Tag Archives: Economic Growth

Regulatory Complexity Gone Wild

The complexities of the Affordable Care Act (aka Obamacare) are multiple, metastasizing, and increasingly well-known. Less known is an additional layer of health care regulation slated for implementation next year: the system by which doctors and hospitals code for conditions, injuries, and treatments. By way of illustration, in the old system, a broken arm might get the code 156; pneumonia might be 397. The new system is much more advanced. As Ben Domenech notes:

In all, the new system, known as ICD-10, will boast 140,000 codes, a near-eight-fold rise over the mere 18,000 codes in ICD-9. It is a good example of the way bureaucracies grow in size and complexity in an attempt to match the complexity of society and the economy. This temptation, however, is usually perverse.

Complexity in the economy means new technologies, more specialized goods and services, and more consumer and vocational choice. Economic complexity, however, is built upon a foundation of simplicity – clear, basic rules and institutions. Simple rules encourage experimentation, promote long-term investments and entrepreneurial ventures, and allow the flexibility to drive and accommodate diversity.

Complex rules, on the other hand, often lead to just the opposite: less experimentation, investment, entrepreneurship, diversity, and choice.

It is difficult to quantify the effects of the metastasizing Administrative State. It is impossible to calculate, say, the cost of regulations that prohibit, discourage, or delay innovation. Likewise, what is the cost of the regulations that, arguably, helped cause the Financial Panic of 2008 and its policy fallout? No one can say with precision. For twenty years, though, the Competitive Enterprise Institute has catalogued regulatory complexity as well as anyone, and its latest report is astonishing.

Federal regulation, CEI’s latest “10,000 Commandments” survey finds, costs the U.S. economy some $1.8 trillion annually. That’s more than 10% of GDP, or nearly $15,000 per citizen. These estimates largely predate the implementation of the ACA, Dodd-Frank, and new rounds of EPA intervention. In other words, it’s only getting worse.

The legal scholar Richard Epstein argues that

The dismal performance of the IRS is but a symptom of a much larger disease which has taken root in the charters of many of the major administrative agencies in the United States today: the permit power. Private individuals are not allowed to engage in certain activities or to claim certain benefits without the approval of some major government agency. The standards for approval are nebulous at best, which makes it hard for any outside reviewer to overturn the agency’s decision on a particular application.

That power also gives the agency discretion to drag out its review, since few individuals or groups are foolhardy enough to jump the gun and set up shop without obtaining the necessary approvals first. It takes literally a few minutes for a skilled government administrator to demand information that costs millions of dollars to collect and that can tie up a project for years. That delay becomes even longer for projects that need approval from multiple agencies at the federal or state level, or both.

The beauty of all of this (for the government) is that there is no effective legal remedy. Any lawsuit that protests the improper government delay only delays the matter more. Worse still, it also invites that agency (and other agencies with which it has good relations) to slow down the clock on any other applications that the same party brings to the table. Faced with this unappetizing scenario, most sophisticated applicants prefer quiet diplomacy to frontal assault, especially if their solid connections or campaign contributions might expedite the application process. Every eager applicant may also be stymied by astute competitors intent on slowing the approval process down, in order to protect their own financial profits. So more quiet diplomacy leads to further social waste.

Epstein argues the FDA, EPA, FCC, and other agencies all use this permit power to control firms, industries, and people beyond any reasonable belief they are providing a net benefit to society.

The agencies are guilty of overreach and promoting their own metastasis. Yet without Congress and the President, they would have little or no power. Congresses and Presidents increasingly pass thousand-page laws that ask agencies to produce tens of thousands of pages of attendant rules and regulations. Complexity grows. Accountability is lost. The economy suffers. And the corrective paths, which fix mistakes and promote renewal in the rest of the economy and society, are blocked. We then pile on tomorrow’s complexity to “fix” the flaws created by yesterday’s complexity.

