Most policymakers and the public still do not recognize the systematic
nature of the crisis and attribute the crush to ad hoc financial
innovation and the temporary housing crisis. They agree with Paul
Krugman that "we were the victims of politics." Yet, the outlook for
potential growth was darkening long before this crisis. The
productivity growth has faded and the rate of labor supply has slowed
down. Hence, the rate of economic growth has slowed down and it is now
the lowest in American's history. Consumer demand hasn't slowed down
because government has reacted by deregulating the banking industry,
maintaining low interest rates, and by borrowing more abroad. And
consumers borrowed and spent heavily. The crisis was postponed but not
avoided. In fact the government created the preconditions for a massive
malfunction: trillions in growing debt secured by an inflated asset
bubble -- a growth that must end in a seizure.
This policy had also other disastrous long-term consequences. The easy
money distorted the structure of the economy. Capital and labor were
"mislocated." The credit went toward one-time pure consumption. When
columnist David Brooks recently suggested that the growing debt
reflects a moral decay rather than a short-term policy mistake, his
colleagues were unhappy. Paul Krugman pointed out that the surge in
debt can largely be attributed to improvised financial deregulation
rather than the decline of Calvinist values. "We did not lose our
economic morality," concluded Krugman. The world is in better shape
than Brooks thinks -- "It's the banks, stupid!"
Yet, a brief look at modern U.S. history shows that David Brooks might
be right. Prior to the 1960s, a conservative culture dominated.
Americans balanced their budgets and believed that government must do
the same. The government shared that view. President Eisenhower for
example apologized for running the $3 billion deficit. The government
spending was only 12 percent of GDP, mostly on defense. State and local
taxes were minimal. Following John Kennedy's large tax cut the economy
suddenly thrived. Small government and a balanced budget proved to be a
recipe for prosperity.
The boomer's generation had a different idea. It was breaking with the
conservative tradition. Boomers saw nothing wrong with the government
running unfunded economic activities and piling up debt. They no longer
balanced their budget. They preferred borrowing over saving and the
group accounts for 49 percent of consumer demand and for only 7 percent
of national savings.
They came to believe that progress was achieved due to the government
and through taxation. In the eyes of the boomers the politicians were
saviors -- not gangsters. And these "saviors" significantly expanded
the Great Society's unfunded programs. They have been running our
economic activities by imposing bottomless deficit spending and
refusing to accept the consequences. They created debt-induced
prosperity. And the boomers celebrated. They've got free lunch and our
children and grandchildren will be paying their bill, plus interest.
The boomer's generation is approaching retirement now. Demographic
forces have a big impact on the economy. The level of retirees to
workers is already rising. As the nation ages, the rate of labor supply
will continue to fade even further. Consumer demand will decrease. An
aging America will have to accept negative GDP growth. It will make the
repayment of debt, financing entitlements, and stimulating the economy
a sheer impossibility.
The U.S. economy has already been struggling to drag itself out of the
growing debt as costly old-age benefits are on the rise. According to
economic research, every $1 increase in government spending reduces
consumer demand by the same amount while each dollar rise in taxes
reduces consumer spending by $3. But seniors play a dominant role in
the elections and political influence of the elderly is growing. It
won't be easy to make cuts in government spending. In fact government
spending -- federal, state and local -- has been rising. Overtaxed
America is heading for icebergs. And not dealing with the problems or
denying that they exist we will create the cataclysm much worse than
anything we know.
We need reforms. Yet, policymakers stick to Keynesian philosophy and
see no need for reforms. Others follow Austrian economist Schumpeter,
who declared that a capitalistic system cannot be reformed and will be
replaced by socialism. He also once declared that he will be the best
horseman, best lover, and the best economist. He admitted he
accomplished only two out of the three.
Matthew Jarosinski lives in Waitsfield.
