Just Blog-in-blog!!!

The United States is facing a depression. Just as Hoover and Roosevelt did in the early 1930s, the government changes its strategy for assisting recovery every few months. Congress and the Treasury Department will try something. If it doesn't work, a month or two later they try something else. This gives them the appearance of being clueless or helpless or both.

Just as in the Great Depression, uncertainty about government action causes businesses to defer investment and job creation. Why build a factory if you don't know what the tax rates are going to be? Is it reasonable to spend cash if customers' purchasing power continues to drop? (Reference: The Forgotten Man).

Precious little business investment is going forward worldwide. The only chance for the United States to recover is if we can capture most of this investment. How can we do that? We would have to convince businesses that this is the best country in the world in which to invest and operate.

What we need to promise

At a minimum, here are the things that we need to promise business managers:

• world's lowest percentage of GDP (among developed nations) spent on government; only with a low spend will investors have faith that taxes will stay low
• corporate governance that relieves investors from worry that profits will be siphoned off by management
• flexible capital expense depreciation schedule so that a company doesn't have to pay taxes when it is cashflow-negative
• world's best school system and best educated workers
• world's cheapest transportation system and one that is virtually free from uncertainty caused by congestion
• predictable product liability system
• less labor market regulation
• immigration that encourages high earners

Some of these promises will be at odds with many Americans' cherished ideals of what makes a good society. However, due to the risk of a prolonged depression and competition from other countries, it is better to face the facts now that we can't afford those ideals.

Reducing Government Spending

In 2006 we were spending roughly 36 percent of GDP on government at local, state, and federal levels (source). This compares unfavorably with South Korea at 27 percent and Thailand at 18 percent. We can set taxes for 2009 at whatever level we want, and we can argue about how the tax burden should be distributed, but businesses won't have long-term faith that taxes will remain low unless we can reduce spending to internationally competitive levels. What's wrong with high taxes? Taxes on workers drive up payroll costs. Taxes on companies reduce the return to investors. Either way investment and job creation are discouraged.

We need to set a credible goal of reducing government spending to 30 percent of GDP within two years and 27 percent within five years. If we can't count on vibrant economic growth, this will involve dramatic changes to government benefits. We'll probably have to do most of the following:

• start paying full Social Security at age 70 rather than the current 67
• reduce the scope of Medicare and Medicaid, e.g., start Medicare at age 70 rather than the current 65
• start paying public employee pensions at age 70 rather than the current system in which many workers may collect benefits starting in their 40s or 50s (example); the average American will need to work until he or she is 70 and can't afford to pay taxes to give 53-year-old former public employees 100 percent of their old salary, adjusted for inflation, for another 30-40 years (example)
• scale back our military ambitions, closing a lot of overseas bases and abandoning attempts to build nations (we can still afford to bomb people who don't like us)
• eliminate government-owned housing so that these properties can be returned to the tax base and used to their full potential (it might be nice to be able to offer five years of free housing in some of our most expensive cities to illegal immigrants such as Obama's Aunt Zeituni, but we can't afford it anymore)
• abandon the war on drugs and associated expenses for police, judges, lawyers, and prisons
• eliminate public employee unions; the average American doesn't get a union paycheck and can't afford to pay union labor rates; the government is not supposed to be such an abusive employer that a union is necessary for worker safety
• eliminate the requirement to use union labor on public works projects; it shouldn't cost the taxpayers more to build a structure than it would cost Microsoft or Google
• eliminate farm subsidies, which raise prices to consumers, distort the market by encouraging monoculture and overproduction of crops such as corn, and have staggering direct costs to taxpayers (the 2007 farm bill was budgeted at $300 billion; source)

What about Keynes?

Cut government spending during a depression? What about classical Keynesian economics? Maybe it was a good idea in 1936, but the world is a lot more globalized today and there is much more competition among countries. In 1936 a multinational business did not enjoy free voice-over-IP telecommunications, cheap air freight, cheap container shipping, nor billions of workers in low-cost foreign countries who were speaking or learning English.

Japan is a good example of the failure of Keynesian economics in the globalized era. The country spent hugely on public works projects in the 1990s, digging an enormous debt hole for its future citizens (170 percent of GDP; compare to 60 percent of GDP for the U.S. (source)). What was the result? Its largest corporations invested substantially in growth and created a lot of new jobs... in China, Thailand, Vietnam, etc. The domestic economy stagnated.

