The Western Economies Are In Trouble And Government Has Wrong Solutions

This article recently published in Foreign Affairs offers an explanation of the problems in western economies and makes an effort to shift the economic debate from inadequate demand to supply side problems. It was also the source of many of the ideas used by David Brooks that I criticized in the post below.

The article starts by telling us that the west can't borrow and spend its way to recovery.  It correctly asserts that many of the problems in western economies are structural, or supply side problems that wont go away.  One problem with this analysis is that we do have short term problems on the demand side that cannot be easily ignored.  The longer they are ignored the more difficult it will be to deal with longer term structural problems.  The other problem is that his analysis of the longer term structural problems, and the solutions that he proposes are primarily based upon fixing the problems created by faulty governments.  Our education system is not delivering the skilled workers demanded by business, and government hand a hand in covering up our problems by encouraging the financial system to create more debt.  Government regulations also create burdens that hinder the entrepreneurship and innovation that we require to create jobs. Thatcher had the right ideas in the UK, as did Reagan in the US. We have gone downhill since.

One of structural problems is the growth in inequality that he acknowledges.  In fact, he correctly points out that  debt has been used as a substitute for growth in income.  Most of the Keynesian's that he criticizes would agree. His explanation is that we have developed a meritocracy.  Those with skills rise to the top of the pyramid, and they are compensated for their rare skills. Weak corporate governance is not responsible for the rise in CEO pay. There may be some exceptions to the rule, but  if that were the problem we wouldn't see compensation for doctors and lawyers rising as well.  The only way to improve inequality in a meritocracy is to provide the education and training that is necessary to compete in a meritocracy.  His analysis of the structural problems in the economy seem to be based more upon opinion than on evidence.  Labor economists have spent a lot of time and energy researching these issues.  He found it convenient to ignore the research.

Some economists argue that a more progressive tax system would mitigate some of the problems in pretax inequality.  His view is that increasing the marginal tax rate on higher incomes would discourage the entrepreneurship and innovation that we require.  It would be better to eliminate tax loopholes than to raise taxes on those with high incomes.  Of course, that only leads to the problem of which loopholes we close. The public has even less understanding of the loopholes in the tax system than it does about tax rates.  I know where that will lead us.

My view is that we need a stronger and more effective government to deal with the structural problems that we face. Government has to be a big part of the solution to these problems.  We also need a better understanding of the problems themselves. Trading opinions is not going to get us anywhere.  We will only get the government that we need when the public demands it.  If we have an education problem in this country it is not a deficiency in employable skills for most in the labor force.  We need a better informed public.