On August 16, 2012, Daniel Mitchell published an article in
the Wall Street Journal under the title “What's Really in the Ryan Budget” and
the subtitle: “Good fiscal policy requires the private sector to grow faster
than the government. That is the crucial goal of the House Republican budget.”
And this is basically what sums up the essence of the article. Rather than
blame one party or the other for the economic difficulties which America is facing at this time, the author
blames both the Bush and Obama administrations for what he calls “the spending
spree that's put America
in a fiscal ditch.”
But he promises that the Ryan budget adopted by the House
Republicans will fix all that. And the promise rests on the fact that the
private sector will be put in charge of the economy which, according to him, is
good news because “what matters for prosperity ... is the degree to which labor
and capital are used productively. This is why policy makers should focus on …
leaving more resources in the private economy.” What is meant by this is that
the private economy is more efficient than government. Well, this may be true –
more or less some of the time -- but is not always as relevant as we would like
it to be.
One of the mistakes that people make is that they
automatically associate growth in the economy with efficiency as if there
exists a cause and effect relationship between the two. But the fact is that no
such relationship exists, and the proof is that you can have a jobless recovery
such as the one we are having at this time. Thus, the reality is that the two
conditions of growth and efficiency can coexist or they can exist separately.
Both can also be missing, or one may coexist with the opposite of the other.
That is, it can happen that growth will coexist with inefficiency, or that
stagnation will coexist with efficiency. In short, any combination is possible,
and this is why the attempt to forecast the exact performance of an economy is
almost always an exercise in futility.
Yet, what Mitchell does throughout the article is discuss
his forecast and those of others when in fact, all that we can do -- if and
when a new policy is contemplated -- is to envisage the broad outlines of what
the policy may accomplish, and no more. This means we cannot tell ahead of time
exactly where the unemployment level will be, or where the growth rate will sit
as a result of an action we may take. The reason why we almost always go wrong
in our forecasts is that we can only talk about a sliver of the economy not
knowing how the sliver relates to the whole because we can never have a grip on
all the factors that enter into the equation. This is a point I shall return to
a little later on.
Yes, what most people advocate is correct, mainly that the
government must work to reduce the national debt and the deficit. But how this
can be done without hurting the economy more than it is already hurting is a
question we cannot always answer with certainty. To see why this is so, we must
realize that the economy is made of two parts; the part that constitutes the
production side of the economic engine, and the part that constitutes the
consumption side. Unaware of this fundamental reality, most people do not
realize that there exists a constant interplay between the two parts, let alone
know what goes on in there.
To take an example, two knowledgeable people could have a
discussion on radio or television that goes this way: When you give a tax break
to the rich, you encourage them to modernize their businesses. This will cause
their operation to be more efficient, something that will lead to a higher
growth for the business, and for the economy as a whole. When this happens,
more money can be raised through taxation without hiking the tax rate. This will
help reduce the deficit immediately, and reduce the national debt in the long
run. Well, someone listening to this conversation who may not be as well versed
in economic matters will be prompted – as it often happens -- to go around and
echo the following: The rich produce the wealth; give them more money and they
will solve all our problems.
Unfortunately, this cannot always be true. What is missing
in that narrative is the fact that the part of the economic engine which
produces the goods and the services cannot keep producing if the part which
consumes those goods and services is unable to consume all that is being
produced. When this happens – as when it is dictated by the economic cycle and
other factors -- you get a bottleneck that forces the engine to slow down. This
is simple enough to understand, but where it gets complicated is when you
introduce the notion that the economic engine must also dedicate some of its
output to do more than just feed the consuming part.
The thing is that every operation needs to allocate
resources to do some repair work and some maintenance as well as do the
occasional renovation, even expand when it is so desired. If we are talking
about the national economy, expansion is always desired to avoid being hit with
stagnation and unemployment. In this context, expansion means the production of
more goods and/or services next year than were produced this year. That is,
what is needed is to register a growth in the economy that will at least match
the growth in the population if not exceed it by a little or even a lot.
When it comes to determining how much maintenance is needed
for a business operation, there is generally little difficulty here because
when a machine breaks down, we know what new parts will be needed, and what
sort of repair crew will work on it. But when it comes to determining how much
of the economic output should be set aside for use to expand the national
economy and register the desired growth -- well, this is a different matter.
What must not be forgotten when working the math in such cases is a phenomenon
called diminishing returns. In plain English, it says that you cannot keep
handing money to the rich and expect them to grow the economy by the same
proportion. What will happen is that a point will be reached where the throwing
of more money at the rich will yield lesser and lesser results, till you get
zero return.
And this brings us to the definition of the word efficiency.
