we teach it. People holding doctorates have been trained to do jobs that are becoming scarce and underfunded in this country, whereas countries like China are pouring money into R&D. Quite frankly, if we don’t embrace our innovation again, we have no chance of coming out of this economic slump to be what we once were.

    So, yes, we are exporting our innovators, but it’s not because of immigration issues (clearly, they can get here for the education). It’s because some never planned to stay here, and because there aren’t even enough jobs for those who did.

  4. Submitted by James Hamilton on 10/21/2011 - 10:58 am.

    Mr. Penny’s principal contribution to the national discussion may not be in the details of his opinions but in his willingness to consider and draw upon all ideas, regardless of their source.

    I’m not familiar with the details of his Farm Credit restructuring legislation or how successful it may have been, so can’t comment on his proposal to adopt a similar approach to today’s housing crisis. I do believe that one component of any plan in this area should be ‘cram down’ legislation which would permit a bankruptcy court to write down mortgage debt based on the current market value of property owned by a bankruptcy debtor. This would not be an option for those able to meet their current obligations, but only for those unable to meet those obligations whose foreclosure, deed in lieu of foreclosure or simple walk away would put them on the street and leave the property vacant to further depress property values and burden the community with the problems inherent in vacant properties. It would force mortgage holders to revise their books to reflect the actual value of the mortgages they hold. But in the long run, it seems to me, it would keep more property occupied and off the market while providing the lenders with at least as much as they would receive from the property in a foreclosure.

    Finally, @Mr. Schulze: Your proposed changes to the tax code have some merit in my eyes, but would require a significant phase-in period in order to avoid a further collapse in property values and panic in many others. All it will take is for those in the country who profit from existing deductions to agree to their elimination. That’s unlikely, to say the least.

  5. Submitted by Thomas Swift on 10/21/2011 - 11:22 am.

    Tim says “we need a pro-trade and pro-immigration policy”, and I wholeheartedly agree, as do most conservatives I know.

    I also applaud Tim for singling out HB1 visa holders as an attractive focus for relaxed immigration policy. All men are created equal, but those that make a sizeable investment in their own education are “more equal” when it comes to the sorts of people America should be encouraging to emigrate.

    Finally, I’d like to thank Tim for providing the kind of thoughtful, and thought provoking commentary that MinnPost too seldom provides.

  6. Submitted by Neal Rovick on 10/21/2011 - 11:59 am.

    Several comments:

    Why should there be a floor under house prices? Is there a floor under wages? The fact is that housing prices MUST reflect the buyers ability to pay. And the time-tested ratio for house prices is that the house should cost no more than 3 times the annual income of the buyer. More than that, and it doesn’t work out in the long-term or requires the extensive funny-money policies that brought the collapse.

    The real issues with the current crisis is that people’s incomes have not kept up with rising costs and challenges. Credit and cashing-in on increasing asset values have made up for the stagnant and falling incomes over the past few decades. Now it is clear that borrowed money must be paid back and that asset prices will not inflate above the point where they are affordable without serious consequences. The real answer is jobs that are well-paid. Walmart-type jobs result in a path to collapse.

    The most vigorous growth areas of the economy over the past few decades include health-care, education and defense. Unfortunately all or a large portion of those sectors are supplied via a real or quasi-tax on the tax-payer. As a country and per-capita basis, the US spends far more on these items than any other country in the world. The out-sized expenditures in these areas have far more effect on the competitiveness of the US than all of the regulations and rules out there. That is the truth of the matter. If we a military that was sized comparatively to the other parts of the industrialized world, if we had as efficient health-care and education system as the rest of the industrialized world, we WOULD be competitive in the world. Instead we feed the out-sized monsters of these areas, which are only for internal consumption, and wonder why our costs of production are not competitive in the world. We are the snake eating it’s own tail and wondering why it’s not working.

  7. Submitted by Jeff Pricco on 10/21/2011 - 12:41 pm.

    Thank you Mr Rovick for your usual well considered comment.

    I believe Rogoff is likely right, this is a balance sheet/debt recession and unless we get rid of partisan gridlock which allows nothing or only short term half hearted solutions to emerge in DC we will likely face a prolonged Japanese period of sluggish malaise. While dont want to throw out Keynes with the bathwater, I agree that only short term deficit spending without long term debt reduction and management is misplaced policy. I think Keynes is incorrectly maligned in that regard, in any case slavish following of Hayek or Keynes in this situation isnt going to get us anywhere, but that is what both political sides are presenting to us right now.

    It was just reported that at least 50% of American workers make $26,364 or less. IT was also reported that the number of workers making $1million or more increased by 18% from 2009. While I also think tax reform is essential, any tax reform that seeks to extract more from those who make $75,000 or less (see Herman Cain, 9-9-9) is a gross injustice given our current situation.

