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Obama's Gorbachev Moment

Two old schoolers make a good point about how subsidies addict us. Could their other points be better honed? This 2009 article from Economix Blog -, June 4, is by Peter Boone, chairman of Effective Intervention and a research associate at the London School of Economics, and Simon Johnson, a professor at MIT and former chief economist at the International Monetary Fund.

by Peter Boone & Simon Johnson

A superpower faces serious economic decline. People become increasingly nervous about the government’s ability to make good on its obligations, and the country’s broader global role comes into question. Recent foreign wars have not gone well. Citizens ask: Can we really afford to project the same degree of worldwide influence as in the past?

Into this difficult situation steps a dynamic young leader, with strong popular support, high expectations and a positive international image.

His name is Mikhail Gorbachev, and the moment is the Soviet Union in 1985.

Gorbachev, of course, did exactly the wrong thing. He borrowed abroad, printed money to finance budget deficits and declined to undertake fundamental reform. You know how that ends.

President Obama’s team has successfully halted what could have been a major financial meltdown, primarily through a combination of fiscal stimulus and a huge amount of unconditional support for big banks.

JJS: People live off government spending are almost unanimous on that point. However, maybe some of those big banks who call the shots should have melted down. We could’ve replaced them with a decentralized system of banks and brokers. And instead of taking on huge debt to make good bad investments, we could have started the program of paying citizens a dividend from the annual rental value of nature and privilege, for which we spend literally trillions annually.

The risk is the administration will rest on this success, and fail to undertake the fundamental reform that we now need.

How can Obama avoid following in Gorbachev’s footsteps?

First, deal with our structural problems.

The most important is the need to end dangerous rent-seeking -- pursuing explicit and implicit government subsidies -- in the financial system. This distorts incentives, leads to crazy risk-taking episodes and ties up resources in unproductive uses.

JJS: This point alone is important enough to validate their whole article.

America needs to refocus on sectors that can generate real value -- think nonfinancial technological innovation, which is our traditional strength.

Unfortunately, the current policy of low short-term interest rates -- which helped break the financial panic -- now feeds our bad financial habit. Anyone still creditworthy can take out a low-interest rate loan in American dollars and make money buying assets overseas. Stand by for another financial bubble masquerading as a “shift in fundamentals” -- probably someone will soon try to sell you on “China rising” or a broader “new emerging market model.” You know the outcome already: A few “financial wizards” and their bosses will get another rich take; we’ll get another big bill to pay.

JJS: Despite any consequence of any interest rate, should setting the rate be a matter of policy, decided by politicians and rich elites, or a matter of course, set by the market, by millions of lenders and borrowers, and re-setting it over and over?

To stop this potential bubble we need to raise interest rates as soon as feasible, i.e., exactly what the Federal Reserve didn’t do as it tried to reflate after the dot-com bust earlier this decade.

JJS: Actually, we don’t “need” to lift rates. What we really need to do is raise taxes -- or charge fees -- on land and privilege. That would stop speculation dead in its tracks, much to the displeasure of economic commentators, politicians, and ruling elite -- not to mention the millions of little people in love with making the “big score”.

Upping interest rates would imply letting some banks fail, as they make less money when short-term interest rates go up relative to long rates. We therefore urgently need measures to ensure no systemically important institution can ever again be “too big to fail”.

JJS: So quit concentrating the commonwealth into few pockets. Recover and share it equitably among us all.

Second, we need to take the bitter pill of fiscal consolidation.

Stop asking the Chinese to buy our debt. Rather, announce a credible path to bring down the fiscal deficit in 2010 towards 5% of gross domestic product. Obama should lay out how to achieve a more nearly balanced budget by the end of his first term -- particularly stressing the need for new sources of revenue. The American state is fiscally underdeveloped, given what we are trying to achieve at home and abroad. This needs to be explained clearly and repeatedly by our top leadership.

JJS: Want a balanced budget? First, quit corporate welfare, military adventurism, etc. Second, a “new” source of public revenue? Tap the commonwealth -- all the money we spend on the nature we use and privileges most of us labor under. You can even grow it by cutting taxes on labor and capital.

Third, we have to stop hoping the Saudis will bail us out.

Let them do as they please with their resources, and let us take serious efforts to end our dependence on oil. Committing to gradually but steadily rising taxes on petroleum products will reduce demand, encourage substitution, and produce a great deal of new innovation -- as well as more government revenue. This is a top priority for national security, as well as good economics.

JJS: Rather than tax petro-products, tax petro-byproducts -- pollution. And quit subsidizing big oil with “research” programs, etc. And quit taxing wages, which hit hardest the labor-intensive industries, such as clean alternative energy sources.

If the choices in such situations were easy or palatable, Mr. Gorbachev would still be in power.

JJS: If the solutions were easy to explain, any of us could be in power. While the two professors who authored the article get the mainstream’s attention, Dr. Fred Foldvary at Sta. Clara U has a student who has put the big picture answer into a video. click here


Jeffery J. Smith runs the Forum on Geonomics.

Also see:

Obama Delivers Economic Progress Report : NPR

Global economic decline will continue in 2009, OECD predicts

Frost Illustrated: American progress report paints dismal economic ...

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