How To Really Fix The Economy (Without Using Economic Theory)

Yesterday we discussed the massive failure that the American political class has incurred over the past few years when it comes to operating a healthy, growing economy. All of the recent political class economic programs have failed miserably relative to their objectives including Cash For Clunkers, First Time Home Buyers Rebate Program, mortgage salvation programs such as HAMP, and worse of all, the economic stimulus program. All these economic failures did was to add to the skyrocketing national debt without providing any long lasting economic benefit.

The economic stimulus program was the worst culprit, if only because it wasted the most amount of taxpayer money, $830 billion, according to the latest Congressional Budget Office estimates. The economic models used to predict what would happen with increased government spending were disasters from a prediction perspective. They were fatally flawed in the assumption that one dollar in government spending would miraculously multiple many times over to create a cascade of economic growth. This did not happen. In fact, we quoted academic sources yesterday that estimated for every $1 spent in the economic stimulus program, far less than one dollar in benefit was received.

How then do you help the economy grow? Today, let's look at three real life situations where less government spending intervention in the economy actually spurred economic growth. The first two examples have actually happened in real life, giving them the advantage over economic theory which we now know failed horribly in real life. The third example is an analogy using the concept of water in a swimming pool and also uses no economic theory, just common sense.

We have already written about this first example but it is worth reviewing again in light of the continued failure of the economic stimulus program. At the end of World War II, the United States needed to do a massive retooling and refocusing of the domestic economy, going from a wartime based economy to a peace time based economy very quickly. Why? There was no longer a need to produce military goods and there were millions and millions of service men and women coming home to look for a job. Today's political class would have introduced a massive economic stimulus spending program, with the corresponding increase in government taxes and budget, to "create jobs."

Fortunately, the political class in 1945 did the exact opposite:

• From 1945 to 1948, the government actually decreased its size and spending by about 68%, going from a Federal budget in 1945 of $92.7 billion to a much smaller size of under $30 billion by 1948.
• During that three year time frame, the economy grew by over 6% a year, going from a GDP of $223 billion in 1945 to over $269 billion by 1948.
• Despite millions of ex-military people flooding the job market, unemployment never went above 4% during the same time period, a level of unemployment that today's politicians would kill for.

Let's review: 1940s government spending is slashed, economic growth skyrockets, and unemployment is kept under an unheard of 4% despite the massive influx of new workers. This is the exact opposite approach of the economic stimulus program. The government expanded in size (as did the national debt) but economic growth has been anemic, unemployment has been stubbornly high, and there was no massive influx of new workers.

If you read the history of this time period from an economic perspective, there actually were economists of the time that never believed this non-interventionist government approach would work. They recommended that the government continue to fund the war time factories and continue to produce unneeded wartime munitions and weapons in order to create work for people. Never mind, that the output of their effort would never be used in the economy, it would just burn through taxpayer resources to create work.

This is eerily similar to the the recent economic stimulus package which also created work but not long lasting, economy building, permanent jobs. Thankfully, the politicians of the 1940s ignored the  advice of these economic wizards and let the economy sort itself out, which it did magnificently. High growth, minimal government taxes, expenditures and debt, and low unemployment. It was that simple.

Let's jump ahead 65 years to present day reality and review what is going on down in  Puerto Rico. I learned of the following from an interview done in the June, 2011 issue of Reason magazine. The subject of the interview was Luis Fortuno who is the current governor of Puerto Rico. Highlights of the interview article include the following:

