Economics – The Dismal Science

Economics is called the dismal science since the topics it normally deals with recession and inflation are not pleasant, ergo, dismal. Economics is not really a science. A scientific method cannot be applied in this field since there is no way to formulate a controlled experiment. There are many variables that cannot be measured satisfactorily in order to establish cause and effect. Often, we hear conflicting opinions from so-called experts. How do we know who is right? Who do we believe? This brings to mind the old joke. How can you tell the difference between an economist and an econometrician? An econometrician uses computers to forecast incorrectly. At the very least, economists should be referring to empirical evidence to support their conclusions. Unfortunately, either we get essays by economists without supporting documentation, or we get erroneous conclusions based on supporting documentation. In my opinion, these are the real reasons economics is the dismal science.

An illustration of an erroneous conclusion based on supporting documentation is Paul Krugman’s column “Failure to Rise” in the February 13 New York Times. He discusses President Obama’s stimulus plan and chastises the republican response by referring to it as “deep voodoo”. He states, “In both the House and the Senate, the vast majority of Republicans rallied behind the idea that the appropriate response to the abject failure of the Bush administration’s tax cuts is more Bush-style tax cuts.” It is remarkable that of all the possible shortcomings that Mr. Krugman could have referred to regarding President Bush’s policies, he chose to single out his tax cuts. There is ample empirical evidence that marginal tax cuts stimulate demand. (Refer to my blog dated February 11, where I quoted Professor Robert Barro from Harvard). Mr. Krugman makes no mention of President Bush’s excessive spending or the feckless SEC during his tenure that let financial companies increase leverage from the usual 13 to 1 to 33 to 1. Mr. Krugman will not discuss the ramifications of excessive spending since he believes that Obama’s $787 billion stimulus package is too timid. That’s right. He believes that America is settling for “half measures”.

As a guide to figuring out what we should do to stimulate our economy, many economists have studied the Japanese stimulus plan that was designed to combat their economic malaise during the decade of the 1990s. Economists tend to be divided into two camps. The first group concludes that the Japanese plan did not spend money fast enough and the total amount of money was inadequate. The second group believes that the spending was poorly directed and, therefore, a colossal waste. According to an article in the February 5 New York Times by Martin Fackler “Japan spent $6.3 trillion on construction-related public investment between 1991 and September of last year, according to the Cabinet Office. The spending peaked in 1995 and remained high until the early 2000s, when it was cut amid growing concerns about ballooning budget deficits. More recently, the governing Liberal Democratic Party has increased spending again to revive the economy and the party’s own flagging popularity.” This article also pointed out that Japan accumulated the largest public debt in the industrialized world which totaled about 180% of its $5.5 trillion economy during nearly two decades. Despite this massive spending, many economists concluded that Japan’s economy finally started to see improvement only when it cleaned up its debt-ridden banking system, and there was an increase in its exports to China and the United States.

Will President Obama’s stimulus plan be effective? Is this spending plan targeted correctly? Are we spending too little? Are we spending too much, thereby, leaving an enormous tax burden for future generations? Economics is a dismal science. However, based on strong empirical evidence regarding the successful tax policies of President Kennedy, President Reagan and the 2003 tax plan of President George W. Bush, President Obama should have followed their plans. Instead, his plan provides one-time tax payments that will not have the lasting impact of marginal tax rate reductions for individuals and businesses that were so beneficial in improving the stock market and economic growth in the past.

Ex Chairman of the Fed, Alan Greenspan – Denial - Not a River in Egypt

Generally, I do not consider myself an armchair quarterback. It is easy to criticize in retrospect when you do not have the responsibility of making decisions. However, in the case of Alan Greenspan, I believe he is fair game since he was lauded as a God during his long tenure as Chairman of the Federal Reserve. I was watching David Faber’s interview with him during the riveting documentary on CNBC about the cause of our financial collapse entitled “House of Cards”. The title of this program for most of us could have equally been called “House of Pain”. I was struck by how smug Greenspan was when David Faber asked him if he could have done something to stop this banking crisis. He said, unapologetically, that he knew the banks were taking on a great deal of risk since he had discussed this with the various managements of these banks. He said the failure was that these bank executives assured him they would know when to stop, and obviously they didn’t. He went on to say that, basically, regulation would have been ineffective since human beings will always find a way around it; that’s part of the human condition. Furthermore, he said very confidently, he believed we would have the same conversation in the distant future, maybe 20 or so years from now.