The hyper-regulation of the economy is not merely an annoyance, not merely about inefficient paperwork. It is damaging our innovative and productive capacity — and thus employment, the budget, and our standard of living.

The McKinsey Global Institute helps us understand why this matters from a macro perspective. McKinsey chose a dozen existing and emerging technologies and estimated their potential economic impact in the year 2025. It found industries like the mobile Internet, cloud computing, self-driving cars, and genomics could produce economic benefits of up to $33 trillion worldwide. The operative word, however, is “might.” Innovation is all about what’s new. And regulation is often about disallowing or discouraging what’s new. The growing complexity of the regulatory state, therefore, can only block some number of these innovations and is thus likely to leave us with a simpler, and thus poorer, world.

— Bret Swanson

Zero GDP Reading Exposes the Real Deficit – Economic Growth

It is currently in fashion to say, with great contrarian flair, that federal spending growth is the slowest since the Eisenhower Administration. Or, as someone famous recently put it, “We don’t have a spending problem.”

This assertion is, to put it mildly, debatable. Spending jumped 18% in just one year during the Panic of 2008-09. If the government keeps spending at that level, but starts counting after the jump, then the growth rate will appear modest. Spending as a share of GDP is higher than at anytime since World War II, and so is the debt-to-GDP ratio. As the OMB chart below shows, it gets much worse.

Nevertheless, does anyone disagree that we have a growth problem, and a serious one? Yesterday’s negative GDP estimate for the fourth quarter of 2012 (-0.1%) should jolt the nation.

Let’s stipulate the GDP reading’s anomalies — lower than expected inventories and defense spending, which could reverse and add a bit to future growth. Yet economists had expected fourth quarter growth of 1.1% — itself an abysmal projection — and actual growth for the entire year was a barely mediocre 2.2%. Consider, too, that lots of economic activity was moved forward into 2012 to beat the Fiscal Cliff taxman. And don’t forget the Federal Reserve’s extraordinary QE programs, which are supposed to boost growth.

Whatever we’re doing, it’s not working. Not nearly well enough to create jobs. And not nearly well enough to help the budget. Because whatever you think about spending or taxes, the key factor in the health of the budget is economic growth.

OMB projects spending will grow (from today’s historically high level) around 2.96% per year through 2050. It projects annual economic growth over the period of 2.5%. That gets us a debt crisis somewhere down the line, and lots of other economic and social problems along the way.

Last year, however, keep in mind, growth was just 2.2%, following 2011’s even worse reading of 1.8%. If we can’t even match the modest 2.5% long-term projection coming out of a severe downturn, our problems may be worse than we think. Economist Robert Gordon of Northwestern asks “Is U.S. Growth Over?” Outlining seven economic headwinds, he projects growth of around 1.5% over the next few decades. In the chart below, you can see what a budget disaster such a slowdown would produce. Deficits quickly grow from a trillion dollars a year today into the many trillions per year.

Perhaps, many are now suggesting, we can tax our way out of the problem. Almost all academic research, however, suggests higher taxes (in terms of rates and as a portion of the economy) hurt economic growth. The Tax Foundation, for example, surveyed the 26 major studies on the topic going back to the early 1980s. Twenty-three of the studies found that taxes hurt economic growth. No study found higher taxes helped growth. Recent experience in Europe tends to confirm these findings.

Today, most of the policy discussion revolves around debt ceilings, sequesters, and the (fading) possibility of grand bargain budget deal. Mostly lost in the equation is economic growth. One question should dominate the thinking of policymakers: What policies would encourage more productive economic activity?

The new possibility of a breakthrough on immigration reform is an encouraging example. A more rational immigration policy for both low-skilled and high-skilled workers could boost economic growth significantly. Can we find more such policies? As you can see in the chart below, higher taxes can’t make up the budget shortfall. Faster growth and modest spending restraint can. This chart once again shows the OMB projected spending path (solid black line). The solid blue line shows what would happen to tax receipts if (1) growth remains mediocre and (2) we somehow find a way to dramatically raise the portion of the economy Washington taxes from the historical 18% to 23%.

