Friday, July 30, 2010

Why Keynes Was Wrong

From Warren Meyer at Forbes:

I have given up on macroeconomics.

Certainly it is a worthy field of study. But the science is too young, the systems it studies are too complex, and its practitioners are too often politicized for me to take its prescripts seriously in most policy debates.

Last week President Obama visited a new stimulus-funded electric-vehicle battery manufacturing facility in Michigan. The factory produces a product for which there is virtually no market, where worldwide manufacturing capacity already outpaces demand by a factor of three, and whose sales will depend on the government heavily subsidizing its customers.

Nobel prize-winning economist Paul Krugman often writes that only by authorizing much more of exactly this kind of government spending can we pull out of the current recession. Apparently, the way to economic growth is to have the operator of the Post Office, rather than private individuals, invest money. Hearing this, I can't come to any conclusion except that the field of macroeconomics is lost.

My training is not in economics, but in business and management. Perhaps I am biased by my background, which includes 15 years of strategy and planning at large corporations and 10 years running my own business. But my framework for economic growth is a simple one: For growth to occur, someone has to make an investment.

When I use the term “investment,” I am using it rather broadly. Clearly building a new steel mill is an investment. But hiring an additional employee and paying his or her salary ahead of any new revenues is an investment too. Quitting one's job and giving up a regular salary with a large company to start a new business represents an investment as well.

Here is my first law of economic growth: When we encourage more investment, and ensure this investment is being channeled to the most productive uses, growth will follow

For all the talk about fiscal stimulus and jobs creation at the federal and state level, almost no one in government is doing anything about reducing the roadblocks to investment. For example, millions of people are newly unemployed, and in past recessions a large number of these folks have eschewed looking for a new corporate job and have started businesses of their own. Unfortunately, such prospective entrepreneurs will face a tangle of registration, regulatory and licensing hurdles, many of which have been backed by established businesses that want to avoid just this kind of new competition. Even steps like the extension of unemployment benefits tend to discourage such entrepreneurship by increasing the opportunity cost of working for oneself.

No one in government, that I have heard, has even suggested any sort of regulation holiday as a potential economic stimulus program. In fact, most of the legislative moves at the national level have made private investment less attractive. Business people making investments today have to plan for higher labor, energy and borrowing costs due to a series of 2,000-page pieces of legislation that few if anyone fully understand (or have even read). Capital gains tax reductions will almost certainly expire next year, and most business people who look at looming government deficits have to assume these shortfalls will be closed the same way they always have been closed: With new taxes on the backs of the most productive.

Rather than attempting to make investment easier, almost all government stimulus efforts to date have focused on trying to better optimize how and where investment capital is deployed. The core assumption behind all of these programs is that a few people in government can invest money more productively than the private entities from whom the government took the money.

This is frankly an absurd assumption, something I know from my own experience of trying to make just these sorts of capital allocation decisions, though on a much smaller scale. In various corporate strategic planning and marketing roles, I was in the position for years of helping to make investment decisions in some of America's largest and best-managed corporations.

These corporations were smart enough to know that a small corporate staff did not have the information to identify and rank investment choices in their myriad of different divisions. Instead, the corporate office acted as a sort of bank, where front-line managers who had detailed knowledge of individual markets came to the corporation via the planning process and proposed investments. Through my years in this process, I was always convinced we were sub-optimizing, that these divisions if spun off and in control of their own destiny likely would have made better decisions. If smart business people couldn't make confident capital-allocation decisions for a $20 billion business, how can a few career government staffers do better for a $16 trillion economy?

In their hubris, however, the Congress and this administration believe they can do what even the most successful corporations can't. They take money away from individuals and businesses, either in the form of taxes or borrowing that squeezes out private capital, and claim to invest that money better than would have those individuals, despite much worse information and inferior performance incentives. The stimulus bill is an obvious example, but we see this phenomenon all over the country. The bailout of GM effectively poured taxpayer money into an entity that private investors had determined was no longer worthy of investment. Here in the Phoenix area, taxpayers of various municipalities have been asked to subsidize a new shopping mall for $97.4 million, cover a years-worth of our pro hockey team's operating losses for up to $25 million, and throw money at absolutely anyone who whispers the word “solar.”

To every one of the supporters of these government projects who claim to have created some number of jobs, I encourage the reader to ask a simple question--who was using the money before the government diverted it, and how many jobs were they creating?

Warren Meyer is a small-business owner in Phoenix and the author behind the popular Coyote Blog: Dispatches from Small Business.

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