Last Friday's report on economic growth for the second quarter of 2011 completes the burial of Obamanomics. The economy grew a paltry 1.3% for the quarter, with reported growth for the first quarter reduced from a meager 1.8% to a negligible 0.4%. The economy for the entire year so far has actually grown less than the weak growth we thought we had for the first quarter alone.
The growth for the fourth quarter of 2010 was also reduced to 2.3%, meaning that for the last nine months the economy has grown a minimal 1.5%, barely treading water as the weekend Wall Street Journal described it. For comparison purposes, economic growth during the first seven quarters of the Reagan recovery in the 1980s boomed at an average of 7.1%. Economic growth during the first seven quarters of the Obama non-recovery has now been reduced to an average of 2.6%, barely a third as much.
Historically, as the Journal also reiterated, "the deeper the recession, the more robust the recovery." So the idea that the recovery is so bad because the recession was so bad doesn't wash. Based on the historical pattern, we should be in the second year of a booming recovery by now. President Obama instead is mired in three and a half years of stagnation with worse to come.
Keynesian Economics, RIP
This catastrophic failure for America's working people has resulted from President Obama doggedly following exactly the opposite of Reaganomics in every detail. In particular, Obama came into office with his Rip Van Winkle attitude pretending not to notice that anything has happened since 1981, and returning to the failed Keynesian economics of the 1970s with a vengeance.
As the Journal explained it this weekend, President Obama "deployed the entire arsenal of neo-Keynesian policies to lift domestic demand," including "nearly a $1 trillion in stimulus, plus a battalion of temporary and targeted programs: cash for clunkers, cash for caulkers, tax credits for homebuyers, 99 weeks of jobless benefits, 'clean energy' grants, subsidies to states, and so much more."
Keynesian economics is the doctrine that economic growth and revival is caused by increased government spending and deficits. The increased spending and deficits are supposed to increase aggregate demand for goods and services, which supposedly causes producers to produce more. If you listen to President Obama carefully, he is always saying that economic growth and prosperity comes from increased government spending.
If the idea that increased government spending and deficits create prosperity doesn't seem to make sense, that's because it doesn't. Keynesian economics has never worked, not when it was born in the 1930s and not when it finally crashed and burned in the 1970s with double-digit inflation, roaring unemployment, and deep recession all at the same time. That is supposed to be impossible under Keynesian economics, because you can't have both too little aggregate demand (the supposed cause of recession and unemployment) and too much aggregate demand (the supposed cause of inflation) at the same time.
The central fallacy behind Keynesian economics is that the money for the increased government spending and deficits has to come from somewhere. If the government borrows a trillion dollars out of the private sector to spend a trillion back into the private sector, it hasn’t done anything to increase the economy on net. If it seizes a trillion dollars in taxes out of the private sector to finance the trillion of increased spending, the result is worse. The economy has not been expanded on net, and the increased taxes reduce the incentives for production, resulting in a net loss to the economy.
Keynesian economics survives not as a matter of logic, but because it provides cover for what the politicians want to do: increase spending and deficits to buy votes for their political machines. For a Chicago machine politician like Barack Obama, that is catnip.
The Failure of President Obama
What drives economic growth and prosperity, however, is not government spending and deficits, but incentives for production. That was the insight behind Reaganomics, and the reason why it was so successful.
Lower tax rates increase the incentives for production by allowing producers to keep more of what they produce. Deregulation increases incentives for production by reducing the costs of production, increasing the resulting reward. Restrained, anti-inflation monetary policy expands the incentives for investment to increase production because investors know the value of their investment will not be depreciated by inflation and a declining dollar. Reduced government spending and deficits reduce the government drain on private-sector investment funds.
Moreover, these are not policies suited for a particular time and its policy challenges. These are timeless free-market economic policies enduring for all time. As I argue in my new book, America's Ticking Bankruptcy Bomb, if we would only restore these planks of Reaganomics, within a year the economy would take off on a new, generation-long economic boom. As the Journal again said this weekend, "The only way out of this mess is to return to the growth policies that nurtured the boom of the 1980s."
The disgrace of Obamanomics is that its rigid, unreconstructed Keynesian economics was discredited in both theory and practice over 30 years ago. The historic success of Reaganomics was a demonstrated fact for all the world to see (and subsequently imitate) over 20 years ago. But President Rip Van Winkle, playacting dumb, takes us back to the future of the 1970s, reflecting the devout prep-school Marxism of his youth.