• When he became governor in 2008, he found a fiscal situation that was far worse than he imagined.
• As soon as he came into office he found that the government did not have enough money to make payroll, necessitating the need to get a loan for the basic function of paying government employees.
• The bond rating agencies were about to classify Puerto Rico bonds as junk status.
• Within two years, he had reduced government spending by 20%, had started to lower taxes across the board, and had averted the junk status rating for the bonds of Puerto Rico.
• He did all of this despite the fact that Puerto Rico's budget was worse than the budget shortfall of any state in the union, coming up 44% short of the revenue needed to cover current expenses at the time.
• In addition, unemployment in Puerto Rico was 17%.
• He set a cost cutting example by cutting his own salary by 10%, the salaries of his cabinet secretaries and the size of government contracts by 15%.
• Within two years he had reduced government employee headcount by 17,000 people on a total base of 140,000 or about 12%.
• He recently reduced government employee headcount by another 4,000.
• He accomplished the reduction by encouraging retirement or providing employees incentives to start their own businesses and leave government employment.
• Unemployment is still high at 14.5% but is down from a high of 17% (a 15% reduction) and is still trending downward.
• For the first time in five years, Puerto Rico is finally seeing positive economic growth indicators.
• He also slashed both corporate and personal income tax rates but still expects to have a balanced budget by 2013.
• The beauty of his tax reduction strategy is that if the budget is not balanced by 2013, some of the future tax reductions will not happen. This encourages all taxpayers to stay on top of their politicians to to get spending under control. Otherwise, taxes go up, a tremendously clever leveraging approach.
• When he took office, Puerto Rico was dead last regarding the relative size of the budget deficit in comparison to the fifty states. Today, it has improved all the way up to 20th, improving its budget situation over 31 other states.

What a great story. A bold leader cuts taxes, reduces government spending, reduces the number of government employees, absorbs the slings and arrows of doubters and what happens: unemployment goes down, taxes go down and the government's fiscal situation gets dramatically healthier. This is not economic theory, this is the economic reality of today when a smart and courageous leader follows the tenets of freedom and makes government smaller and the people it is supposed to be serving, freer.

And everyone wins. Families get to keep more of their hard earned dollars, businesses have more money to expand and pay for more workers, and government is smaller and more effective as it narrows its focus onto only important priorities.

Two quotes from the article really fly in the face of the attitudes we get from our politicians in Washington:

"There are some that have a philosophy that the government can handle our money much better than we can. I totally disagree. I believe that, actually, people are working hard, sometimes with two or three jobs, to earn that money. They should keep it. And they know much better than any government how to handle it, starting with their own."

"Certainly the minority in our state legislature (have been sources of opposition). The unions have been trying to block us as well. But at the end of the day, there's nothing more powerful than individual freedom to start to grow and do better for yourself and your family. And that's more powerful than any union, any government, any party, and I'm convinced that that's why this (economy improvement) will be permanent."

I love this guy. A freedom lover, a guy who understands reality and human behavior, and whose ego is not so big that he thinks the world revolves around him. Totally contrary to those currently sitting in the White House and in Congress. And most importantly, he has a successful economic track record, they have a record of failure and futility.

Two examples from two different time periods with the same successful results. Freedom of choice, low taxation, and minimal government interference wins out. Seems funny that the New York Times never reviewed these two economic success stories, still stuck in the old failed theories that government knows best.

The third example is not based on actual economic success stories, just common sense. I came across this economic analogy of  a swimming pool on a chat room session and wanted to share it. The analogy likens the economy to the water in a large swimming pool. The political class has this brilliant idea that it wants to grow the economy. How does it do it?

Simple, it takes water out of the left side of the pool and carries it over and pours it into the right side of the pool. While the pouring process may have increased the water on that right side of the pool, the effects are limited and minimal since the water eventually equalizes out, with no net gain of water or economic activity and growth.

The problem is that government spending does not create wealth, it does not create water. It simply takes wealth out of the economy (the left side of the pool), repackages it as economic stimulus (the right side of the pool) and nothing is gained.

In fact, you could make the case that water is lost (i.e. economic vitality is lost) as the politicians splash water onto the pavement in the process of moving it. This would be equivalent of spending stimulus money on such inane economic stimulus projects as insect investigation in Africa and replacing windows in a government building that was not in use and will likely never be in use.

The wealth and money they took out of the economy on the left side of the pool would have been much better spent and spent more efficiently if it had been left in the hands of individuals, families, and businesses. They would have had enough ingenuity to find a water hose and actually increased the amount of water in the pool. The political class could not even find the tax cheaters that got awarded stimulus money, never mind finding a water hose and using it.

The stimulus program is a bust, it turns out to be nothing more than moving water form the left side of the pool to the right side of the pool, losing water int he transfer process. It has not reduced unemployment, it has not led to significant economic growth, and it's negative impact on the national debt will last for decades to come. Truman in World War II and Fortuno today have shown the way to economic growth, a way that works and nobody, not even the New York Times, can argue with success.

Note: we will cover more of the Fortuno interview in future posts, seems like this individual truly understands the limited role of government in our lives and the need for government to focus on major issues only, seriously increasing the potential for success.




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