The Calico Cat

Teddy, at a blog called It's Still the Economy, Stupid, wrote this post commenting on an article that appeared in today's New York Times, Cloudy Thinking on Tax Cuts. I also found this article worthy of commentary.

Alan Krueger, the author of the New York Times article, clearly intends to imply that, if only the average person knew how they were being taken advantage of by the rich, and how much they would benefit from a more "progressive" tax structure, then they wouldn't support tax cuts. It was suggested that "good political spin creates preferences that aren't in people's interest."

It should be clear that there's a lot more than "political spin" going on here. At the same time that Republicans are spinning their tax cuts, the Democrats are spinning the opposite point of view. One would think that the two "spins" would cancel each other out, and therefore spin wouldn't be much of a factor.

Nowhere in the article is it suggested that people might know about the Laffer Curve (which demonstrates how lowering tax rates can cause tax revenues to increase). Or that they might believe that tax cuts for the rich would trickle down to benefit everyone. This is not to say that either of these viewpoints are correct, but they are viewpoints that are out there and the article is remiss not to mention them.

Perhaps people follow the libertarian philosophies of Ayn Rand, and view government confiscation of rightfully earned money as ethically wrong, even if it's done--or maybe especially if it's done--for the purpose of wealth redistribution?

Of course, I'd be the first to point out that the average person has neither read The Fountainhead nor has ever heard of Arthur Laffer. But I feel that there is some truth in the point that many people who aren't rich are nevertheless philosophically opposed to big government, even if the purpose of big government is, theoretically, to benefit those who aren't rich.

So far, the article sounds like just another example of liberal bias at the New York Times. But if the author of the article wanted to go further to show that the average voter is uninformed, he should have pointed out that a Time Magazine survey done for the 2000 election "revealed that 19 percent of Americans believe that they have incomes in the top 1 percent, and a further 20 percent believe they will someday." (Source: New York Times: On Target and Off in 2002.) This indicates that a sizeable plurality of 39% of Americans believe that they are presently rich, or will someday be rich, and thus would have a clear motivation for supporting tax cuts for the rich.

How could so many people irrationally believe that they are rich? My guess is that the two factors working here are optimism and cognitive dissonance. In the United States, optimism is strongly encouraged, and rational realism is looked down upon. For example, tell someone that you won't likely ever get a much better job than you currently have, and you will be sternly rebuked for your "negative thinking." And the other factor, cognitive dissonance, means that people are unable to admit to themselves that they are failures, and thus prefer to believe in the fantasy that they are actually at the top.

Given those surprising survey results, liberals who want to convince Americans to support redistributionist tax and spend policies will have a tough row to hoe. Not only do they have to rebut the arguments of libertarians and conservative economists, they also have to overcome the powerful psychology that compels people to believe that they are rich when they really aren't.

The buzzword in the U.S news media is "jobless recovery". Corporate profits, national income, and even the stock market, are all up, yet in the United States people can't find jobs. This commentary comes from an American point of view, but probably applies to all developed countries around the world, so you may want to read the rest of it even if you're in Europe, Australia, Japan, or some other developed area of the world.

An article on the front page of today's Wall Street Journal (see Clues to the Cure For Unemployment Begin to Emerge - note link will only work if you have a paid subscription) explores this issue, and also does some editorializing that I disagree with.

According to the article, "The U.S. economy is growing again, yet it has been unusually slow to add new jobs. The Bureau of Labor Statistics says new and expanding businesses added fewer jobs in the fourth quarter, 7.75 million, than in any quarter since 1995."

What caught my attention was this admonition contained in the article: "[Some people] seek to protect workers by blocking job-threatening advances in trade, technology or competition. But that strategy would arrest the very forces that have improved the lives of Americans over the past 50 years."

I agree that advances have greatly improved our lives, even though workers have been displaced along the way. I don't think that anyone wants to go back to a pre-industrial economy where the overwhelming majority of the people work on farms.

But I believe that foreign competition is of a different nature today than it was fifty years ago, and this competition is not good for developed nations. Advances in technology have had the effect of removing the barriers to exporting jobs. A hundred years ago, there may have been a big workforce of people overseas willing to work for practically nothing, but there was no practical way to communicate with foreign countries, and transportation across vast oceans was slow and costly.

Move forward a hundred years, and we have the internet which enables large amounts of digital information to be transferred around the globe at a negligible expense. Consequently, information jobs such as computer programming are now being effectively moved to places like India where computer programmers are willing to work for a fraction of what computers programmers get paid in the United States.