He is not the only one. Witness the spectacle of the equally self-absorbed Ezra Klein, who in his uninformed blog for the Washington Post just last month ridiculed the Republican Cut, Cap and Balance Plan for failing the test of Keynesian economics. He writes:
The only way to prevent massive layoffs, the only way to give the unemployed some help and the underpaid some relief, is for the federal government to spend. And yet we want to write into the Constitution a requirement that spending remain at 18 percent of the previous year's GDP? That is to say, a requirement that the federal government needs to make recessions worse rather than drawing on its unique capacity to make them better? Are we mad?
Klein is blissfully unaware that there is even any dispute over Keynesian economics, let alone that it was thoroughly discredited 30 years ago, and replaced by an historical success proven over 20 years ago. Indeed, he is so behind the curve in recognizing the economic policy debate that he indicates that anyone who doesn't genuflect to the 1930s wisdom of Keynesian economics must be "mad." That only raises, and answers, the question of whether Klein can helpfully comment on today's politics and public policy in America when he is not even following, let alone understanding, a central, decades-old, fundamental economic policy debate.
That is apparently not a problem for the Washington Post, which institutionally presents an open question of whether it is so behind the curve of what is happening in America today that it can even cover and report on current politics adequately for its readers. Certainly no one relying on that paper for political coverage in 2010 would have had any idea of the New Deal-sized political earthquake coming in November. That little item was first predicted in this space, by contrast, in 2009.
But arguably even worse: the New York Times, whose resident economics scholar, Paul Krugman, argues that the only thing wrong with the Keynesianism of Obamanomics is that the spending stimulus wasn't several times bigger. He offers as his model the spending of World War II. Federal spending in 1943 was 43.6% of GDP, with the federal deficit at 30.3% of GDP. In today's equivalent terms, that would mean a federal budget of $6.54 trillion, or over 70% higher than today, and a federal deficit of $4.55 trillion, almost 3 times higher than today.
Talk about mad. The runaway Keynesian spending spree we have already suffered has driven the nation to the edge of bankruptcy. Do we have to drive America over the bankruptcy cliff before Krugman acknowledges the proven failure of Keynesian economics? The answer is no, because his devotion to the doctrine is religious, not intellectual, and so it can't be falsified.
Professor Richard Rumelt of the UCLA Anderson School of Management timely reviews the economics of World War II spending and other policies in the weekend Journal. He explains that it wasn't Keynesian-increased consumption from all that World War II spending that ended the Depression, writing:
Government policy didn't stimulate personal consumption, as Keynesian policy makers aim to do today. During World War II, there was no investment in civilian infrastructure and the government placed severe restrictions on consumption.… Thrift restored personal balance sheets, ultimately setting the stage for the postwar boom.
Rumelt adds that contrary to Keynesian economics:
During the 1941-1945 war years, over 22% of disposable income was saved. This high savings rate was driven by fiat. Thanks to wartime rationing, Americans were only allowed to purchase small amounts of sugar, butter, meat, gasoline, tires, shoes, bicycles, processed foods and other goods. Plus, there was virtually no production of new cars, radios, home appliances, or housing. In fact, when inflation and increased working hours are taken into account, consumption per hour worked actually declined for the bulk of civilians during the war. Civilian living standards stayed at Depression-era levels.
Rumelt explains that it was actually after World War II, when government spending was reduced by nearly two-thirds as a percent of GDP, and the deficit was nearly wiped out, that the economy boomed. The foundation for that boom was not the Keynesian consumption spending of the World War II years, but the increased personal savings and debt repayment of those years. So Krugman completely misinterprets the government spending effects of the war years.
The more sophisticated (I would argue sophistic) defense of the tragic failure of Obamanomics states that recoveries that follow financial panics are supposedly slower. But that has not been the experience of the American economy. Over the last 70 years, recessions in America have previously lasted only 10 months on average, with the longest previously being 16 months. Moreover, again, the deeper the downturn, the stronger the recovery. Yet, we are three and a half years beyond the last recession's starting date, and there has been no effective recovery.
It was only the Great Depression itself, prolonged with Keynesian economics, where the human suffering dragged on for over a decade. Historically, recessions or downturns have often been accompanied by financial panics, a classic feature of the business cycle. The sophistry of this argument is just an attempt to devise a political excuse for the failure of President Obama and his outdated, benighted economic policies.
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