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The Failure of Conservative Economics Part VI – Our Current Problems and Why

March 26th, 2013 · 1 Comment · Capitalism, Economics, Politics, Populism

We have talked about the problems with our economy. We have discussed how they have been caused by a cynical use of failed economic policies by Republican politicians backed by billionaires and giant corporations. But one person sticks out to us as analogous to the entire period of Neo-Conservative dominance of the weak American mind.

Perhaps, the great economic Quisling of the 21st Century so far has been the slightly foppish but somehow academically certified Douglass Holtz-Eakin. He has latched on to the Republican Party as his personal fiscal lifeboat and spends his life trying to give academic credence to the false hope of a Conservative-sponsored balanced budget…which never comes.

The Neo-Conservative theory was that, if we just cut taxes, that money will flow into the private sector and create investment. That, in turn, will create jobs and taxes, increasing government revenues far beyond the cost of the tax cuts. Supply-side economics at work. It didn’t work. We cut taxes and all we got was more debt.

While Holtz-Eakin was head of the Congressional Budget Office under President George W Bush (Dubya) the CBO published a strong report stating that lower taxes did not create more revenue. It only reduced government income. Tax cuts, the CBO said, do not cause an eventual increase in revenues in an amount that even pays back the loss in tax revenues. In fact, the study said, and Holtz-Eakin and other Neo-Conservative economists know, only between 1% and 20% of the lost revenues are ever recovered.

Is it any surprise then, that since 1981, when Ronald Reagan cut the top marginal income tax rate from 74% to 50% and then later from 50% to 28%…we have steadily increased our debt to the point that it is now $16.7 trillion.

In other words, Quisling Holtz-Eakin and the other pandering Right Wing economists, know that they are lying but they lie anyway because that is where the money is. Tax cuts temporarily help those whose taxes are cut. They help no one else.

Under President Reagan, six million new jobs were created. But under President Reagan, there was also $2.14 trillion of debt at the end of his tenure and an average of 7.5% unemployment over those 8 years. Average…7.5% which is only .2% lower than it is right now in the worst economic era since the Great Depression. Top marginal tax rates were lowered to 50%, and then 28% on the top earners.

So that while 6 million jobs were created, after a huge downturn in the economy, those jobs did not decrease the national debt. Revenues did not increase over the amounts spent by the Reagan Administration nor did they increase enough from this added employment to even maintain the same budget levels. While supposedly creating these jobs, the Reagan Administration spent us into huge debt.

Compare that to Bill Clinton’s two terms, where he raised taxes at the beginning of his term, “the largest tax increase in the history of the country” according to Republicans. Not one Republican voted for those tax increases. Yet even with tax increases of 4.6% on the top earners, and quite naturally commensurate tax increases on all Americans, the Clinton Administration created 22 million jobs and balanced the budget in four years.

In addition, the Clinton Administration saw the longest sustained period of prosperity in our country’s history, even better than the post-WWII period up to the mid-seventies. Employment fell below 5% and in some places below 2%.

All of this is a prelude to saying that our current problem is two-fold and it can be solved easily. But it cannot be solved at all while people like Holtz-Eakin have any standing and while the Republicans in the House and Senate working for the Right Wing, block any legislation to create jobs and return the economy to balance.

We have two major economic problems. Problem one is the national debt. Republicans—alone and without any question—have built into 90% of our GDP. Problem number two is the deliberate theft of our national aggregate wealth. This was stolen by Wall Street as were the jobs of 15 million former workers. The solution to the latter problem is also about 75% of the solution to the former.

Supply side economics, which could also be termed Neo-Classical economics, basically says…make it and they will come. In other words, economic cycles come and go. We are in a down cycle and it is gradually turning upward. Production creates its own market. In a free and openly competitive society. Say’s Law says that supply creates its own demand. Production creates income which creates purchasing power which is enough to purchase the goods produced.

Well, Say can’t answer for himself these days as he has been dead for over 200 years. But let’s make some assumptions so that we can take on the current economy and its solutions. Even if we were to call ourselves “supply siders” and simply say that we produce goods and people will buy them, we don’t have perfectly competitive markets, so it won’t work.

In other words, profits are not saved and returned to the economy in the form of investment. In order for free and competitive Conservative economics to work…whether or not they work…the first thing you need is totally free markets. Our principal industries are not free markets. They are oligopolies…just a handful of firms controlling each industry.

So, Hayakian economics or Friedman economics could never work. We don’t have the right environment for them to work. There may be some true Conservative theoreticians who are still working on this problem, but most Conservative economists have long-since abandoned the truth.

They look at the deficits and the controlled economy in the same was as other people, but their jobs depend on their theories, which appeal to giant corporations and billionaires who do not want to pay more taxes and thus want smaller government. So, sadly, candidly, what they do is…lie.

Now, since this economic theory begins with production…something must be produced. To produce something, either profits or savings must be invested. When investment does not occur, from hoarding or from simple fear of a downturn in business cycles, supply side economics breaks down.

