How Capitalism Will Save Us (65 page)

That’s right. You read it correctly. He said “81 percent.”

What does this mean? Higher income-tax rates will increase the cost of risk taking, productive work, and success. People talk about this spending having an impact “on future generations.” However, experts like distinguished Harvard University economist Martin Feldstein believe that
the future is now
. Feldstein had been an economic adviser to President Reagan as well as to the Obama administration. He is the former head of the National Bureau of Economic Research—the nonprofit research organization that determines when recessions begin and end. He predicted that the
expected rise in taxation under the current administration would “kill any chance of an early and sustained recovery.”
¹⁶

Because hiring people will become more expensive, fewer people will be hired. Higher taxes will soak up capital that would have been invested in new and existing businesses that create new jobs and innovate. The economy will slow. Feldstein writes that the very expectation of this happening will depress the economy:

The seemingly dry numbers augur profound changes—not only in today’s economy but also in America as a society—that would make the nation a radically different place than it has been in the previous 230 years. Imagine the future this holds for young people—instead of saving to buy a house, you have to pay off the pension and medical bills of Grandma and Grandpa because your payroll taxes are 30 percent instead of 15 percent.

What does it really mean when an economy stagnates? New jobs and opportunities aren’t created. Businesses can’t grow or come into existence.

We pointed out earlier in this book that the United States, from the early 1970s until the recession, has been a far better job creator than Western Europe and Japan. With high taxes draining capital away from job creation, we’ll get what we already see in Western Europe—high unemployment among the young. Even before the current crisis, unemployment among young people in France and Germany was over 20 percent. With higher unemployment and more people needing government assistance, we will evolve into a European-style culture of dependence.

With less capital available for risk taking, entrepreneurship, and initiative, innovation will decline. Existing services—such as in health care—won’t be able to be developed or even maintained and will start to deteriorate.

Another consequence: society will become even more politicized, as
interest groups of various stripes fight over government benefits. We’ll see the kind of generational conflict that is starting to occur in parts of Europe, where the elderly are increasingly looked upon as burdens. Several years ago, Holland was hit with scandals when it was discovered that hospitals short of beds were, not so coincidentally, euthanizing older, critically ill patients. Yes, this nightmare scenario actually occurred. Meanwhile, in Sweden, as we mentioned earlier, pressure has been exerted on the old to retire to “create jobs” for younger people.

Such episodes are extreme instances of what is essentially rationing. And rationing results when resources are limited and there isn’t enough of something to go around—whether that may be health care, energy, or jobs.

Most of the time, of course, bureaucrats end up deciding who gets what and how much.

The Real World bottom line in a government-dominated economy is indeed the Golden Rule: he who has the gold makes the rules. In a staterun market or economy, that means the needs and wants of people—and often, their rights—take a backseat to the agendas of politicians. The government, for example, tells auto companies what kind of cars they’re allowed to make, even if people don’t want to buy them. We’ve seen with Fannie and Freddie and with TARPed banks and life-insurance companies that it can mean that lending will be directed to politically desirable projects and not to those that make economic sense.

Recall the cases of Chrysler and General Motors, where senior secured creditors were browbeaten into accepting a reorganization that harmed their interests in favor of the politically powerful United Auto Workers union. And we’ve experienced the economic disaster that can be caused when politics, and not the market, drives economic decisions—namely, the misdirection of hundreds of billions of dollars into subprime mortgages.

If government direction were the way to go economically, the Soviet Union, and not the United States, would have won the cold war.

G
rowth in a democratic capitalist economy comes from production and innovation. It comes from finding better ways of doing things—new technologies, new processes, and new ventures that increase productivity and allow jobs and capital to be created. A wealth-producing innovation can be a wireless device that helps diagnose disease, a retail store that sells merchandise in a new way, or, as we’ve noted before, a single-size lid for coffee cups.

The Federal Reserve, the nation’s central bank, is charged with managing monetary policy and overseeing part of the banking system. It is not a wealth creator. However, throughout history, politicians and others have mistakenly believed that the Fed can soften the effects of business cycles. The notion has persisted that the Fed can cook up an economic expansion by simply printing more money, generating economic activity and more wealth for all.

Thus, the conventional wisdom has been that, during a downturn, all the Fed needs to do is “fine-tune” the economy by manipulating interest rates and the supply of money. But artificially changing the cost of money won’t in the long term create more wealth. As we learned from Hayek, as well as from the events in the last few years, it will only distort economic activity and can potentially be dangerous.

Hayek could have written the lesson provided by recent events. By keeping the cost of money artificially low, the Fed stimulated a massive boom in housing. Millions of people who really couldn’t afford a house ended up buying. Today we know that this proved to be disastrous for them, as well as for home builders, who became overextended, and a financial system that offered credit on the basis of inflated asset values. The boom in the housing and credit markets created by so much available money eventually collapsed, dragging the nation’s and the world’s economy down with it.

A similar scenario played out in the early 1970s. John Tamny, editor of
Forbes’s
RealClearMarkets.com
, writes that Richard Nixon sought to achieve the Keynesian goal of “full employment” by increasing the money supply by 8 percent. This worked for a time.

But Tamny recounts that the balloon deflated.

The following year both the economy and the stock market tanked. Remember our point in
chapter 6
about attempting to manipulate the balance of trade with a weak dollar—the gains it produces are always temporary. Sooner or later, the market corrects. Same goes for the domestic economy. The market eventually seeks to correct artificially inflated prices of goods and services. And the results are traumatic.

The inflation that ensued in Nixon’s second term inflamed nerves already frayed by the debate over the Vietnam War. In an angry atmosphere exacerbated by the Watergate scandal, Nixon was forced to resign. The economy suffered through a decade of “stagflation.”

The Federal Reserve can’t “manage” an economy for the same reason that the rest of government can’t: there’s no way that a handful of people—even smart people—in Washington can effectively guide the economic actions of three hundred million Americans or, for that matter, 6.5 billion people around the world.

The Fed suffers from the shortcomings of any government bureaucracy. While supposedly independent, it’s vulnerable to political agendas. Nixon’s Federal Reserve chairman, Arthur Burns, was accused of pumping up the money supply, not only to boost the economy but also to increase the president’s chances of winning the 1972 presidential election. The Fed has made countless mistakes in regulating money. It was seen as undermining the value of the dollar in the fall of 1987, which
helped precipitate the stock market crash that October. In the late 1990s, the Fed’s tight money policy caused the collapse of agricultural commodities. This in turn created political pressure to substantially increase wasteful farm subsidies under President Bush in 2001.

The Fed’s record regulating banks has been dreadful. Despite this, people have responded to the current financial crisis—a disaster that, as we’ve said, the Fed helped to cause—by wanting to endow the central bank with still more regulatory power. That would be a truly perverse mistake.