It is fair to say that regulation is not going to prevent every indiscretion in the financial industry. He is right about human nature. However, we are not talking about just any indiscretion since this crisis will go down as one of the worst in our history. It is embarrassing to think that we, the United States, not Mexico, Latin America, or Russia, were responsible for creating this worldwide financial mess. This crisis did not happen abruptly, without any warning. All we have to do is review what happened in 1998 when Long-Term Capital almost collapsed the financial system. If a hedge fund just the size of Long-Term Capital could have brought down our financial system as a result of too much leverage, that should have been a warning shot across Greenspan’s ship’s bow.

Ex Chairman of the Fed, Alan Greenspan – Denial , Not a River in Egypt.

Addendum to President Obama's Press Conference

After posting my commentary about President Obama's press conference, I read the Wednesday, February 11th, Wall Street Journal and on the Op Ed page under "Notable & Quotable, Harvard economist Robert Barro was quoted in an interview by the Atlantic. This article was very timely since the professor supports my main contention that tax rate changes will boost aggregate demand. I am quoting the interview that pertains to tax policy as follows:
"Atlantic: And I take it from the Wall Street Journal piece you wrote last week...well, the piece is just specifically about measuring multipliers, but I take it that you are fairly skeptical in general that fiscal policy will boost aggregate demand.
Barro: Right. There's a big difference between tax rate changes and things that look just like throwing money at people. Tax rate changes have actual incentive effects. And we have some experience with those actually working.
Atlantic: What would you say is the best empirical evidence there?
Barro: Well, you know, it worked to expand GDP for example in '63 and'64 with the Kennedy/Johnson cuts. And the Reagan twice in '81 and '83 and then in'86. And then the Bush 2003 tax-cutting program. Those all worked in the sense of promoting economic growth in a short time frame"...

The difficulty with the economic profession is there are too many conflicting "expert" opinions. However, we should pay attention to those that are supported by strong empirical evidence.

President Obama's First Press Conference - "The Agony and the Ecstasy"

It certainly was refreshing to see President Obama deliver his first official press conference. This was a commanding performance compared to President Bush's past press conferences. One of President Bush's weaknesses was his inability to effectively communicate without a prepared script. This became painfully evident at his press conferences which, unfortunately, is not a small problem. He, therefore, gave very few press conferences and relinquished an important venue to affirm to the voters that he had a firm grasp on pressing issues of the day.

President Obama deserves high marks for being articulate and demonstrating and in-depth knowledge of the topics that were discussed. There is no question that leadership requires an effective ability to communicate ideas and be persuasive. While this is important, what is equally if not more important, is the content of these ideas and their effectiveness.

Unfortunately, the President presented the American public with some poor choices. This is illustrated when he forcefully stated that, while he is open to good ideas from the Republicans, he will not listen to the same failed policies that got us into this crisis in the first place. We can infer from this important remark, based on what he has said in the past, that President Bush's tax cuts were a major contributor to these failed policies.

We all know the cliche that in order to solve a problem you have to identify the cause. Unfortunately, President Obama is putting himself in a box if he believes that President Bush's tax cuts were a major cause of the current crisis. According to Milton Friedman, permanent tax cuts are a more effective way to increase consumer spending than one-time payouts. This is predicated on his theory of permanency, which states that you can more favorably influence behavior when change is not temporary. In the past, when we reduced capital gains taxes and lowered the marginal tax rates, we had seen a commensurate improvement in the economy and the stock market. This occurred under the Kennedy administration, the Reagan administration, and the Bush administration after 2003 when his more permanent tax cuts became effective.

It was excessive government spending, in conjunction with tax cuts, and a vigorous monetary policy under Greenspan that put too much liquidity in the system. Furthermore, interest rates were kept too low for too long and provided the fuel for the housing fire that burned out of control. In addition, in his book "The Age of Turbulence" Greenspan suggests a more hands-off approach to capitalism. Thus, he provided little oversight or regulation of our financial system as leverage, risk, and complex financial derivatives dramatically increased.

Executive compensation.

I've become deeply saddened over the years as capitalism has been driven into a huge ditch by greed and corrupt management practices. Compensation packages have been so excessive that in many cases it bears no relationship to reality. This largess has corrupted top management and the boards who are supposed to be responsible to shareholders. Furthermore, it seems that the way many compensation packages are structured are having a perverse effect. There is too much emphasis on the short term with no commensurate adjustment for what happens in the future, and there is no significant penalty for failure. The capital system works since people will usually do what is in their best interest. Managements are being compensated to take on more and more risk for short term gains since the payoffs are high, and there appears to be no appropriate penalty for current or future failures due to these risks.