With international phone calls so inexpensive, call centers are now being moved to India also. When you call up for computer tech support, you may discover that the person who answers the phone with an Indian accent is talking to you from halfway around the world.

Miniaturization means that the cost of transporting manufactured goods, even by air freight, can be minimal. Computer chips are an example of a relatively expensive and important manufactured good that is small and lightweight and thus easily transported by airplane. It's cheaper for companies to open chip manufacturing plants in Asia and then fly the finished products back to the United States than it is for them to manufacture them here in the first place.

I also think that the whole philosophy of foreign manufactured goods has changed. It used to be that people in the United States viewed goods manufactured in developing nations as being second rate. Even Japanese goods, which now have a reputation for high quality, were once viewed as inferior to the same products that were made in the USA.

Not only has the stigma of imported goods disappeared, but corporate executives feel like they aren't doing their jobs properly unless they are moving more and more operations overseas. It seems as if operations are moved overseas even when it doesn't make any economic sense.

All the factors above create a whole new competitive dynamic. The worker in Ohio who is looking for a job isn't just competing against other American workers. He's competing against workers in China, India, and Mexico who are willing to work for a fraction of the U.S. minimum wage (which itself is a pitifully low salary for the U.S.).

I have to conclude that the buzzword "shrinking middle class" is not just a class warfare slogan coined by Democrats, but is actually a reality. Whether this is a good thing or a bad thing is open to debate. Some say that if the U.S. economy as a whole is growing, then the country as a whole benefits. But I say that whether you perceive benefit from the new competitive paradigm depends upon which side of the shrinking middle class you happen to be. If we suppose that 25% of the middle class is moving towards being wealthier, and 75% are moving towards being poorer, then probably the 25% moving up are quite happy with the new competitive paradigm, while the 75% moving down are surely quite dissatisfied.

Dick Grasso, who made millions of dollars a year as the head of the New York Stock Exchange is probably ecstatic, while the factory worker who once upon a time earned $15/hour but now earns only $8/hour is probably not a happy camper at all.

Because the United States is a democracy with majority rule, politicians from both the left and the right should take heed. If the majority of Americans feel that they are being hurt by the new competitive paradigm, they will vote for candidates who promise to do something to help them. I fear that this will most likely lead to greater socialism and less freedom, and there will be anti-capitalist "reforms" that will hurt everyone. It therefore may be prudent to put in place some protectionist policies now to protect American workers from foreign competition, rather than wait until the disparity between the well off minority and the non-well off majority becomes even greater.

The Dow is at 9674, almost back at the 10,000 level. To be fair, the S&P; 500 is really a better indicator of the U.S. stock market because it includes the entire gamut of companies that people invest in. The S&P; 500 is at 1038, which is down 32% from its peak of 1527 back in March of 2000. Nevertheless, 1038 represents a 34% increase from its trough of 776 only a year ago in October 2002. A 34% return over a one year period is a pretty darn good return!

Non-investing types' eyes may glaze over when I write about the stock market levels, but this is something that all should be concerned about. Stock values are often an indicator of how the economy as a whole is doing, because high values create a wealth effect, and high stock values also mean that there is a lot more capital available for companies to spend, and when companies are spending money we have high employment and everybody is happy. There is no doubt that the booming economy we experienced in the late 1990s was a result of the rising stock market. And the painful economy of the last few years has been a result of the falling stock market. (This correlation leads some people to the wrong conclusion that we need to "pump up" the stock market in order to have a healthy economy--this might be the topic of a future post.)

Yale economist Robert Shiller, in his book Irrational Exuberance, examined the PE ratio of the S&P; 500 based upon ten year trailing earnings numbers. In January 2000, right before the book was published, he showed that this ratio was at an all time high of 44.3. In 1929, the ratio only reached 32.6. He also showed that at the troughs of bear markets, this ratio would fall below 10, which happened after the 1929 peak, and also after the 1966 peak (reaching rock bottom valuations in the early 1980s).

If history is to repeat itself, then the U.S. stock market is in for an extended bear market, and the stock price increases we've been experiencing during the last year have merely been an echo bubble. The same conclusion was reached by blogger Karsten in his CurryBlog.

However, it's always possible that things really are different this time, and that the stock market going forward will have permanently higher valuation levels than in the past. The basis for this could be all of those 401K programs. Never before have so many Americans become stock market investors. Even through the bear market, the majority of Americans still put their 401K money into stock mutual funds. This auto-pilot investing surely helps to pump up the prices of U.S. equities.