What is really wrong with the economy?

Posted By Elgin Hushbeck

Amidst all the claims, counter-claims and finger pointing, the economy continues to struggle. Sure the unemployment rate finally dropped below 9%, but there was not a lot of celebration as only a little more than 100,000 new jobs were created, while nearly 3 times that number were so discouraged that they gave up looking, or at least are no longer counted as looking for work. Thus the unemployment rate dropped more from discouraged workers leaving the job market than from job creation.

While the reasons for sliding into this deep recession are complex, the reasons we remain there are not. At its core the reason is simple: “the rich” are people too. Even all those evil corporations are run by people. And this is why Obama’s class warfare election strategy of trying to get a majority of people to vote for him by demonizing those whom he claims do not pay “their fair share” is doomed as an actual economic strategy.

This is because the growth of the economy ultimately depends on those individuals who have excess money, i.e., money beyond what is needed on an ongoing basis. For an individual or a business, this would be the money left over after paying their required monthly expenses. It is what is done with this excess money that will determine the fate of the economy.

When it comes to this excess money, while it may vary in degree, in the end people are in one of two modes; either they are trying to use/grow their wealth, or they are trying to preserve it. A large part of any economic downturn is that people suddenly switch to preserving their wealth. They cut back on spending because they are uncertain what the future holds. As things turn around, people feel more confident about the future, and more willing to spend, or put another way, are willing to take a risk. They are willing to take the risk that they will not need that money in the future, and therefore are willing to spend or invest it today.

While this happens at all levels of the economy this willingness to take risks is particularly important for that group commonly labeled “the rich,” as they are the people with the amounts of excess cash needed to fund the innovation and change that is required to keep an economy growing. For example, without “the rich” willing to take the risks and thus provide the financial backing, there never would have been companies like Apple, Microsoft, Google, McDonalds or any number of other companies.

Thus the real problem at the moment is that far too few people are willing to take the risks necessary to get the economy growing. While this is normal at the beginning of an economic downturn, the real question now is why is this still the case nearly 4 years later? The answer is really not that hard to figure out and comes from two main areas, both centered on uncertainty.

The first is uncertainty concerning the amount of risk. As the economy slid into this recession, the politicians did not understand what was going on, but that did not stop them from trying to do something, and so under Bush, they passed the first half of TARP, which, since it did not address the real problem, did nothing to stem the slide. Then Obama got the second half of TARP passed, along with the Omnibus spending bill, and the Stimulus bill. But still none of this addressed the real problem, which was actually an accounting rule change that had been put in place in Nov 2007. It was only after this rule was finally repealed in in March-April 2009, that markets began to recover somewhat, but by them the government had run up such huge debts with all the “fixes” that this debt itself was a concern.

In addition to the unprecedented debt, the new Obama administration used the borrowed money to pay for a huge expansion in the role of government and government regulation. Not stopping there, Obama pushed for the passage of Obama care, and then the Dodd-Frank banking bill among other things. Even, now there is still considerable uncertainty as to what Obama Care and Dodd-Frank will actually mean for business, other that higher costs.

But it is not just recent legislation. Following the Internet bubble Sarbanes-Oxley was passed. Now business decisions that in the past would be written off as bad judgment or possibly resulted in a shareholders lawsuit, can now be criminally prosecuted and land a CEO in jail. Throwing CEOs in jail may have been emotionally satisfying following the losses from the Internet bubble, but is not helpful at a time when we need CEOs to take the risks required to expand business and thus grow the economy. At the very time we need people to take risks to get the economy growing, we have made it very difficult to understand what the risks are, and if a CEO makes a bad decision, they may find themselves in prison. Is it any wonder that CEOs are overly cautious?

The other reason for the continued slowdown comes from uncertainty over the rewards that can come from risk taking. The benefit of taking a risk is the possibility of increasing one’s wealth or for a business earning a profit. Unlike earning a paycheck, the investments and expansions needed to grow the economy come at the risk of loss. Invest in a startup company and you could also lose all the money you invest if the startup does not work out. Thus to get people to take such risks, the rewards must be high enough to offset the risk. Yet while Government has been increasing the risks, they have been reducing the potential reward by driving up the cost through additional regulation. Increase regulation means that it takes more money to get a company started, and reduces the potential profits. In other words, you have to pay more and you get less, which makes finding those willing to take the risk more difficult.

Finally at the federal level, politicians have been threatening to reduce any remaining reward even further through increased taxes. At the state and local level, they have, in some cases, already done so. Thus to succeed is to place yourselves into the crosshairs.

The bottom line is that government has been increasing the risks, and reducing the rewards of the types of investment needed to get the economy growing again, while they demonize those who would take such risks. Then they wonder why people are “sitting on $8 trillion in cash” and why the economy continues to struggle. Ultimately, to get the economy growing again people’s attitudes need to switch from being risk adverse to risk taking, from preserving wealth to growing wealth. Obama’s current strategy of expanding regulation even further (e.g., use of EPA to set fuel standards), blocking development (e.g., the Keystone Pipeline), combined with a steady diet of speeches centered on class warfare is at best counter-productive.

Dec 9th, 2011

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