Investor Representation on Public Company Boards

Right now the shareholders of a public company are at the mercy of management. Without an expensive proxy fight, the shareholders cannot nominate or vote for their own representatives on the Board of Directors. The CEO nominates a slate of golfing buddies to serve on the Board, while he or she will in turn serve on their boards. Lately it seems that the typical CEO's golfing buddies have decided on very generous compensation for the CEO, often amounting to a substantial share of the company's profits. The golfing buddies have also decided that the public shareholders should be diluted by stock options granted to executives and that the price on those options should be reset every time the company's stock takes a dive.

If current trends continue, the CEO and the rest of the executive team will eventually have salaries that consume 100 percent of a public company's profits and they will collect half ownership of the company via stock options every few years. Who would want to invest in that?

Corporations are supposed to operate for the benefit of shareholders. The only way that this can happen is if a majority of Directors are nominated by and selected by shareholders. It may have been the case that social mores in the 1950s constrained CEO-nominated Boards from paying their friend $50 million per year, but those mores are apparently gone and the present structure in which management regulates itself serves only to facilitate large-scale looting by management.

[Photo at right: Typical Greenwich, CT home of Executive VP of Fortune 500 company.]

Depreciation of Capital Expenses

Suppose you spend $1 million on new machine tools for a new factory, plus another $1 million to run the tools. You take in $1.4 million in revenue the first year, so you've lost $600,000 in cash. Under standard rules of deprecation, however, you can't deduct the full $1 million spent on those machine tools and therefore you will have to pay tax on a reportable profit of something like $400,000 minus whatever portion of the machine tools the IRS allows you to depreciate (complex subject, with each kind of equipment having its own schedule). So you need to come up with more cash to pay the IRS, even though you cashflow-negative for the year.

When the economy or an industry goes into the toilet, the government comes up with various "bonus depreciation" schemes that allow businesses to deduct capital expenses faster. The idea is to encourage capital spending, which tends to generate jobs and economic growth.

It looks as though we have moved into the toilet for the foreseeable future. Why not simply allow a business to deduct capital expenses however seems most advantageous or sensible to them? If a computer system is expected to last for two years, the business can deduct half this year and half next year rather than abide by the standard IRS 5-year schedule for computers. If the business is cashflow-negative, it can expense enough of its capital expenses in the current year to reduce its tax bill to zero. The IRS will still get its money eventually because, just as with the current system, the business's total deduction for a capital item over the years cannot exceed the original cost.

Want a company to replace its fleet of trucks? Want a company to build a new factory? These expenditures might result in the company burning through some cash. Let's not discourage this investment by simultaneously forcing them to raise more cash to pay a tax bill.

Education

We keep talking about school reform but we never achieve anything except spending more taxpayer money than any other country on Earth. Businesses don't want to invest based on the hope that 2008's promises to fix public education will work better than promises made in 2007, 2006, 2005, etc. If our standard high school graduate isn't a lot better educated than someone from a country with lower labor costs, we are finished.

Nobody has ever made a compelling argument for how having unionized teachers helps students. Nor has anyone ever made a compelling argument for how having tenured teachers helps student performance. Our country's best performing schools (all of them private) have non-unionized teaching staffs. We can't afford to experiment with unionized teachers anymore. The government created the right for public employees to unionize and it can remove that right very quickly if it has the political will.

How good a job would you do at your company if customers were required by law to buy your product? That's the situation faced by public school management today. It would be illegal for a 14-year-old not to attend the local school, unless his or her family can scratch up a huge tuition payment for a private school. We need to set a deadline by which every American family has the choice to send children to a school other than the local one. There wouldn't be a problem with "failing schools" anymore because parents would have withdrawn nearly all of their kids from such a school and the building would end up being taken over by a new school with new management.

Currently we force nearly all of our children to attend their local school where they are taught by unionized mostly tenured employees. It isn't working. Businesses aren't fooled. We keep slipping behind other countries in the subject areas that matter in the highest paying jobs. We need to take action drastic enough to convince investors that our graduates 10 years from now will be fully competitive with those of the world's smartest countries.

Transportation System Reform

Suppose that your business depends on the timely arrival of supplies or salespeople and customers being able to meet. A traffic jam on the local highways will cost your business a lot of money. You're paying workers to sit in traffic instead of doing their job. You're paying more for supplies because it costs suppliers more to deliver them. We need sensors, wireless Internet, and congestion pricing for our highways and urban streets so that high-value business transportation is almost never impeded and companies can predict their door-to-door travel time. In Boston we spent $15 billion of taxpayer funds on a few miles of highways and tunnels. It would have made a lot more sense to buy some $50 wireless Internet base stations so that cars could talk to each other about whether or not traffic had ground to a halt inside those tunnels.