To be efficient in a business operation is to obtain a larger output even as
you feed the input with the regular amount or less of it. A word that is often
used by mathematicians to mean the attainment of maximum efficiency is
“optimization.” The branch of mathematics that allows you to find the optimum
point of a process is called differential calculus. The difficulty here is that
you can find the optimum point of a process only if you can set up the correct
equation. This is usually done with ease in geometry and in science where the
number of variables are limited, and can easily be determined. But the same
cannot be said about economics or the other human activities because the number
of variables involved is unlimited, and every situation has a unique
combination of them. This necessitates that you determine a unique equation for
each situation, something that is almost always impossible to get exactly
right.
In fact, there exists, right now, a number of equations in
the memory banks of many a government computer describing all sorts of
economies that happen to stand at a different level of their development, and a
different point in their cycle. But these are approximate equations that will
only yield an indication as to how an economy may respond to a policy decision
but will not yield an exact answer. To get a sense of what is involved here,
consider the following example in geometry – the simplest I could think of:
You have a string that is 12 feet in length. You need to
make an enclosure, other than a circle, that will optimize the surface area of
the enclosure. What dimensions should you give the rectangle you make with that
string? Well, given that the surface of a rectangle is determined by
multiplying one side called the length by the other side called the width, you
reason that one length and one width will have to be 6 feet long – half the
perimeter of the rectangle. Not knowing how to set up an equation let alone
solve it, you look for the answer by the method of trial and error.
To this end, you make the length equal to 5 feet, and make
the width equal to 1 foot. Multiplying the two numbers gives the surface area
of the enclosure as being 5 square feet. You now try 4 and 2, thus get the
result 8 square feet which is a greater value than before. You now try 3 and 3
to get the result of 9 square feet which is an even greater value. And you
realize that this will have to be the optimum point because to go further is to
reverse the operation and get the same results in the reverse order. Thus, the
rectangle that has the optimum surface area in this type of problems is actually
the square -- where the length and the width are equal.
Instead of experimenting as we did here, an equation could
have been written and solved by differentiation, and it would have given the
same answer. This being a simple problem, it was possible to arrive at the
answer by trial and error, something that could not be done with more
complicated problems. This is why calculus was invented, but here too, calculus
will do well when solving problems of geometry or science. However, it will
never do as well when trying to solve economic problems or the other situations
where human nature is involved. This is because the factors are endless – most
of which we don't even know about. Try as we may, the answer will never be
exactly right.
Well then, absent a scientific way to determine how we can
optimize the growth of the economy without getting caught in a situation of
diminishing return, what is there to do? To be sure, this is a serious
question, and the answer is that you should experiment. What is meant by this
is not that you do an experiment in the lab and apply the result somewhere
else. Rather, it means that the management of the national economy must be a
continuous experimentation; a never ending process of trial and error. With it
comes the predicate that accompanies every experiment, and the risks that
result from it.
The predicate is that you will need to have flexibility when
you take on the task of solving the economic problems of the nation. This will
be necessary given that you will proceed blindly as if walking through a
minefield. As to the risk, it is that flexibility will require the suppression
of the checks and balances that can tie the hands of the czar or the committee
in charge of conducting the experiment. Such suppression will be necessary
because decisions will have to be taken on the spot when the experiment starts
to go wrong, and decisions will have to be executed without delay.
The central bank has this kind of flexibility as well as the
authority to act on a weekly, even daily basis when necessary. It does well
when the economy is running normally or running a little out of whack. But when
the economy goes very bad, the central bank alone cannot solve the complex
problems that ensue because the treasury has a part to play as well. However,
in a democracy -- or what passes for one -- the treasury is overseen by the
legislature and by the rest of the executive branch. This slows the decision
making process so much that fixing the economy becomes a difficult thing, if
not an impossible thing to accomplish. Thus, the economy is left alone to fix
itself most of the time, something that takes a long time to do.
What is needed instead, is that a czar or a small committee
be given a broad and flexible mandate, and put in charge of running the economy
till it is fixed, after which things are returned to their normal state. As to
the Mitchell view that: “the Ryan budget … limits the growth rate of federal
spending, with outlays increasing by an average of 3.1% annually … If spending
is left on autopilot ... it would grow by 4.3%” cannot be seen to change
anything because it still reflects a rigid approach with no provision to
navigate around the waves that hit the economy on a daily basis.
What is needed, therefore, is the release of the central or
federal treasurer from any constraints so as to act alone when necessary, or
act in conjunction with the central banker. The two should also be able to
suggest to the chief executive and to the ministries or the departments what
else needs to be done to get the nation back on its feet.
And everyone will have to work together on fine tuning the
economic machine on a daily basis to get the exact balance between the
production side, the consumption side and what must be set aside to provide for
maintenance and for growth without wasting anything on diminishing returns.