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The Consequences of Jawboning

Jawboning American industries to comply with political wishes has been with us at least as long as Teddy Roosevelt negotiated an end  to the Pennsylvania coal strikes.  John F Kennedy pressured the steel industry to settle a labor strike. Bailouts and tax payer funded bribes to attract and keep industry is used by every state and most nations.  But just as Trump threatens consequences to those who will leave, there are consequences to his method which are beyond his control.

To be fare to the president elect, there are signs that his policy will rely more on carrots than sticks; that his preferred method is to reduce corporate taxes and friction costs and make the American economic environment more desirable for commercial activity.  The incentives and the jawboning to keep and least a portion of the Carrier employee base in Indiana is a clear victory for the workers and clear political victory for Trump.

But it is also an example of Bastiat’s broken window fallacy that should teach us to examine the entire cost and all the consequences of an economic decision.  The rejection of ideology for immediate pragmatic results is a hall mark of progressivism, as is the use of central government power to drive local decision making. If this is only a short term pragmatic solution with an eye to creating an environment more amenable to bottom up economic growth then the harm will be limited.

The use of threats from a central authority, however, can become  a slippery slope.

Kevin Williamson in National Review writes The Economic Stupidity of the Carrier Bailout:

The ethical question is more complicated than the pop-cons let on, too. Our government runs deficits, which means that a federal tax credit of $1 million given to Smith is $1 million in taxes that eventually will have to be paid — by Jones, and Wilson, and Humperdink — with interest. Carrier is a division of United Technologies (the Otis elevator and Pratt & Whitney engines people), which is first and foremost a government contractor, a firm that derives at least a quarter of its revenue from government contracts, and 10 percent of it from Pentagon contracts alone. It is a company that has competitors — competitors who employ Americans and pay taxes, just as Carrier does. These firms and their employees are put at an economic disadvantage by the subsidies paid to Carrier thanks to Trump and Pence. That means that some of these companies probably will be less profitable, and that they will not hire people they otherwise would have hired. But you’ll see no Trump press conference celebrating that. This is a case of Frédéric Bastiat’s problem of the seen vs. the unseen. The benefits are easy to see, all those sympathetic workers in Indiana. The costs are born by sympathetic workers, too, around the country, and by their families and by their neighbors. But those are widely dispersed, so they are harder to see and do not hit with the same dramatic impact.

From Don Boudreaux at Cafe Hayek, An Open Letter to Generalissimo Trump:

How do you anticipate business executives will respond to your bullying threats?  Are you truly so stupid as not to understand that among the results of your intimidation is that fewer firms will open in America?  That fewer businesses here will expand?  That those that do open or expand will use a higher ratio of capital to labor because they fear that the greater the number of workers they employ the more likely they are to be victimized by your arbitrary diktats?  That no matter how much you cut the monetary taxes they pay, the uncertainty and absurdity of your promised autocratic rule drastically raises firms’ costs of starting and growing on U.S. soil?  And that each of these inevitable responses to your imperious fulminations will be slower job and wage growth for Americans?

From the Wall Street Journal Editors, Trump’s Carrier Shakedown:

The company is also betting that Mr. Trump will fulfill his promise for tax and regulatory reform to make U.S. manufacturing more competitive. United Technologies does about 61% of its sales outside the U.S., and it has some $6 billion in cash overseas that would be taxed at a 35% rate if it brought the money home today. Carrier currently pays a 28% effective tax rate, so a tax reform that cut the corporate rate to 20% and only taxed earnings in the country where they are earned would more than make up for the Indianapolis concession.

From The Editors of National Review, The Winners and Losers of the Carrier Deal

We are not very enthusiastic about government-run economic-development programs that rely on industry-specific — or firm-specific — tax breaks, grants, or other concessions. In the long run (and generally in the short run, too), these programs are almost always corrupt in themselves and a source of corruption in others, with the benefits going mainly to politically influential and well-connected companies, whether that means Solyndra during the Obama administration or Carrier in the Trump administration. Inevitably, what happens is this: The government creates a set of incentives to encourage certain kinds of business activity, from “green” energy to manufacturing, and then, after a few years pass, complains mightily that companies are responding to the incentives that the government created. Consider those periodic journalistic spasms over General Electric’s low corporate-tax bill or the criticism that Starbucks encountered for taking advantage of manufacturing credits in its manufacturing operations: Those deductions and carve-outs didn’t happen by accident — they happened exactly the way the Carrier deal is happening.

 

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Better Economic Policy Trumps Grandstanding Deals

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Trump’s political victory in keeping Carrier and Ford plants from moving out of the country should not be confused with an economic victory.

Trade is a critical component of any economy, but we are addressing the location of a plant.  If Toyota builds a plant in Mexico there is nothing Trump can do about it.  If there is some economic advantage to that location, then when he strong arms or otherwise bribes an American plant not to seek that competitive advantage then he is directly harming that company. He may compensate that company with tax breaks but that is just more of the crony capitalism which is already problematic.