Neo-Conservative economics has no trigger mechanism to initiate demand. What we know now is that simple production does not create demand, except, possibly, in perfect market conditions. It is not only logical but it is economically tested. At very large numbers of depressed demand, the private sector economy will not risk capital investment. They will follow only sure things. And there are not enough sure things that, once begun, will guarantee enough demand to assure profitability. And money—investment–follows profits.

In the 1930s, and again in the early 2000s, monetary supply was eventually eased, putting more money into the marketplace, making money cheaper and easier to get for use in starting businesses or merchandising products. The fear of investment comes when large numbers of people are out of work and consumer products, and consumer products leading to industrial products, have no ostensible market. With no demand, Conservatives simply do not act and the economy becomes stagnant.

And Conservatives feel justified in doing nothing because it is perfectly justifiable from the personal self-interest point of view. Who will be the first to test the water in an economy that demonstrates no demand? That is where supply side economics bogs down.

Conservatives would argue that in a competitive market situation…and they propose that this is what we currently have…that the “virtuous circle” will allow the economy to return on its own. But it will not. The cycle has been broken.

Let’s test the “virtuous circle.” Let’s start at the point in October 2008 when the market crashed. At that point, businesses closed, many people were unemployed. As a result, wages diminished, prices fell, and, in a variety of industries and businesses, the buyer was dominant and the seller became subordinate.

So the cycle, we could say would begin with lower business profits and lower wages leading to lower prices, which should lead to more sales which would lead to higher prices which would lead to higher wages and greater sales leading to higher profits leading to more investment and a climbing economy.

But this didn’t happen. Only slight government intervention moved the needle at all, reducing unemployment gradually, over several years down from 10% to around 8% with no particular industry activity. So the “virtuous” circle, or cycle, did not perform. Supply did not create demand.

What about the “vicious circle” or cycle? Once again, the markets crashed, businesses failed. Demand was low. Then prices and wages fell, but nothing happened. No new businesses were created. Unemployment stayed high. Even dramatic infusions of cash into the system by the Federal Reserve did nothing of any significance to move things forward. The vicious cycle was overcoming the virtuous cycle. The classic virtuous cycle was not engaging. The Neo-Conservative theory failed.

The reasons are actually pretty simple. You see, the Neo-Conservative (“new” Conservative) system is no economic philosophy at all. It merely uses some Conservative platitudes as an excuse to hide a policy of what one could call looting the government. In other words, a cycle in which taxes are low, an economy is in trouble and many people are unemployed.

This drives down wages which drives down prices. It does offer opportunity for new companies to form and for old companies to diversify and expand. This would result in hiring and eventually to expanded production which would result in profits and more investment. Thus with companies investing profits and savings in more production, the cycle would have been complete.

But our situation is different from what we expected and what we were told would happen. We have low levels of employment, which, while it has driven down wages, has not resulted in a resumption of the business cycle. The simple reason is that we do not have a competitive economy any longer.

The few, large, minimally competing industries that control very high market shares pay their people well but leave a large segment of the workforce without jobs. They do not create more jobs because they do not grow. They do not grow because they–being one among only a handful of companies in that industry—their “cartel”–control the entire market. Cartel economics does not call for highly competitive actions.

The result is very slow recovery, if at all and very slow advancement of the economy resulting in much slower capitalization based on low prices and wages. What could take only months in a highly competitive economy becomes years in an oligopolist or cartel-like environment across all major industrial and commercial categories. Markets are sated. Big firms control all aspects of competition.

In addition, today, because much of excess labor capacity has been created by jobs having been sent abroad, lower employment levels and lower consumer demand becomes a drag on the economy. And low taxes on the wealthy mean that large corporations and rich individuals are much more likely to keep their after tax income rather than invest it.

Consequently, the vicious cycle continues with insufficient domestic investment, heavy public debt and diminished consumer expectations. The virtuous cycle has been broken. Only extraneous actions—by the investor of last resort—the government—will set the virtuous cycle back in motion.

The effects of oligopoly

Oligopoly causes slack in the labor market. Foreign manufacture of U.S. products accelerates it. The excess labor supply reduces consumer demand. And low taxes on corporations and wealthy investors reduces their incentive to invest. So the virtuous cycle can never get started.

As a result of this stagnation, a massive amount of potential economic activity is frozen in the assets of five or six banks and the wealth of the top .1% of the country (estimated at between $45 and $80 trillion dollars) is held in the hands of literally less than 10,000 corporate owners and families.

This means that what would normally happen, namely progress in the economy…i.e., production efficiency and output…is not happening. Money is not flowing back into the system. And here is why.

In earlier generations, old companies and new companies competed for top positions in the marketplace. Even in the days when there were huge monopolies like U.S. Steel and Standard Oil, the domestic productivity of the country was directed at domestic needs. So, while we expanded as a nation, we created the products that we needed for expansion right here in the U.S. Monopoly break-up was done to allow more companies into the field, because a growing U.S. economy needed fierce competition to grow rapidly to meet domestic needs.

