Cochrane points to the official Congressional Budget Office long-range outlook, which assumes 2.2% growth from now through 2040. That would be an improvement over the recent past, but it’s still historically low.
If you change that assumption from 2.2% to 3.5%, total GDP in 2040 will be 38% higher. That GDP boost means tax revenues will be 38% higher, and much of our debt problem will disappear. Shades of Newt Gingrich! Conversely, Cochrane notes that 1% GDP growth over that period would yield a 26% drop in GDP and tax revenue, leaving us in a deep hole.
On the other hand, there is no reason to think 3.5% growth is the ceiling. With a few changes we might be able to boost it even higher. Cochrane says what I have long believed: Rising productivity is the key to economic growth. The more each human can produce, on average, the higher everyone’s standard of living can rise.
Restoring Growth
Cochrane takes a matter-of-fact approach to the growth problem. What are the barriers to productivity growth, and what can we do to remove them? Not surprisingly, most barriers are the result of counterproductive government policies. He breaks them down into categories. I’ll highlight a few.
Regulation: The government interferes in just about every segment of the economy. Sometimes it brings benefits like traffic safety and clean air. More often, regulation simply slows growth in order to transfer wealth from one group to another. It interferes with growth by impeding competition and distorting economic incentives. It distorts the signal that individuals send markets about their preferences and adds a great deal of noise and cost, which distorts economic activity from being its most efficient.
Finance: The Dodd-Frank financial regulations had the laudable goal of preventing future bank crises, but in reality they simply work against other government policies. Washington encourages and subsidizes debt and then tries to prevent the inevitable consequences. We wouldn’t need Dodd-Frank if the government were not rewarding excessive debt. As I’ve written about extensively in this letter (often citing Dr. Lacy Hunt and others), excessive, unproductive debt of the type we are generating in the US and Europe actually inhibits growth.
Healthcare: We’re all frustrated by Obamacare and health insurance generally. What we need is simple, portable, catastrophic health insurance. Instead of promoting it, the government makes it illegal.
Energy: Here again the government works at cross-purposes with itself. It subsidizes energy so that it costs less, then tries to prevent us from using too much of it. Cochrane says the ethanol mandate helps no one but the large corn-producing companies. Ditto for solar subsidies.
Taxes: Taxes should raise revenue, but instead we use them to redistribute income and encourage/discourage behavior. A simpler tax code would remove massive economic distortions, and it would be far better to tax consumption instead of income.
Social programs: Cochrane sees no need to be stingy with helping people in genuine need. Welfare programs are far less costly than the many subsidies we give the middle class and large corporations. The problem is that perverse incentives trap people and make them permanently dependent. He suggests consolidating all the aid programs and making them time-based, like unemployment benefits, rather than income-based.
Immigration: We can end illegal immigration overnight, says Cochrane, by making it legal. The question is the terms we apply to legal immigration. We should welcome skilled workers who want to stay in the US and contribute to our economy. He also points out, wisely, that whether someone should be here is a separate question from whether they should be allowed to work here.
Education: Public schools do not need more money; they need correct incentives. The way to deliver them and ensure better opportunities for all is to adopt vouchers and charter schools. The government doesn’t have to directly provide the service in order to help people afford it.
Implementing these reforms is a political challenge, not an economic one. One man’s waste is another man’s subsidy. People naturally resist when they perceive they are on the losing end of the bargain. Serious change is very hard if everyone insists on keeping whatever benefits they presently have.
Frankly, I realize that making these fundamental changes will be difficult, but we have to try. Cochrane stresses that even small changes make a big difference over time. In a few weeks, I will be sending you a very special Outside the Box, written by former Oklahoma Senator Tom Coburn, who has become my friend and who is one of the most focused and dedicated men I know when it comes to dealing with the deficit and debt. He is advocating a Convention of the States to propose constitutional amendments to force the government to effectively deal with the debt and regulation.
Numerous states (including Texas) have already adopted these proposals, and we anticipate as many as 15 more will adopt a resolution by the end of the year. Such a movement wouldn’t be necessary if we had a Congress and president that were capable of acting responsibly, but it appears the politicians of both parties are all too willing to make small changes around the edges without dealing with our central problems.
It is not just personal and government incomes that will continue to be affected if we don’t do something to boost growth; investors are going to suffer, too.
From Carrot To Stick
This week I received a very kind email from my friend Ed Easterling of Crestmont Research. Ed and I have collaborated many times over the past 15 years, most recently on “It’s Not Over Until the Fat Lady Goes on a P/E Diet.”
A big part of Ed’s research focuses on the relationships between price/earnings ratios and economic cycles. Bull markets end when company valuations grow excessively high. Then the ensuing bear market ends when valuations get unreasonably low. These secular bull or bear markets take many years (on average 17) to play out.
I noted at the end of last week’s letter that I would be writing about growth. Ed reminded me that economic growth is directly related to P/E growth and thus stock market returns. In the aggregate over a cycle, corporate profits can’t grow faster than the economy grows. Yes, you can always point to exceptions, but we’re looking at the aggregate here.