There are many reasons one would build a plant overseas, and lower wage costs are only one.  They may desire to be closer to their customers, or they may be trying to circumvent trade barriers in that country.  They could be saving transportation costs or responding to incentives from the host country. The host may have lower energy costs or other non-labor cost advantages.

Threatening higher tariffs is reprehensible. Is he going to charge Toyota a higher tariff as well or does this punitive objective only apply to American companies? Will the threat of such intimidation cause foreign companies to think twice about building plants in this country? Threats to the free flow of capital can create serious disincentives to investment.

While we relish the benefits that the workers received, there are consequences to the means deployed to accomplish this change in the companies’ plans.

There are indications that Trump and his team may lean more toward the carrot than the stick.  There are better ways to encourage American companies to expand at home:  lower tax rates, reasonable regulations, a productive workforce, and respect.  Telling entrepreneurs that “you did not build that” is not the voice of respect; neither are direct threats.

Where plants locate is dependent on many factors.  To think that these interrelated decisions can be accurately assessed by any central planner is to make the mistake that the progressives have made since FDR.  To address specific issues like Carrier’s with bribes and tax breaks is consistent with Trump’s penchant for making deals, but it encourages cronyism  and inequality before the law.

A trade policy is very different from trade deals.  A broad based low tax policy will serve America’s companies, workers and customers very well.  Trump should use his bully pulpit to restore the respect for American industry that the radical leftists like Elizabeth Warren so casually squandered.

With better policy, we will need fewer deals.

Don Boudreaux at Cafe Hayek makes a similar case:

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The Greenspan Put

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The Man Who Knew by Sebastian Mallaby is an excellent biography of Alan Greenspan, but it may have greater value in understanding the power and limitations of the Federal Reserve itself.

Greenspan has been accused of being an ideologue by some and a betrayer of free market economic ideology by others.  He was a brilliant thinker and in his early career in his consulting firm, Townsend and Greenspan, consumed vast quantities of technical industry specific data long before econometrics was a word.  He gathered unique insights facilitating valuable forecasts clients paid for dearly and willingly.

His close relationship with Ayn Rand fit with his market bias, but was tempered with pragmatic realities when he entered the political halls from Nixon to the second Bush. He served as Fed Chairman from 1987 to 2006.

With the analytical skills of a technocrat, he also possessed the depth of a philosopher.  He understood the limitations of models. For example, in 1977 his firm realized that mortgage extraction was providing a spending source that was not included in the current models.  Fueled by higher home prices it was also a vulnerable retardant if the home price boom ended.

Greenspan was one of the first to realize the value of financial assets in economic forecasting. As the financial sector grew in importance this moved to the center of many of his economic analysis and decisions.  Yet while he knew that the financial sector was subject to excesses he was sharply criticized for failing to act in a way that would have prevented the calamity of the 2007-09 bust.

There were several reasons.

Volcker was considered a hero for staying with painful and politically unpopular actions to bring the inflation of the 1970’s under control.  Following Volcker at the Fed, Greenspan remain stubbornly focused on managing inflation and protecting the difficult accomplishment of Volcker.

He became quite adept at digesting data and raising interest rates just enough to head off inflationary expectations while avoiding larger increases that would slow down the economy too much.

When his board viewed wages increasing and not matched by productivity they saw inflation on the horizon and recommended higher rates to avert the inevitable growth in inflation.  Alan saw this did not fit with frequent stories about the productivity gains CEOs of industry spoke.  Further diligent study saw that the industrial sector was reaping very strong productivity gains, but was offset by weak productivity gains in the service sector. This insight led him to a much smaller boost which proved correct.

Should the Fed act to prick financial asset bubbles?  This was a frequent question as his tenure spanned a stock bubble in 1987 and 1999, a bond bubble in 1993 and of the course the mortgage bubble which burst painfully immediately after his term. Financial bubbles often occurred in a low inflation environment and this further complicated his work. The Fed had a mission to fight inflation and unemployment; bubbles seemed at best a peripheral issue.

Greenspan remained focused on inflation because it was easier to assess than market bubbles.  He well understood that financial markets tended to excess but assumed self-discipline would generally yield better results than regulation. There was just too much information to process for most regulators to be able to assess effectively.

He assumed that the basics of the system were strong. When he learned of the accounting irregularities of Enron he was furious, understanding how the system depended on accurate accounting information. Still he understood that to supervise at this level would require a fivefold increase in the size of regulatory bodies, and weaknesses in the regulatory solution would remain.

He also assumed that in the event of a failure that would have serious economic consequences that the Fed would remain the lender of last result and could impose its power only when necessary.