As the major companies, thousands of them, grew in the 1960s and 1970s, many small companies grew into very good sized firms, employing thousands of employees each. But in the 1980s and 1990s, consolidation of these companies was allowed to take place. The Reagan Administration, with their newly discovered “Conservative” principles, despite economic history that said monopolies not good for competition, pushed for consolidation. It was good for the corporations and large stockolders, but, in the long run, bad for society.

Consequently, from the 1980s, government reduced competitiveness by allowing mergers to leave only a handful of major corporations in every industry. With that as the government pattern, owners of the smaller corporations sold out to larger companies and became major stockholders in the larger companies.

Now, instead of ten corporations with 80% of the market, there were 4 corporations with 90% of the market. The dozen or so smaller corporate heads, now were part of what became only 4 or 5 decisions being made on the marketplace. And those decisions, you can be sure, are far less competitive and much, much safer. U.S. industry became far less dynamic.

This continuous consolidation meant something else. The largest 500 corporations are owned enough by literally a couple of thousand people, the owners of the smaller corporations who sold out to the larger ones. A smaller number of people, as few as perhaps 2,500 make decisions on virtually the entire domestic economy. This is because only a few people control the stock of each major corporation, and there are only half a dozen major corporations in each major industrial category.

With only a few corporations in each business, the personal self interest of the owners is to act like a cartel, not to engage in price wars but maintain collaborative relationships within a legal framework. As long as they can control prices and market shares do not fluctuate, they remain very profitable. There is no more incentive to compete.

But then we have the problem of manufacturing abroad. This increases profits for the handful of companies comprising each cartel. Sooner or later the progression will lay off more and more U.S. workers and reduce prices and therefore wages. At some point, the marginal utility of wages abroad will cross with the line beyond which the U.S. consumer market has become less attractive.

Eventually, should the restriction of competition continue and the outsourcing of U.S. manufacture to foreign countries continue, the powerful U.S. domestic market will decline. There simply will not be enough domestic employment to create demand, even at much lower prices.

It is clear that most Neo-Conservative economists see that these cycles are broken. They understand that the lack of competitive action restricts the growth of the economy. But corporations in an oligopoly do not want to return to full competition.

As a result of restricted competition, money goes up the chain, but does not return to the market as investment. This is partially the result of already diminished U.S. buying power. What seems to be temporary Depression is merely a lower standard of living that will stay in place as long as supply-side Neo-Conservative economics continues to mask the real problems.

Despite what classical economics says, personal self interest does not lead one into self-sacrifice. In business, personal self interest tells us to go where the money is. Investment flows to profits. So supply does not create demand.

So, what do we do? We make an adjustment. In the 1920s and 1930s. John Maynard Keynes put forth the idea that, if supply side economics does not allow for positive action to create markets. If it is unreasonable for one man or one company to be the ones to take the first step, then government, as the financier of last resort, has the obligation to step up and make investments.

Why would government do such a thing, if supply side economics is correct, and production is not working to create demand? The reason is the old principle of hoarding. You may think of hoarding as some old man in a brownstone piling up dollars in closets. But hoarding can be more loosely interpreted. Hoarding is actually preventing action in the marketplace by people who have the profits or savings to do so.

There is no implied motivation to hoarding. It could be fear of failure and ruin. It could be greed. It could be a misunderstanding of what may happen. Or it may be a legitimate understanding that this product has no market at this time because it is too expensive, or out of date or some other reason.

But whatever the reason, hoarding is one of the triggers of classical economics. Hoarding mis-aligns the economic equilibrium. When a company makes something, sells it, and takes revenues, the next step is for money to flow back into the cycle. When it does not—for whatever reason—the system gets out of sequence. Remember, in classical economics and supply side economics all income from profits becomes savings and investment.

So in the days of the First Great Depression, Keynes basically said…no one is investing. The system is broken. In order to make it easier for the “hoarders” to come back into the market, we make a market. We do so by creating worthwhile jobs, government projects that require materials and manpower. As these jobs start and as consumption, demand, begins to show itself, we can phase out government work and channel production into consumer and industrial goods.

There is nothing that says that the government has to stay in the market. In fact, the government should get out of the marketplace as much as possible. We need a post office, an army, a group to fix the roads, public schools, a public health care system and a legislative body to make laws, perhaps a few other things, and the rest should be as small as possible for the number of citizens that government must serve.

Social Security must be a government program, but under the right circumstances—which is mostly proper funding–it could eventually be run as a private, non-profit organization. But since the Social Security system runs on about 3% costs with government administration, why would you want to change it?

Keynes said that if the private economy will not see to the establishment of markets, then the government must step in. If you follow the alternative to its ultimate conclusion, the private economy would grow smaller and smaller.

So what can we do to restore the private economy? That is the next and last section of this report.

Next—The Real Solutions.

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