Why Obama and Romney are Both Wrong About the U.S. Economy

I'm reminded of the saying, "Fools rush in where angels fear to tread." With this week's blog post there's a good chance that I'll step on lots of toes, but what the heck I'm an equal opportunity offender.

One of the problems we are facing this election cycle is neither candidate has given the American voter the top three things they would do to get the economy going again.  They are both more concerned about trashing their opponent than providing us with reasons for voting for them. 

My premise is that the U.S. economic model is broken and cannot be fixed by the trite solutions offered by both political parties.  Since the 1980s 70 percent of GDP growth has been fueled by consumer spending.  As the economy expanded, our wealth increased - stocks, bonds and especially the rising value of our homes made us feel more prosperous resulting in our trading up for better cars, homes and vacations and at the same time taking on more and more debt.

Then came the Great Recession.  A recent Federal Reserve report indicated that the net worth of the median U.S. Household fell 39 percent from 2007 to 2010.  Feeling poorer, and rightly so, has resulted in Americans cutting back on purchases and even making token attempts to put money in savings.

So how do we get the economy going again?  The basic equation that summaries a nation's gross domestic product is:

GDP = C + Inv + G + E - Imp

Gross domestic product of a country is equal to its consumption (personal and business) plus investments plus government spending plus exports minus imports.  It is true for all countries and all times.  There are no exceptions.

What happens if C drops?  That means, absent something happening elsewhere in the equation, GDP is going to drop.  That circumstance is typically called a recession.

Therefore there are only five ways to stimulate the economy:

1. Increase exports
2. Decrease imports
3. Increase business investment
4. Increase government spending
5. Increase consumer spending

That's it.  Pretty simple, isn't it?  So what are Obama and Romney proposing and will any one of it work?  Both are emphasizing job creation as the key to their economic proposals.  But is it just rhetoric?  Let's look and see.

Increasing our exports - If you haven't noticed, Europe is on the verge of imploding economically.  At the very least they will be in a full blown recession before the year is out, which means less demand for our exports, not more.  The economies of other countries around the world are also contracting, certainly not expanding so the hope of greater exports fueling our economic recovery is highly unlikely.  We will have to look elsewhere to get our economy going again.  Both candidates are bloviating when they talk about increasing exports resulting from implementing some vague proposed policy.

Decreasing our imports - One area of enormous potential for boosting our economy is in energy production.  For every barrel of oil we produce in the U.S. it is one less barrel of oil we import.  From a purely economic argument, the environmentalists have no leg to stand on.  Romney is in favor of oil exploration, the president at best is very reluctant to do so.  The Canadian pipeline project, the exploration of oil off our coastlines and opening up the 1/2 of 1% of the Alaska National Wildlife Refuge that was proposed years ago would have a positive long term impact on our economy.  To prove my point, just observe what's going on North Dakota at the present time.  This state's economy is booming because of the vast oil reserves recently tapped.

More business investment - that's not going to happen until there's stonger demand for a company's products.  In the movie Field of Dreams, an Iowa farmer hears an ethereal voice whispering, "If you build it they will come" referring to building a baseball field.  There is no equivalent in business.  Demand by consumers must precede a businessman's rational decision to increase their production of more widgets.  But in fairness to Romney he is proposing to reduce the tax rate for businesses.  This is a positive first step as the U.S has the highest corporate tax rate among the most industrialized countries of the world.  Lowering the corporate tax rate would, over the long run, make it a more favorable business climate in the U.S.

Increasing government spending - contrary to what Republicans are telling you, higher government spending does promote economic growth.  It has to.  It's simple math.  But the problem of ever increasing government debt is that it puts a drag on our economy.  So in the short run, higher government spending does modestly stimulate the economy but over the long run it slows the rate of growth as more and more of the budget goes to making interest payments on the debt and less for investments in other segments of our economy.  In the long run higher government spending slows economic growth.

Increasing consumer spending - for the economy to get moving again the American public needs to lead the way.  So what are Obama and Romney proposing?

• In 2011 the president put into place, with the help of Congress, a payroll tax cut of 2% which directly goes into the pockets of all American workers.  This can only help increase consumer spending.  But the problem is this tax cut reduces the amount of revenue funding Social Security, which is slowly working its way to insolvency.  So the tax cut is helping the Social Security Trust Fund go insolvent more quickly than it would if the payroll tax cut had not been implemented.
• The president is also proposing to increase the tax rates on the wealthy so they "pay their fair share" whatever that means.  Increasing taxes on the wealthy may be good politics but it certainly isn't good economics to raise taxes on anyone in a slow economy.
• Romney on the other is talking about further tax cuts, which doesn't make any sense either.  Most economists agree that a further reduction in tax rates will explode our already enormous deficit.  And when almost half of all Americans didn't pay any income tax last year how effective will it be to lower tax rates even further?

Wouldn't it be refreshing if the candidates:

• Were talking to the American people as if we were adults?
• Would lay out in complete terms their economic plan and debate the merits of their plans.
• Would ask us to sacrifice a little for the good of the country?

Whoever becomes our next president I hope has the vision and courage to lead us during difficult economic times.  Unfortunately I don't believe either candidate has the "spine" to do the right thing.  The next president will have difficult decisions to make that have enormous long-term consequences.  It will be far easier to "kick the can down the road" and stay popular among his base than to lead and be villified for making the difficult choices.  I hope I'm wrong because this country is at a crossroads.  We can follow Europe down the path to destruction or we can make smart, difficult choices that pull us back from the precipice.  This isn't just another election.

Sources: Endgame: The End of the Debt Supercycle and How It Changes Everything by John Mauldin; June 30, 2012, Robert J. Samuelson, Washington Post.