Mass transit is critical to business in the parts of our country where workers use public transit to get to work. Public transit unions should be eliminated because a strike at a mass transit system can shut down an entire city, as has happened several times in New York due to subway system and commuter rail strikes (see this New York Times article on the Long Island Rail Roadfor example). It is difficult enough to make the decision to invest right now and create jobs. We can't also ask businesses to wonder if their employees will be able to get to work.

Should we spend more on mass transit? If we can take the funds out of congestion fees, if we can have the systems built and operated by private companies using non-union labor... maybe.

Predictable Product Liability System

A business making a product that might injure someone has a reasonable chance of predicting the maximum potential for actual damages that the product could inflict. If the product kills someone with a salary of $50,000 per year and 20 working years remaining, that is approximately $1 million in liability. What a business cannot predict are the punitive damages of $50 or $100 million that are sometimes awarded by juries. The punitive damage system has a rational basis. Without it, businesses would be less cautious. But we can't afford it right now.

We need a fixed range of prices for people killed or injured by products, similar to workman's compensation but with much higher numbers and taking into account the victim's age, education level, and other factors that determine lifetime earning potential. Punitive damages must be eliminated and a manufacturer's liability for its products or actions should be limited to no more than 20 years after the product was shipped. (Note that a similar time limit was signed into law by President Clinton for aircraft manufacturers and had a big positive effect on the industry.)

[More: a story about a lawsuit that put an aircraft carburetor manufacturer out of business]

Labor Market Deregulation

We may soon have deflation. Workers who are young or with poor skills need entry-level jobs in order to build skills and experience. They won't be able to get them if the minimum wage is set higher than the market-clearing wage. During the Great Depression, Hoover and Roosevelt tried desperately to prevent wage deflation and insisted on companies paying workers more than the market-clearing wage. The result was that a lot of America's workers were overpaid, which was great for them, but about 30 percent of us were unemployed. The government was powerless to prevent deflation, in the end, and businesses that could not afford to pay their workers the minimum wage were forced to shut their doors.

Eliminating state and federal minimum wages would send a message to business that it will be safe to operate in the U.S. even in the event of deflation.

Our system of discrimination against workers on the basis of race or sex ("affirmative action") should be eliminated. When we were rich we could argue about the benefits of government, non-profit organizations, and private companies trying to have a specific mix of race and sex among workers. Now we can't afford to spend time arguing about whether a person of the right color or sex was hired. An employer will be lucky to be able to afford to hire anyone and they should be able to hire the best-qualified candidate without fear that they will be sued for not hiring someone with the right skin color or chromosomes. [Note that this is not an argument for eliminating laws requiring equal opportunity.]

Substitute Web-based Education and Trade for Foreign Aid

We don't spend a large percentage of GDP on foreign aid, but the perception is that the absolute amount is large and nearly all of it is wasted or siphoned off by Third World officials. Even if aid money reached its intended population it might not accomplish what we think it will. In A Farewell to Alms, Gregory Clark, the Chairman of the Economics department at UC Davis, argues that Malthus was right for most societies throughout most of human history. Clark points out that giving food aid to a poor country will not result in raising the subsistence standard of living in that country. Food aid will result in more babies being born and a larger number of people living at the same or even lower standard of living. Medical aid or improved hygiene will result in a larger number of people being able to survive on an even lower daily calorie intake.

It would send a good message to investors if they knew that all of the money that they and their workers paid in taxes would be used to improve and maintain U.S. infrastructure.

Where would it leave poor countries if we eliminated all current foreign aid programs? The most valuable thing that a poor country can get from the world's advanced countries is knowledge. This was true when the only way to distribute knowledge was by physically transporting books, students, and teachers. It remains true now that the cost of distributing knowledge has fallen nearly to zero. In terms of long-term development, Wikipedia is already probably more valuable to poor countries than all of the foreign aid that they receive. So let's give them more knowledge, but in a way that benefits Americans equally and does not sound like throwing good money after bad.

