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Chapter 31: Economics in America: What’s wrong & how to fix it

May 17, 2012

“Only when the human spirit is allowed to invent and create, only when individuals are given a personal stake in deciding economic policies and benefiting from their success—only then can societies remain economically alive, dynamic, prosperous, progressive and free.” —Former U.S. President Ronald Reagan

 “The key insight of Adam Smith’s Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it. Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.” —Milton Friedman, Nobel Prize-winning economist, and author of Free to Choose

Too few Americans understand

these basic truths about economics:

  • Government-run markets don’t work. Economics are natural forces that can’t be managed politically without enabling corrupt politicians, hampering growth, and disrupting stability. In government-run economies, only a few individuals—usually dictators and their bureaucrats and military leaders—make the decisions for everybody else. Only the political elite are able to thrive; everybody else is forced to accept the decisions of their rulers.
  • Free markets work best. The only proven way to increase prosperity and reduce poverty is through individual liberty, capitalism, and free markets. Free markets work because nothing happens unless both parties feel they can benefit. Businesses succeed only if they can get enough consumers to choose their products and services. Both the buyer and seller must agree on the price. Both the employee and employer must agree on the wage. Every individual makes his or her own choices. Nobody is forced to do anything. Free markets are efficient and democratic because they involve millions of people making millions of tiny buy-sell (or work-wages) decisions every day, with everybody making constant adjustments in response to market forces (supply and demand).
  • Gentle adjustments. Free market economies make gentle adjustments every day based on millions of individual decisions by millions of consumers and investors. Everybody gets time to react to changing realities.
  • Governments cause bubbles and painful crashes. It’s when politicians get involved that we experience painful cycles of boom and bust instead of the gradual daily adjustments of a free economy. Misguided politicians prolonged the Great Depression and caused the 2008 housing crash and financial crisis. The government does a lot of harm by trying to manage or stimulate the economy—often artificially prolonging boom periods—which only means that crashes hit harder and recoveries take more time. Yet politicians keep tinkering because they benefit themselves in the process and because too many unthinking voters say they want politicians to manage the economy, create jobs, and so on.
  • Government guarantees and insurance are bad deals. Politicians love to use government guarantees because they don’t show up in the budget. Citizens need to understand that government guarantees and government insurance are needed only for bad deals; otherwise somebody in the private sector would make the loan or insure the risk. If Fannie Mae and Freddie Mac didn’t exist, banks would have a legitimate place to invest their money; they could make mortgage loans based on their merits and wouldn’t have to spin them off to put the risk on somebody else.
  • Government-fueled booms lead to big crashes. When political/government meddling (Fannie Mae and Freddy Mac) caused the artificial housing boom, Wall Street greed made it easy for people to borrow against the equity in their homes so they could live far beyond their means. This worked as long as the boom continued. When the inevitable housing crash came, the politicians bailed out the reckless bankers and Wall Street firms. Working people lost their homes, and taxpayers got stuck with the costs of the government bailouts.
  • The law of unintended consequences. Government-imposed solutions usually backfire and hurt everybody. One good example is government price controls, which usually lead to shortages. Another example is minimum wage laws, which have increased the unemployment rate of young black males from less than 10 percent a generation ago to 30–40 percent now.
  • Government economies invite political mischief. Government controls always create new opportunities for politicians to dish out political favors to friends and deny favors to others. That’s how they make their money and attract contributions.
  • People make their own smart decisions. We all make better decisions when we know we have the potential to benefit from our good decisions and suffer from the results of our bad ones. Nobody’s decisions are as good when they are spending somebody else’s money—which explains why home owners take better care of their property than renters and why bureaucrats and politicians make so many lousy decisions.
  • Profits are good. Many Americans have been brainwashed by media, educators, politicians, and bureaucrats to think profit is a dirty word. They need to think about how profits benefit all of us. First, profits are taxed, which reduces the tax burden on the rest of us. What’s left is reinvested in creating new jobs; purchasing equipment; developing new, better, and less expensive products; or paid out as dividends to investors—including the retirement plans of millions of Americans. Yes, some of these dividends go to rich people, but they pay taxes first and then stimulate the economy even more by spending or investing what’s left after taxes.
  • Corporate taxes. Higher corporate taxes can only come from three sources: higher prices for consumers, lower dividends for our pension plans, or the elimination of jobs. The key is to make sure corporate taxes (on the whole) are competitive globally so employers won’t move more jobs to other countries.
  • Creating jobs. The government can’t create additional jobs. When it takes money from others to create a government job, there’s no net gain; it’s usually a matter of turning a productive job in the private sector into a nonproductive and higher-cost government job (at taxpayer expense).
  • Uncertainty hurts. When politicians try to manage the economy and bureaucrats try to regulate it, they create economic uncertainty. As explained in the chapter titled “Taxes,” investors and consumers hate uncertainty, so investment and consumption tend to stop, slow, or become volatile when politicians tinker with the economy. Uncertain tax policies and the uncertain costs of regulatory compliance often drive investors underground or overseas. Businesses hire when there is demand for their products and services. Banks lend when they can make enough money to justify the risk. When businesses fear higher taxes, more government mandates, and more government regulations, they stop investing and stop hiring. And when consumers fear for their own jobs, they reduce their spending.
  • Government isn’t free. As explained in the “Government” chapter, there is no such thing as a free government service. Government can only take some people’s money and give it to others—and it does an inefficient job because its ever-expanding bureaucracies take so much off the top and then spend what’s left poorly.
  • Dividing the pie. The economic “pie” isn’t a fixed amount that must be divided up fairly. Freeing the economy so the pie can grow (and benefit everybody) is the better approach. However, this shouldn’t rule out the possibility of a safety net for the least fortunate among us, as explained in the chapter titled “Poverty.”
  • The global economy. The shift to a global economy is particularly difficult for the United States because there’s so much competition from third world countries that are leaner, hungrier, and sometimes even more creative than we are. Our overall standard of living is declining relative to the rest of the world, which is uncomfortable for us short-term but may be beneficial for humankind over the long haul.