For some this was a unacceptable inconsistency. The Fed would support failures, but not prick bubbles. The would protect firms on the downside, but not limit any risk on the upside.  This would encourage excess risk.

He also recognized the risk of a long string of successes at the Fed though the 1990s.  Success breeds confidence, confidence breeds complacency, and complacency breeds failure.  The confidence in the Fed to act to reduce downside risk became known as the Greenspan Put.  (A put is an option contract designed to profit from or protect from a market loss.)

Greenspan understood the risks of the insanely complicated financial and mortgage options. Even though he was warned about the unregulated derivatives by Brooksley Born in 1999, he understood how they helped availability and targeting of risks, and remained skeptical of regulatory solutions. He was alarmed at the massive size of the GSEs, Fannie Mae and Freddie Mac and the damage that would ensue from a housing bust.

He knew of the risks of bubbles but underestimated the size of the damage.

While he commanded interest rate and price stability quite well, this did not translate into financial stability. While we can see in hindsight the failures of reliance on self discipline, that does not mean that we understand the failures of excess regulation.

We have designed a fragile system that depends on regulation, rather than a robust system that requires less regulation.  The regulatory system stifles competition rather than encouraging it.  Fewer firms following the same rules may increase risk rather than mitigating it.  We also suffer from a fractured regulatory system.

We need fewer rules more firmly enforced.  Higher cap requirements for banks would reduce the need for bailouts, but Greenspan warned that this should vary greatly depending on the assets held.  Low cap requirements for mortgages from the regulatory agencies led banks to prefer these instruments and made the mortgage collapse more painful.

The Fed firewall, the lender of last result, is necessary for ultimate stability, but such bailouts should come at a stiff price.  Wage contracts and terms at the banks requiring such rescue should become null and void.

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Death by Diktat

from the editors at The Wall Street Journal, Trump and the Democrats:

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Blaming “white-lash” is silly—of the roughly 700 U.S. counties that Mr. Obama won twice, about one-third broke this time for Mr. Trump—but these cultural rationalizations are lamentable and instructive. Too many liberals, and some conservatives, simply cannot imagine how great numbers of Americans think and perceive their own interests. Thus wrong opinions must be the result of cognitive limitations or character flaws. Mrs. Clinton called Trump supporters “deplorables,” “irredeemable” and “not America,” as if there could be no other explanation.

Democrats now face some decisions about how to deal with a Republican majority, and one irony is that their methods under Mr. Obama will make Mr. Trump’s job easier. The Harry Reid-Obama decision to break the filibuster for nominations will ease the path for Mr. Trump’s cabinet and judicial nominees. A GOP Senate won’t tolerate a filibuster of a Supreme Court pick.

The lesson for smart Democrats is that progressive policy goals can’t be imposed on a reluctant America by political diktat. They have to be won by persuasion and inevitably by compromise. Relying on judges and regulation left millions of Americans feeling disenfranchised and inspired the Trump backlash. This wasn’t about race or gender or Hillary Clinton’s emails. It was about reclaiming a voice in how their country is governed.

The same political lesson applies to Mr. Trump and Republicans as they seek to pass the agenda they campaigned on. But they now have that opportunity in large part because the Obama progressives were so uncompromising and condescending to Americans beyond the coasts. The tides of American politics mean Democrats will inevitably make a comeback, but that return will arrive stronger and maybe sooner if they learn the lessons of Mr. Obama’s disdain for his political opponents.

HKO

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A Thousand Little Messes

Some advice for the new president from economist John Cochrane in the Wall Street Journal, Don’t Believe the Economic Pessimists:

  • Health. Replace ObamaCare with a simple health-insurance voucher. Deregulate insurance and entry into health care dramatically.
  • Finance. Replace strangling regulation of financial companies with a simple rule: If you issue enough equity that stockholders bear the risks, you can do what you want. Rep. Jeb Hensarling has proposed such legislation. Hearty competition is the best consumer protection.
  • Labor. The best worker protection is a worker’s ability to swiftly change jobs. This is more likely if employers do not face a mountain of red tape, complex rules and legal liability.

So why is there so little talk of serious growth-oriented policy? Regulated and protected industries and unions, and the politicians who extract support from them in return for favors, will lose enormously. The global policy elite, steeped in Keynesian demand management for the economy as a whole, and microregulation of individual businesses, are intellectually unprepared for the hard project of “structural reform”—fixing the entire economy by cleaning up the thousands of little messes. Even economists fight to protect outdated skills.

HKO

Real structural reforms is arduous and involves eliminating the thousands of messes accumulated over decades. Each little mess has a constituency that will fight for its continuation, hiding behind a thin veil of moral outrage to mask its own greedy self- interest.  It is much easier to promise great systemic overhauls and unrealistic promises.

America’s weakness is also its asset: impatience.  It makes us all suckers for the quick fix and the false promise.