That’s a major jump in taxation. Yet it doesn’t get us close to a healthy budget.

Faster growth and modest spending restraint, on the other hand, close the budget gap. And they do so without increasing the share Washington historically takes from the economy. The orange dashed line shows tax receipts under an economy growing at 3.5% with the historic 18% tax-to-GDP ratio. (Growth of 3.5% may sound like an ambitious goal. Keep in mind, however, that we are still far below trend — we’ve never really recovered from the Great Recession. Long term growth of 3.5%, therefore, merely includes a more rapid recovery to trend over the next several years and then a resumption of the long-term average of 3%.) In the medium to long term, a faster growth-lower tax regime generates more tax revenue than a slow growth-high tax regime.

Faster growth alone would be enough to stabilize budget deficits at today’s levels. But that is not enough. Trillion dollar deficits and Washington spending an ever rising share of the economy are not acceptable. Look, however, at the very modest spending restraint that would be required to essentially balance the budget by 2050. If we slowed spending growth from the projected 2.96% annual rate to just 2.7%, we could close the gap.

Does anyone think spending growth of 2.7% per year versus 2.96% is going to tear apart Social Security, Medicare, the military, or other essential government functions. Many of us could imagine responsible ways to reduce projected spending far, far more than that. All this shows is that a little restraint and robust economic growth go a long way.

The slow growth-high tax scenario produces a budget deficit of almost $3.5 trillion in 2050. Under the faster growth-lower tax scenario, with a touch of spending restraint, the 2050 budget deficit would be just $58 billion.

Now, I’m not pretending I know that a higher tax-to-GDP ratio will produce a particular rate of economic growth. The above are just rough scenarios. Lots of factors are in play. And that is precisely the point. Given an complex, uncertain world, we should attempt to align all our policies for economic growth. We know what policies tend to encourage growth, and those that tend to stunt it.

That means getting immigration policy right — and it appears we may finally be getting somewhere. It means smart, reasonable regulatory policies in energy, health care, education, communications, and intellectual property. It means a healthy division of powers between the federal and state governments. And, yes, it means sweeping tax reform — both individual and corporate.

What we are doing today isn’t working. We are on a dangerous path. Two percent growth won’t get us anywhere. No matter how much we tax ourselves. Only robust growth fueled by entrepreneurship and investment, with a healthy faith in the unknown possibilities of America’s future, will get us there.

This kind of “prosperity” isn’t good enough

Today, Princeton’s Alan Blinder says things are looking up, that we’re finally traveling the road to prosperity, albeit slowly. It’s a rather timid claim:

there are definitely positive signs. The stock market is near a five-year high. Recent data on consumer spending and confidence show improvement, though we need more data before declaring victory. At long last, the housing market is growing rapidly, albeit from a very low base . . . .

On balance, the U.S. economy is healing its wounds—that’s another fact. But none of this puts us on the verge of an exuberant boom. Still, if the fiscal cliff is avoided and the European debt crisis doesn’t explode in our face, both GDP growth and job growth should be higher in 2013 than in 2012—even under current policies. But that’s a forecast, not a fact.

Stanford’s John Taylor counters some of Blinder’s claims:

First, he admits that real GDP growth—the most comprehensive measure we have of the state of the economy—is declining; that’s not an improvement.

Second, he admits that, according to the payroll survey, job growth isn’t faster in 2012 than 2011; that’s not an improvement either.

Third, he mentions that the household survey shows employment growth is faster, but that growth must be measured relative to a growing population. If you look at the employment to population ratio, it is the same (58.5%) in the 12 month period starting in October 2009 (the month he chooses as the low point) as in the past 12 months. That’s not an improvement.

