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November 23, 2009

Why Obamanomics Will Not Improve the Economy

By Monty Pelerin
"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."
 - Friedrich Hayek
The economic programs and policies currently in place are truly astounding. I don't think I have ever seen a more harmful economic environment for the country. While some of these programs started with Bush, the Obama administration has advanced them to insane levels. Logic, economics, common sense, and history must be defied to believe a recovery is possible in this environment. The nation's standard of living will be substantially lowered without prompt changes in policy.

To understand why this economy cannot recover under these policies, it is necessary to differentiate between the macroeconomic and microeconomic approach. Arguably, macroeconomics is not economics, but that topic cannot be fully explored today.

Macroeconomics deals with aggregates, statistics, and mathematical models. Macroeconomics purports to describe and explain the behavior of the economy. But economics is not about aggregates; it is about human beings and their behavior. The building block for meaningful economics must be the individual, not some aggregate called Consumption, Investment, or Government. These aggregates are nothing more than the outcomes of millions of individual decisions, summed up and categorized into classifications.

The field of economics that studies the individual is known as microeconomics. This segment of economics deals with the institutional framework and incentive structures that influence human behavior. When faced with a stable microeconomic environment, aggregate individual decisions tend to appear stable over time. Under such conditions, correlation can be found between some aggregates.   

A key point to understand is that aggregates do not make decisions; aggregates result from decisions. Aggregates are statistical constructs only. They are often useful to summarize history. However, no causal relationship exists amongst aggregates. The economy cannot be treated as if it were some giant machine, yet the machine analogy forms the basis for macroeconomics. If you "input" more Investment, then the "output" of the machine will increase. If you increase Government spending, it will increase GDP. If you increase the Money Supply then... Such is the world of macroeconomics, which confuses correlation with causality.

Macro advocates implicitly assume causality, an assumption that easily leads to the conclusion that an economy can be centrally managed. Macroeconomic policy "works" only in the sense that a crowing rooster "causes" the sun to rise. Macro policies provide "scientific" cover for politicians to add more power and control to their portfolio. This rationale, and the fact that professing belief in macroeconomics raises the incomes of pseudo-economists, are probably the two primary reasons the macro myth lives on.

The Obama economic program has much to be disliked even when viewed through a macroeconomic prism. Commentary amongst economists is nowhere near consensus: our deficits are too large, we are spending too much, we are not spending enough, more should go to Main Street, banks should be allowed to fail, etc., etc. Even the political allocation of funds has been criticized. Chris Dunn at the Huffington Post states:

According to the most recent data, 98 percent of all U.S. firms have less than 100 employees. These firms are responsible for 98 percent of all new jobs in America and employ 50.2 percent of the private sector workforce. American small businesses are responsible for over 97 percent of all exported goods and generate the majority of innovations that come from the United States.

Not one dollar of the $2.3 trillion in economic stimulus funds will go to the 27 million small businesses where most Americans work. One hundred percent of the stimulus bill funds not destined for states will go to the top 1 percent of U.S. firms. The firms in that top 1 percent have not created one net new job in America since 1977.

Criticism at the microeconomic level has been limited. That results more from the complexity of the field rather than any sense of satisfaction. Microeconomics is not simplistic like macroeconomics. No recognizable model can be developed because microeconomics is too complex. The famous supply-demand cross-diagram might be pointed to as a model, but it is useful merely as a simplistic pedagogical tool, nothing more.

In our "cookbook" world, people and journalists want simple answers even when the situation does not allow for them. Macroeconomics produces simple (often wrong) answers. Microeconomics cannot do so. Microeconomics cannot be captured in a sound bite. Complex analysis of incentives, interactions, prices, expectations, uncertainties, etc. is required. These must be analyzed at the level of the economic decision-maker, and this type of analysis is not easy. Once completed, the results are virtually impossible to communicate in sound-bite terms.

What can be said about the microeconomic effects of current economic policy? Probably the best answer is expressed by the words, reactions, intentions, and deeds of actual decision-makers. Unfortunately, such information is scarce and necessarily anecdotal. Most businessmen don't usually express their intentions under the best of conditions. It is even rarer for them to do so when they feel targeted by government.

Larger businesses are especially vulnerable to targeting, although many have been co-opted by various government programs. Emerson Electric is an exception. They are a $1.7-billion-dollar company. David Farr, their CEO, commented bravely (and perhaps foolishly) in Bloomberg:

Washington is doing everything in their manpower capability, to destroy U.S. manufacturing," "Cap and trade, medical reform, labor rules.

I'm not going to hire anybody in the United States. I'm moving. They are doing everything possible to destroy jobs.

We as a company today are putting our best people, our best technology and our best investment in these marketplaces [overseas] to grow," he said. "My job is to grow that top line, grow my earnings, grow my cash flow and grow my returns to the shareholders. My job is not to shrink and roll over for the U.S. government.

An informative article on businessmen and incentives by C. Edmund Wright appeared in American Thinker. Some of his observations follow:

With the threat of this administration and Congress, what is the possible motivation for anyone with ideas and capital to invest his time, talent, and money into a risky endeavor? There appears to be none. In fact, there appear to be powerful incentives not to invest any time or treasure -- thus an economy with almost zero creative inertia.

This is not about tax policy.  It is not about health care.  It is not about Cap and Trade.  While all of those things are terrible and need to be stopped, the dying American dream is in trouble because there is a class of people in Washington now that will relentlessly pursue these and a never ending stream of similarly un-American agenda's until they are removed from power.

The businessman is under attack, and he/she knows it. 

The reason that Obamanomics will not and cannot work is because an economy cannot be managed from the top. Economics is a bottom-up process that depends upon individual incentives. Critical incentives have been diminished or destroyed by recent economic policies. Fear, uncertainty, threats, tax increases, penalties, and violations of the rule of law are but some of the conditions anathema to entrepreneurs, small business, and large business. Businesses will not hire, invest, or expand in a climate of disincentives. No commands from on high can force economic activity. That was a lesson that should have been learned from Eastern Europe and the former USSR.

If these disincentives are left in place, our economy will continue to shrink and our standard of living will continue to diminish. Capital has no nationality, and it will start to flee our shores. Talent will follow. We will not recover from this economic downturn until businesses and individuals have a more favorable incentive structure.

It is unlikely that the Obama administration will reverse course and put in place the structure necessary to foster a recovery.

Monty Pelerin economicnoise.com
on "Why Obamanomics Will Not Improve the Economy"