How to fix

America’s economics 

  • Education. Voters need to understand basic economics. Once they do, they will stop asking politicians to fix the economy. (See the “Education” chapter for more about this.)
  • Stop economic micromanagement. The government’s first rule when it comes to the economy should be “first, do no harm.” Politicians can’t manage the economy, and bureaucratic efforts to control economics eventually backfire and do harm. No Congress or central planners can repeal the laws of supply and demand. Economies work best when millions of consumers are free to make their own individual decisions every day on a level playing field” with as little political interference and bureaucratic manipulation as possible.
  • Phase out the Federal Reserve.  The money supply should be increased proportionate with actual economic growth; and interest rates and the value of the dollar should be determined by free markets rather than government manipulation.
  • Get the government out of the insurance business. Whenever the government guarantees or insures anything, it’s almost always because no sane person or business will take the risk. (See more about this point in the “Government” chapter.)
  • Energy independence. As explained in the
    “Energy” chapter, we must relax some of the environmental regulations that prevent us from developing our own proven sources of energy. Doing this now would also be a powerful economic stimulus at a time when we desperately need one.
  • Stability. Political uncertainty kills jobs. The best thing the government could do is create a favorable climate for economic growth by providing consistent and competitive taxes (as explained in the “Taxes” chapter) and regulation (as explained in the “Freedom” and “Government” chapters). Economic cycles will still occur, but they will correct themselves naturally and more gently. The painful periods of boom and bust that governments cause and prolong will be minimized.
  • Stop welfare for businesses. Phase out tax loopholes and government payments to businesses. (See the “Big Business” chapter for more details about this proposal.)
  • Corporate governance reform. Stockholders should demand an end to the boardroom cronyism, interlocking directorships, and fat-cat consulting firms that allow management to rip off their companies at the expense of employees and shareholders. (Also see the “Big Business” chapter.)
  • Negative income tax. The federal government should replace all its failing poverty programs with a brilliantly simple negative income tax. (See the “Poverty” chapter for more details about how the negative income tax would work.)

 “The strongest argument for free enterprise is that it prevents anybody from having too much power. Whether that person is a government official, a trade union official, or a business executive, it forces them to put up or shut up. They either have to deliver the goods, produce something that people are willing to pay for, are willing to buy, or else they have to go into a different business.” —American economist and author Milton Friedman

 “Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” —Former U.S. President Ronald Reagan 

 “It was self-serving politicians who convinced recent generations of Americans that we could all stand in a circle with our hands in each other’s pockets and somehow get rich.” —American author and columnist Paul Harvey

 “Inflation is not caused by the actions of private citizens, but by the government: by an artificial expansion of the money supply required to support deficit spending. No private embezzlers or bank robbers in history have ever plundered people’s savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments.” —Ayn Rand, author, Atlas Shrugged

 “DEMOCRAT: You have two cows. Your neighbor has none. You feel guilty for being successful. You push for higher taxes so the government can provide cows for everyone.

REPUBLICAN: You have two cows. Your neighbor has none. So?

SOCIALIST: You have two cows. The government takes one and gives it to your neighbor. You form a cooperative to tell him how to manage his cow.

COMMUNIST: You have two cows. The government seizes both and provides you with milk. You wait in line for hours to get it. It is expensive and sour.

CAPITALISM, AMERICAN STYLE:  You have two cows. You sell one, buy a bull, and build a herd of cows.

BUREAUCRACY, AMERICAN STYLE: You have two cows. Under the new farm program, the government pays you to shoot one, milk the other, and then pour the milk down the drain.

AMERICAN CORPORATION: You have two cows. You sell one, lease it back to yourself and do an IPO on the 2nd one. You force the two cows to produce the milk of four cows. You are surprised when one cow drops dead. You spin an announcement to the analysts stating you have downsized and are reducing expenses. Your stock goes up.” —From the Internet, source unknown

 “The preservation of freedom is the protective reason for limiting and decentralizing governmental power. But there is also a constructive reason. The great advances of civilization, whether in architecture or painting, in science or in literature, in industry or agriculture, have never come from centralized government.” —Milton Friedman, author and economist

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