Fourth, he shows that the unemployment rate is coming down. But much of that improvement is due to the decline in the labor force participation rate as people drop out of the labor force. According to the CBO, unemployment would be 9 percent if that unusual and distressing decline–certainly not an improvement–had not occurred.

He then goes on to consider forecasts, saying that there are promising signs, such as the housing market. The problem here, however, is that growth is weakening even as housing is less of a drag, because other components of GDP are flagging.

Meanwhile, there is Northwestern’s Bob Gordon, who is making a much stronger, longer term forecast — that the next several decades will be pretty awful. Specifically, that real U.S. economic growth is likely to halve — or worse — from its recent and historical trend of about 2% per-capita per-year.

We’ve been emphasizing just how important it is to get the economy moving again, and how important long term growth is for jobs, incomes, overall opportunity, and for governmental budgets. The Gordon scenario is even worse than the so-called New Normal of around 1% per-capita growth (or 2% overall growth). Gordon projects per-capita growth over the next few decades of around 0.7%. (In non-per-capita terms, the way GDP figures are most often reported, that’s about 1.7%). He thinks growth for the “99%” will be far worse — just 0.2% per-capita.

In the chart below, you can see just how devastating a New Normal scenario would be, let alone Gordon’s even more pessimistic projection. It’s urgent that we implement a sweeping new set pro-growth reforms on taxes, regulation, immigration, trade, education, and monetary policy.

Anemic Growth and Why Only Non-Fed Policy Can Boost It

The central economic problem — one that exacerbates all our other serious challenges, from debt to entitlements to persistently low employment — is a sluggish rate of economic growth. Worse than sluggish, really. At less than 2% per annum real growth, the economy is barely limping along. We are growing at perhaps just a third or a fourth the speed (or worse!) compared to previous recoveries from recessions of similar severity.

One school of thought, however, says that there’s not much we can do about it. The nature of the panic — with housing and financial institutions at its core — makes stagnation all but certain. Nonsense, says John Taylor of Stanford, in this new video (part 2 of 3) hosted by the Hoover Institution’s Russ Roberts:

In the next video, Yale’s Robert Shiller reinforces the point about housing. The author of the Case-Shiller Home Price Index questions whether the Fed can reflate home prices with “one button” and whether its zero-rates-forever policy might not do more harm than good. It’s more about “animal spirits,” Shiller says, which means housing is more a function of economic growth than growth is a function of housing.

The Growth Effect on Jobs

Is the persistently high unemployment rate a secular, rather than cyclical, occurrence? Is it, in other words, a basic shift in the labor market that will leave us with semi-permanently higher joblessness for years or decades to come — no matter what we try to do about it?

Ed Lazear of Stanford and James Spletzer of the U.S. Census Bureau dug into the matter and presented their findings over the weekend at the Fed’s Jackson Hole economic gathering. Lazear also summarized the research in The Wall Street Journal. “The unemployment rate has exceeded 8% for more than three years,” wrote Lazear.

This has led some commentators and policy makers to speculate that there has been a fundamental change in the labor market. The view is that today’s economy cannot support unemployment rates below 5%—like the levels that prevailed before the recession and in the late 1990s. Those in government may take some comfort in this view. It lowers expectations and provides a rationale for the dismal labor market.

Lazear and Spletzer looked at what happened in particular industries and specific jobs, asking whether the real problem is that some industries are too old and aren’t coming back and whether there is substantial “mismatch” between job requirements and worker skills that prevent jobs from being filled. No doubt the economy is always changing, and few industries or jobs stay the same forever, but they found, for example, that

mismatch increased dramatically from 2007 to 2009. But just as rapidly, it decreased from 2009 to 2012. Like unemployment itself, industrial mismatch rises during recessions and falls as the economy recovers. The measure of mismatch that we use, which is an index of how far out of balance are supply and demand, is already back to 2005 levels.