There are people all over the U.S. and all over the world who would benefit from an improved education. We now have the technology to give it to them at a marginal cost of $0 per motivated student. Putting textbooks, problem sets and solutions, project challenges, and lectures online costs next to nothing. Providing Web-based collaboration environments for students to work together with each other and with volunteer tutors is also inexpensive. Online teaching materials and online classrooms can make a huge difference in the life of a poor but motivated person.

Should we call it foreign aid? No. We build it for Americans and if citizens of other countries want to use it, we welcome them as well. There are plenty of Americans who need a lot more education if they are to compete in the global workforce.

What else do poor people in foreign countries get from Americans? A lot of private aid and probably much more if we could restore the U.S. economy to health. Already private donations from Americans are larger than current official aid (source).

Poor countries also get some help from the existence of the U.S. military. Even in a scaled-back form, the U.S. military discourages piracy and other lawless behavior. This makes it cheaper and more efficient to trade. Foreign governments that are friendly to U.S. policy interests could also avail themselves of military training and aid.

What else could we do that would sustainably improve the lives of people in poor countries? Trade! We can buy their products. We can start by eliminating quotas and tariffs on products from poor countries, especially agricultural products. It would be nice to continue to enrich America's sugar producers, but domestic consumers can't afford it anymore and certainly people in poor sugar-producing countries are suffering because of reduced demand from the U.S. and the substitution of corn syrup. (see Wikipedia for more)

Let's start with a simple message that business investors can embrace: "We've eliminated all U.S. foreign aid spending."

Immigration Policy

During our time as a rich country, we in the U.S. have had a wide variety of immigration policies. We wanted to help political refugees. We wanted to reunite families. We wanted ethnic diversity.

With our crushing overhang of government debt, entitlement programs, and public-employee pensions, the only question we can afford to ask about an immigrant is "How much in taxes will this person pay and for how long?"

Countries such as New Zealand apply a point system. Being young gets points, as a young person will have more working and taxpaying years before retiring and drawing on taxpayer funds for healthcare, pension, etc. Being well-educated gets point, as educated people have higher earnings and pay higher taxes. Being wealthy gets points. Having a health problem, or children with a health problem, results in a subtraction of points.

How would recent immigrants to the U.S. do on such a point system? Let's look at Barack Obama's Aunt Zeituni. She came to the U.S. at the age of 50. She does not seem to have been especially well educated or wealthy. She seems to have been a net absorber of taxpayer dollars by (1) having worked only for the government here, and (2) living at taxpayer expense in city- and state-owned housing.

Surely it would be interesting to talk to Aunt Zeituni, but American taxpayers would have been a lot better off financially if she had stayed in Kenya and they had talked to her via an Internet videoconference link.

Unconventional Ideas?

The ideas in this essay have virtually nothing in common with those one hears from politicians. Why? The perspective of a politician is completely different than that of a business manager. For the politician, U.S. citizens and corporations are an endless reserve of potential tax dollars ripe for the taking. The politician's career goals are generally 2-6 years ahead. An increased tax today will yield an instant revenue increase. It might take businesses or individuals subject to the tax 5 or 10 years to move their factories or otherwise adjust. By that time the politician will have moved up to the next office. Giving public employees a more costly pension may avoid a strike and will cost almost nothing in the short run. By the time the pension obligation has buried a city or state, the politician has moved on to a national office.

How about federal politicians? They spend all of their time in Washington, D.C., surrounded by wealth and beautiful marble architecture. They give speeches every day where they refer to the U.S. as the greatest country in the world. Humans are highly suggestible and we eventually begin to believe our own rhetoric. A person who is constantly saying how the U.S. is the world's best country is unable to imagine that a multinational company might move its headquarters to Ireland or Dubai and turn the U.S. operation into one of many local subsidiaries.

The business manager sees a newspaper article about how South Korea public school graduates have the highest math achievement of any nation worldwide and thinks "Maybe we should set up a laboratory over there." The politician thinks "How can I use this number to damage my opponent in the next election?"

The more skilled, experienced, and successful the politician, the less likely he or she is to consider how the U.S. compares to other countries for a long-term business investment. Unfortunately for the average citizen, without long-term business investment the U.S. is going to suffer from extremely high rates of unemployment.

Conclusion

We know what America's future looks like if we continue along our present path. It looks like Michigan.

Why do so much so quickly? These changes will require a lot of political will, which normally could not be mustered to alter the status quo. With 20 or 30 percent of Americans facing a realistic probability of losing their jobs, however, there is a chance that everyone will agree.