Monday, February 6, 2012

Romer Offers Wrong Diagnosis And Wrong Medicine For US Economy Employment Slump

Christina D Romer, former chairwoman of President Obama’s Council of Economic Advisers, in The New York Times Economic View section, "Do Manufacturers Need Special Treatment?" correctly argues that Obama's and others call for more manufacturing in the US to create more employment is a sentimental and nostalgic call for an earlier day, that will not return, when manufacturing employed many more workers than it does today.

Romer wrote:
JOBS A key argument for encouraging manufacturing is to create jobs and reduce unemployment. Unfortunately, those effects are probably small.

Unemployment today is high, but not because of a decline in manufacturing. That decline has been going on for 30 years — and for most of the 1990s and 2000s, the unemployment rate was less than 6 percent.

Today, we face a profound shortfall of demand. That truly is a terrible market failure, and it warrants government intervention. But we need actions that raise overall demand — like a tax cut for households so they have more take-home pay to spend, more aid to troubled state and local governments, and public investments in infrastructure. These are all things that President Obama has advocated.
AS an economic historian, I appreciate what manufacturing has contributed to the United States. It was the engine of growth that allowed us to win two world wars and provided millions of families with a ticket to the middle class. But public policy needs to go beyond sentiment and history. It should be based on hard evidence of market failures, and reliable data on the proposals’ impact on jobs and income inequality. So far, a persuasive case for a manufacturing policy remains to be made, while that for many other economic policies is well established.
Efficient And Capital Intensive

Manufacturing has become much more efficient and capital intensive than it was 30 years ago. Today, a smaller US manufacturing workforce can produce more than 30 years ago with many fewer workers. Likewise, manufacturing output is a smaller part of the total US economy, though the US manufactures more than it did 30 years ago. Manufacturing has followed the same path as agriculture did a 100 years ago. A 100+ years ago about 80 percent of the US was employed in agriculture. Today, the percent of agricultural employees is in the low single digits, while the US is growing much more than it did a 100 years ago.

Similarly, agriculture and manufacturing are a smaller share of GDP than there were in the past. Services are a much greater share of the US output than there were 30 or a 100 years ago.

There is a natural economic tendency for companies to invest in capital to increase employee productivity and lower the manufacturing costs of goods. Employers have no choice. The employer that can produce more at a lower cost by using more machines and other capital investment will be able to sell more of his goods a a lower price, and make more profit, than the manufacturer who uses a more expensive production method. The higher price manufacturer will be forced out of business by loss of the consumers of its products who switch to the lower cost seller.

The total US economy, inflation adjusted GDP, is above its pre-recession levels, while the number of employees is still millions below the pre-recession level.

Romer's Call For Action

Romer calls for more aid to local governments, more public infrastructure investment and more household tax cuts. In other words, Romer calls for more deficit spending and government stimulus. Unfortunately, none of Romer's prescriptions will cure our employment problem.

Households need to expect future growth in their personal incomes. Growth comes from making productive investments, which will have a positive payback net of taxes. If households expected the US economy to make productive investments, households would expect higher incomes net of taxes. With an anticipation of future higher incomes, households would spend more now, companies would invest more to meet demand and employment growth would accelerate.

Government Investment

Government investment has a much lower return than private investment. Government is significantly much less efficient and productive than the private sector in getting a job done. Plus, government decision-making about investments is often based on political reasons instead of the private sector's economic criteria of the rate of return on the investment.

Infrastructure investment by governments is non-productive and inefficient. The older infrastructure that needs repair or replacement is often in the older communities that are no longer the economic centers that they were when the original infrastructure was built. When the original US highway system, or the original cross country railroad system, was built, it shortened the travel time between two distant points. There was an economic gain in shortening shipping and travel times. Today, much of infrastructure investment is pork barrel spending with insufficient economic return on the investment to justify the expense.

Taxes, Deficits And Take Home Pay

Households understand that lowering their taxes and increasing their take home pay today without lowering government spending will lower their future take home pay. The government debt, and the interest on the debt, created by deficit spending will consume a larger part of a household's total pay in the future. As the US debt increases, the probability of non-payment of future, promised obligations like social security or Medicare increases and bears more heavily on current spending and increases the need for current savings.

Likewise, corporate taxes, which are ultimately consumer and employee taxes, and investment taxes, such as capital gains, hinder private sector investment and lower worker take home pay.

Health Care

Heath Care is a huge expense in the US, but that is not the problem. Much of health care is paid for by employers for their employees and for senior citizens through the Medicare payroll tax. While it is true that lower health care costs and lower Medicare payroll taxes would increase the take home pay to workers, it is irrelevant if the workers would spend that same amount on health care anyway.

The harm that occurs to our economy and that lowers consumer spending is that consumers spend more on health care than they would otherwise. Consumers do not face a market price system in health care. Without a health care market price system, consumers allocate a larger share of resources to health care than they would if they faced market prices.

Similarly, health insurance and Medicare with their fee for services payment schedules instill rigidity and stifle medical delivery system innovation, efficiency gains and cost reductions. For example, doctors do not use emails, webcams, telephones or their nurses to diagnose simple patient ailments, such as conjunctivitis (pinkeye), etc., for which costs could be much less than for an office visit. Medicare and health insurance reimbursement is geared towards visits to the doctor's office and diagnosis by a doctor and this payment structure promotes inefficiencies and inhibits cost reductions.

It is the current government structure of health care, both in Medicare and in the employer tax deduction, that leads to an expected continued inefficiency in the delivery of health care, in an over investment in health care services and in over spending on consumer health care.

The over investment and inefficiencies of that investment in health care also lead to a household expectation of lower income net of taxes and health care expenses.

Solution For Employment Growth

The best solution for accelerated employment growth is to decrease government investments, including infrastructure. Increase private investment through removal of government barriers and government competition to private investment. Instill market pricing in health care at the consumer level so resource allocation will be made more productive.

With less government spending and investment, with more private sector investment and with restored market based price signals in health care, the US economy would see accelerated GDP and employment growth.

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