Will the US Economy Survive Obamas Economic Policies?

By: Gerard Jackson | Sun, Mar 21, 2010
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With reference to the loss of the American colonies Adam Smith remarked "that there is a great deal of ruin in a nation". He didn't mean by this that Great Britain was finished but merely that countries can endure enormous losses and humiliation and still recover. Smith's observation was confirmed by the phenomenal rise of British power in the nineteenth century.

However, no sensible man would argue that there is no limit to national recovery. This raises the vitally important question of whether Obama's economic policies are rapidly driving the US economy beyond the Adam Smith's "ruin", the region in which economic decline becomes irreversible.

The sheer magnitude of Obama's tax and spending program is completely unprecedented. It's fiscal weight is such that if allowed to go unchecked it will do to the American economy what similar policies did to Argentina. Thanks to this economic lunacy by 2020 the aggregate US public debt will exceed a staggering $20 trillion, an increase of over 170 per cent in a mere 10 years. And this is the minimum estimate. At the rate things are going debt as a proportion of GDP will exceed 90 per cent in 2020, a rise of more than 75 per cent over last year.

Making it even scarier is the fact that the debt does not include the hundreds of billions that Medicare and social security owe. Defenders of this madness argue that these don't matter because the government owes the money to itself. This is plain ridiculous. It is promised to the American people and not to any government. These promises must be either paid for or the government must default in part or in full. What will happen -- in my opinion -- is that the government will default in part by raising taxes and printing money. (You get what you vote for and Americans voted for Obama.)

As expected, it gets worse. Every reasonably intelligent person knows that the one sure-fire way of reducing the supply of any good is to raise the cost of producing it. The same goes for economic growth. Now it needs to constantly borne in mind that growth is defined as net capital accumulation which is another term for investment. It follows that any policy that raises the cost of accumulating capital will therefore lower the rate of growth. And this is exactly what Obama is doing.

Investment always comes from savings. It is saving and not government spending that fuels an economy and it is entrepreneurship and not politicians and bureaucrats that drive it. So what is the brilliant Obama and his fellow patriotic Democrats going to do? They going to dramatically reduce the supply of savings by raising the capital gains tax from 15 per cent to 24 per cent, leaving less for capital formation by taxing future living standards and trapping billions of dollars in current investments.(A capital gains tax is also a transaction tax and a tax on risk that strikes at entrepreneurship.)

He then intends to top off this idiocy with a 3.9 per cent Medicare payroll tax on capital gains and other investments. All of which will be accompanied by the total repeal of the Bush tax cuts.

Let's try and tie all of this together. A study by economists Carmen Reinhart and Kenneth Rogoff for the National Bureau of Economic Research found that very high levels of debt can have a severe detrimental effect on economic growth, with a 90 per cent debt level being especially dangerous. (See their book This Time is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009).

Against Rogoff and Reinhart it has been argued that there is no economic law that says a certain level of debt will produce the results they record. True. But there is an economic law that underpins their work. It is called opportunity cost. What is spent on A cannot be spent on B. Or as Maynard Keynes said: "Bygones are bygones". Economic growth is the choice between consumption and investment: spending on present goods versus spending on future goods. This is why growth is sometimes called "forgone consumption". It is also why classical economists argued that spending on consumption does nothing to raise real wage rates.

Rogoff and Reinhart have basically done no more than show that when the government drains away sufficient resources from private use economic growth will slow, sometimes dramatically. In short, entrepreneurs cannot invest that which politicians and bureaucrats command and then consume. Massive amounts directed to government programs like Medicare come at the expense of growth, no matter how many people these programs employ, because spending on these programs is a form of personal consumption.

In a free market medical improvements and necessities are paid for out of growth. Under Obama they will be paid for at the expense of growth and that means a lower standard of living. Given the enormity of the Democrats' financial depredations I cannot see how economic growth can continue unless Obama is forced to retreat.



Author: Gerard Jackson

Gerard Jackson

Gerard Jackson is Brookes economics editor.

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