Learn From History, Or Repeat It


The 1929 crash and subsequent credit contraction were bad, but what made the Great Depression Great was a series of government interventions that prevented the economy from recovering, keeping unemployment rates hovering around 20% for a decade. Obama and the Democratic Congress are poised to replicate these exact interventions, and then add some new ones.

(1) Putting the Federal Government Behind Unions, as did first Hoover, and then FDR. The whole point of Labor Unions is to prevent labor markets from clearing. A market clears when supply equals demand, which happens by arriving at a market clearing price (in this case, wage). Unions create a protected class of workers, who demand (and get) more than the clearing price. This causes unemployment, and discourages investment. In an inflationary environment, it ratchets up prices rapidly. In a deflationary environment, it prevents wages from falling appropriately with prices, causing even more massive unemployment.

Last Winter Obama won the nomination in large part by making a number of promises to Unions. They're now spending $450 million on the campaign so it is reasonable to expect these are promises he will keep.

The first step will be "The Employee Free Choice Act", which already passed the Democratic House. This ends the secret ballot for union certification, instead allowing union certification of companies if they can get cards signed by 50% of the workers. The predictable outcome is that Union Goons will visit people in their homes at night, obtain signatures, and unionize huge swaths of the economy. It also imposes forced contract arbitration on companies.

In recent years, numerous foreign companies (eg Toyota) have seen fit to invest in new, non-union factories in right to work states. Say bye bye to those sorts of investments, or indeed any investment in new plants that are near certain to be unionized. Why would Toyota, or anybody else, make an investment when the law says it can essentially be looted?

For a Union President, unemployment is a good thing-- it makes his minions fearful and subservient, and maybe even grateful, not perceiving they would be much better off in a win-win world.

(2) Protectionism. The Smoot-Hawley Tariff was famously passed under Hoover after the crash and played a role in the Great Depression (particularly rendering the agricultural sector disfunctional-- leading to the dust bowl, and government subsidies to this day). Protectionism is integral to Unionization because otherwise as unions push up costs of products, they will simply be imported more cheaply. Obama promised the unions last winter to "unilaterally renegotiate NAFTA". The Democrats in Congress have already stalled fully negotiated Free Trade Agreements with Columbia, South Korea, and Peru. Protectionism will be far more damaging today even than it was in the 1930's because our economy depends so much more on international trade.

(3) Raise taxes on the productive and businesses. Obama's tax plan is a disaster for incentives. He's going to take from the highly paid and give to the less well paid, creating huge effective marginal tax rates not only for the upper brackets (and more productive S- corporations) but also for lower and middle classes (and less profitable S-corporations), as they phase out of subsidies. Who will invest/strive in this environment?

Economic theory (and according to Becker, empirical verification) holds that Cap Gains taxes are paid entirely by labor in the long run. Investment capital dries up until the after-tax expected return is equal to what investors would have demanded without the tax, so labor are forced to work with less capital, thus produce and earn less, accounting for the entirety of the tax collections. As it happens, there aren't going to be any cap gains taxes collected in the short run (since nobody has profits unless they've been holding a capital investment since the early 90's, in which case the Cap Gains tax they pay is almost entirely on illusory earnings due to inflation and thus is highly unfair) so the only impact of increasing Cap Gains taxes will be to dry up new, desperately needed investment.

Also, as income and business tax rates go up, taxable income will go down as it always does, so projected revenues will not be realized. But the gov't will pay out the tax credits, inflating the deficit.

(4) Huge Spending Programs. Big spending programs proved a disaster in our Great Depression, the Japanese Depression of the 90's, in the '70's when Nixon held "We're all Keynesian's now", everywhere they've been tried. They misallocate resources. Now that Paulson asked for $700B, the Dems in Congress have naturally lost any sense of restraint. The bill they actually passed was $850B, and now Pelosi is looking for a $300B stimulus plan. Discipline has gone out the window. We're watching pork get more zeros. And just wait till unemployment ratchets up, and they start frantic "jobs" programs.

Its easy to understand why these stimulus plans always make things worse. When you tax something, whether labor, investment, or whatever, you get less of it. This leads to the "deadweight loss of taxation". The taxes to raise $1.00 for the government to spend not only subtract that $1.00 from somebody's pocket, who would spend, or invest it; they also cause him to produce less. This unproduced amount benefits no-one, and has been estimated at between $.30 and $2.00 for each $1.00 raised (depending how its raised). Then the government picks something to spend on, like a hugely expensive train to nowhere in Japan, or subsidizing ethanol (which actually turned out to radically increase CO2 emissions when land use effects were calculated in), or keeping Detroit operating at a loss for a few more months (assuming they go ahead and do this.) The benefit from these expenditures or "investments" is on average much less than would have come from $1.00 spent or invested in the private sector, and vastly less than the $1.30 to $3.00 that would have been spent or invested in the private sector. So each additional $1.00 of stimulus spending winds up subtracting perhaps as much as $2.50 from GDP. Depression here we come.

The above are errors that replicate the ones made under Hoover and FDR. However, the next administration is likely to come up with dramatic new errors in addition.

(5) A war on Carbon through Cap and Trade or some such. This will massively raise costs of business and misallocate resources. And its totally unnecessary, because Global Warming is basically a hoax.

(6) Nationalize the health care industry. Price caps on pharmaceuticals already passed the Democratic House. In addition to the effects on health care, such measures will radically discourage investment in the pharmaceutical and health care industries, killing jobs.

(7) Massive new regulation on various industries, raising costs and discouraging investment.

(8) Resist drilling, coal mining, shale oil, nuclear power. Leaving aside fantasies of becoming "energy independent", the US economy could badly use the massive infusion of hard wealth that is available for the taking, if only we choose to, under the ground.

Assuming Obama wins, I predict double digit unemployment, probably 20% unemployment, right through whenever he leaves office, whether it be in 4 yrs or 8. Even if McCain wins, unemployment could reach double digits, but if he is smart enough to veto most of the above errors, should not stay there.

Question for any economist who supports Obama: name something he is proposing that would actually be good for the economy?

Email me if you have a suggestion.



Eric Baum
Last modified: Mon Jan 5 21:00:40 EST 2009