Whatever mismatch exists today was also present when the labor market was booming. Turning construction workers into nurses might help a little, because some of the shortages in health and other industries are a long-run problem. But high unemployment today is not a result of the job openings being where the appropriately skilled workers are unavailable.

Lazear and Spletzer concluded that no, the jobless problem is not mostly secular, and we shouldn’t accept high unemployment.

The reason for the high level of unemployment is the obvious one: Overall economic growth has been very slow. Since the recession formally ended in June 2009, the economy has grown at 2.2% per year, or 6.6% in total. An empirical rule of thumb is that each percentage point of growth contributes about one-half a percentage point to employment.

The economy has regained about four million jobs since bottoming out in early 2010, which is right around 3% of employment—just the gain that would be predicted from past experience. Things aren’t great, but the failure is a result of weak economic growth, not of a labor market that is not in sync with the rest of the economy.

The evidence suggests that to reduce unemployment, all we need to do is grow the economy. Unfortunately, current policies aren’t doing that. The problems in the economy are not structural and this is not a jobless recovery. A more accurate view is that it is not a recovery at all.

The upside of this dismal situation is that we can do something about it. Think about what a different set of pro-growth policies could mean for American workers. Using Lazear’s very rough rule of “one point growth, half a point employment,” we can get an idea of what faster growth might yield in the labor market.

At today’s feeble 2% growth rate, we might expect to add several tens of thousands, or maybe a hundred thousand or two, of jobs each month. Over the next five years, at 2%, we might add something like seven million jobs. But that’s barely enough to keep up with population growth. Three percent growth, the historic average, meanwhile, would likely yield around 10 million net new jobs, 3 million more than at today’s 2% growth rate.

But three percent growth coming out of a deep recession and slow recovery is itself slower-than-usual recovery speed. It is certainly not an ambitious objective. Coming out of a slump like today’s we should be able to grow at 4, 5, or 6% for several years, as we did in the mid-1980s. Four percent growth for the next five years could add 14 million net new jobs, and 5% growth could add 17.5 million — meaning in 2017 something approaching 11 million more Americans would be working compared to today’s sclerotic 2% growth.

Keep in mind, these are rough rules of thumb, not forecasts or projections, and we’re leaving out lots of technical dynamics. There’s a lot going on in an economy, and we do not pretend these are precise estimates. The point is to show the magnitudes involved — that faster growth can provide jobs for millions more Americans in a relatively short period of time.

The problem is that U.S. policy before and after the financial panic and recession has not supported growth — I’d argue it has impeded growth. Faster growth is so important, we should be doing everything possible to enact policies that encourage it — or, if we can’t enact them today, then at least pointing the nation in the right direction.

A more efficient tax code that rewards rather than punishes investment and entrepreneurship would make a huge difference. Unfortunately, some in Washington and the states are proposing higher tax rates and new carve-outs and favors that will make real tax reform impossible. We need to ensure that Washington doesn’t keep consuming an ever greater share of the economy. But again, we’ve just seen a huge jump in the government-economy ratio, from 20% to 25%, and the current budget path just makes this ratio worse and worse over time.

Does anyone believe we have a regulatory system that promotes economic growth? In each of the last two years, the Federal Register of government regulations has grown by more than 81,000 pages. We’ve recently seen Washington drape vast new blankets of regulation over finance and health care and interfere at every turn with our energy economy — a sector that is poised to deliver explosive growth in coming years. Other regulatory actions, like FCC interference in broadband and mobile networks, can slow growth at the margins or, depending on how zealous regulators choose to be, severely disrupt an innovation ecosystem.

The economy is too complex to dial up exactly what we want. I am not suggesting a simple flip of a switch can achieve this dramatic improvement. But we should be giving ourselves — and American citizens — as many chances as possible. Given what’s at stake, there’s no excuse for not lining up policy to maximize the opportunities for faster growth.