  8. Submitted by Thomas Swift on 10/21/2011 - 12:41 pm.

    “Is there a floor under wages?”

    Why yes, yes there is.

    “The fact is that housing prices MUST reflect the buyers ability to pay.”

    Keep that in mind, when you want to sell *your* house. “That’s all I can afford” closes the negotiation and seals the deal without regard to price.

  9. Submitted by Neal Rovick on 10/21/2011 - 01:42 pm.

    Mr. Swift, is the “floor under wages” the minimum wage?

    Does that sub-poverty level reassures you? How much of an economy and quality of life will the US have if a substantial portion of the population is at that floor? Do a little thought exercise and tell me what housing prices would be in that wage regime.

    For all your free market advocacy, I’m surprised that you want house price supports–exactly how would that system work? You were badly mislead if you think that housing prices can exist outside normal economic cost restraints of a seller and a buyer.

  10. Submitted by Thomas Swift on 10/21/2011 - 04:32 pm.

    Dude, you asked the question, and I answered it; there is a floor on wages.

    And are badly mistaken if you think I’m in favor of housing prices that don’t rely on normal economic cost restraints of a seller and a buyer.

    We call it “the market”, which means you shop for the house you can afford, not make the price of the house you want reflect what you can pay for it, which is what you said.

    Maybe you’d like to qualify your earlier statement?

  11. Submitted by Richard Schulze on 10/21/2011 - 06:15 pm.

    The questions that need to be answered are:
    1. How large should the federal government be?
    2. How large an economic transfer should be made from working people to the elderly? Is the government acting simply to reduce poverty, or to accomplish some other objective through universal entitlements?
    3. How much should individuals be forced to share in the cost of health care for others? How much should an individual have to pay before the government helps pay their health care bills?
    4. What are the things that the federal government does that it doesn’t really need to do? Which programs, subsidies and tax breaks can be eliminated?
    5. Should the United States continue to play the role of global hegemon? Are we prepared to accept the alternative?

    Come to a consensus on those 5 issues, and balancing the budget is a matter of simple math. But that’s the problem, of course. There is a wide disagreement on many of these issues, amongst Politicians, and amongst 300 million Americans.

  12. Submitted by Rachel Kahler on 10/24/2011 - 04:44 pm.

    Dude, you’re arguing with yourself. Neal rightfully pointed out that there isn’t a floor on wages (yes, there is a minimum wage, but it does not guarantee a minimum income). He also suggested that if there is no bottom on earning potential, why should there be a bottom on home prices? He was saying that homes SHOULD be market valued because to put a floor under the value would only lead to the same “funny money” economics that created the bubble and ultimate bust of the housing market.

    Then you called him “dude” and said “we call it the ‘market’.”


    Do you even read what anyone, including yourself, says?

  13. Submitted by Karen Sandness on 10/24/2011 - 05:06 pm.

    There’s no shortage of high tech workers. There’s only a shortage of employers willing to pay American professional salaries (as opposed to something that seems like a fortune to a new immigrant from India or China but is really less than the medium income) or to spend six weeks retraining a smart American with a decade-old degree in computer science in some of the newer developments.

    If there’s a shortage of Americans majoring in computer science and engineering now it’s because they’ve seen their parents’ and older siblings’ jobs outsourced to low-wage countries or replaced by jobs for H1B workers. When I was teaching college in the 1980s, computer science and engineering were THE hot majors. What happened to all those people? It’s too soon for them to have died off.

    Furthermore, unless a “free” trade agreement is between countries of roughly equal living standards, it is an open invitation for employers from the more prosperous country to leave in search of cheap labor and at the same time, to destroy the less prosperous country’s agriculture by flooding it with U.S. surplus food.

    Free trade between the U.S. and Canada or the U.S. and Australia or the U.S. and Western Europe makes sense. Free trade with South Korea makes more sense than it used to because of that country’s prosperity. “Free” trade between the U.S. and Colombia or Mexico or any other Third World nation is a bad deal for anyone who is not one of the financial elites in either country.

    I mentioned South Korea in the previous paragraph. Yes, they were very poor within my lifetime. But they did not get rich through “free” trade. They let foreign manufacturers in to take advantage of cheap labor, but like Taiwan, they insisted on technology transfers and the training of Korean nationals for technical and managerial positions. They invested heavily in education, health care, and infrastructure. They protected their agricultural sector. In other words, aside from letting foreign manufacturers in, they did everything “wrong” according to the gospel of laissez-faire economics.

    No “free” trade advocate has ever explained what we’re going to do with all those people who are not good at academic work and therefore need physical or manufacturing jobs, on the one hand, and, on the other hand, the people who did what they were told and trained for high tech careers, only to find that the high tech industry doesn’t want them anymore.

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