— Bret Swanson

The Who-What-Where-Why-How of Economic Growth

In all the recent debates over deficits, debt, unemployment, entitlements, bond markets, the euro, housing, etc., the absolutely central factor has too often been ignored. A new book, however, deals with nothing but this central factor — economic growth. If we’re going to improve the economic discussion, and the economy itself, The 4% Solution: Unleashing the Economic Growth America Needs is likely to serve as a good foundation.

The book contains chapters by five Nobel economists, including the modern dean of economic growth Robert Lucas, Ed Prescott on marginal tax rates, and Myron Scholes on true innovation; also Bob Litan on “home run” start-up firms, Nick Schulz on intangible assets, David Malpass on monetary policy, and others on entrepreneurs, immigration, debt, and budgets.

I’ve only skimmed many of the chapters, but one thing that jumped out is an important point about the links, and distinctions, between supply and demand. When economic growth has been discussed these last few years, the cause/cure usually cited is a drop in aggregate demand and the “stimulus” measures needed to boost it. It’s of course true that the housing bust and banking troubles caused lots of deleveraging and that government spending and interest rate cuts may help tide over certain consumers and businesses during temporary tough times. Despite substantial Keynesian fiscal and monetary “stimulus,” however — wild deficit spending, four years of zero-interest-rates, and a tripling of the Fed’s balance sheet — businesses, consumers, and the economy-at-large have not responded as hoped. Even if you believe in the efficacy of short term Keynesian growth policies, you ignore at great forecasting peril the array of countervailing anti-growth policies.

Here is how I put it in a Forbes online column last December:

the real problem with demand is supply. Consumption is partly based on current income and needs, sure, but more importantly it is a function of the expected future. Milton Friedman’s version of this idea was the permanent income hypothesis. More generally, we might ask, what are the prospects for prosperity?

We live in a complex, uncertain world. But it’s not unreasonable to believe, even after the Great Recession, that America and the globe still have prodigious potential to create new wealth. It’s also not unreasonable to believe that Washington has severely impaired America’s innovative capacity and our ability to grow.

If you think ObamaCare reinforces and expands many of the worst features of our overpriced, government-heavy health system, then you worry we might not get the productivity revolution we need in one of the largest sectors of our economy. If you think Dodd-Frank and other post-crisis ideas will discourage true financial innovation while preserving “too big to fail,”  then you worry more financial disruptions are in store. If you think tax rates on capital and entrepreneurship are going up, then you might downgrade your estimates of the amount of investment and dynamism — and thus good jobs — America will enjoy.

A downgrade of expected long term growth impairs growth today.

In the new book, Lucas makes a similar argument:

imagine that households and businesses were somehow convinced that the United States would soon move toward a European-level welfare state, financed by a European tax structure. These beliefs would naturally be translated into beliefs that labor costs would soon increase and returns on investment decrease. Beliefs of a future GDP reduction of 30% would be brought forward into the present even before these beliefs could be realized (or refuted).

This is just hypothetical, of course, but it is a hypothesis that is entirely consistent with the way that we know economies work, everyone basing current decisions on expectations about future returns. What I have called recovery growth has happened after previous U.S. recessions and depressions and is certainly a worthy and attainable objective for economic policy today, but it would be foolish to take it as a foregone conclusion.

In the next chapter, Ed Prescott reinforces the point:

what people expect policies to be in the future determines what happens now. Bad policies can and often do depress the economy even before they are implemented. Peoples actions now depend on what they think policy will be — not what it was.

. . .

The disturbing fact is that, as of the beginning of 2012, the economy has not even partially recovered from the this recession. When it will recover is a political question and not an economic question. Only if the Americans making personal economic decisions knew what future policy would be could economists predict when recovery would occur.

This is one reason long term growth policies are often more important, even in the short term, than most short term “growth” policies.

John Cochrane’s “Unpleasant Fiscal Arithmetic”

Can economic growth stop the coming fiscal inflation?

See my new Forbes column on the puzzling economic outlook and a new way to think about monetary policy . . . .