How to Fix the U.S. Economy
This Year
You are an importer
of goods and services to the United States. So far, you have persuaded
producers abroad to hold their prices — in spite of the falling dollar —
to maintain market share. You know that can’t continue much longer.
You raise the prices of imported goods and services.
Since imported
goods (especially oil) are used throughout the economy, producers are
seeing that higher costs cause their margins to drop. They raise
prices. Rising prices cut into the demand from customers, and people
have to be laid off. That cuts the demand further. More “stimulus”
will be needed. If it is monetary (such as the lowering of interest
rates and infusing cash into the economy), the dollar will drop
further. If it is fiscal (like increasing the government deficit),
people will conclude that inflation is likely to follow. Inflation will
cut into their real incomes; so they cut their consumption more; thus
setting the stage for even more people losing their jobs.
Rule No. 1:
To beat a recession, we must produce more, so that more goods and
services will cause the economy to grow rather than contract.
Rule No. 2:
We must increase real wages so people can afford to buy the increased
production.
Rule No. 3:
We must lower real prices so that people have a stronger incentive to
buy goods and services than they had before.
Rule No. 4: we must increase real profits
so investors have a stronger incentive to build facilities to expand
production.
We must deal with
the REAL economy — this means we must remove the distortive effect of
inflation to see clearly what is beneath. If we don’t, we might revisit
our experience of the 1970s: An economy suffering both inflation and
stagnation — the worst of all possible worlds for an economy that should
grow and prosper.
You will be
surprised to know that this problem can be solved — and with
surprisingly little pain. Conventionally, it is solved by a recession,
whereby the economy rids itself of noncompetitive and wasteful
practices, expands those parts of the economy that are globally
competitive, and suffers a wave of bankruptcies and defaults. All this
involves much pain — pain that is distributed unequally throughout the
economy.
There is a better
way.
This way will
cause more production to be initiated, prices to fall, wages
to rise, and new jobs to be created.
There is only one
thing that could cause all this to happen: It is to increase
productivity. No other economic measure can achieve all these
objectives at the same time, nor as quickly. Increasing the numbers of
hours worked in the current economy by adding to the labor force does
not increase per capita income; it is increasing output per hour
(productivity) that leads to higher income for the labor force.
How can that be?
The correlation between changes in wages and
productivity is 0.99. What that means is that there may be
temporary gaps between increases in productivity and wages, but that
over time, there will be no gap. If employers have to pay workers
more than the value that they add, employers will go broke, and jobs
will be lost. If workers are paid less than the value they add,
they will leave
Higher productivity will result in higher wages
The gains from higher productivity also accrue to
stockholders because there are ample gains to capital as well when
productivity increases
The gains will come to the general public in at
least three ways:
1.
Prices will be lowered and financed by the surplus created by the
productivity improvement.
2.
Wages will be higher, so demand is stimulated both by increased
income and by lower prices.
3.
Since most workers have retirement funds invested in stocks,
their holdings will increase, further increasing their wealth.
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How do we know that this really happens when
productivity increases?
1.
Silicon Valley has done this for thirty years. It is the most
productive sector of the economy (16% increase in 2007), it has created
enormous wealth for the owners of its stock (think Google,
Hewlett-Packard, Bill Gates), wages are high, and prices for information
technology that they produce have been reduced every year for thirty
years.
2.
Jean-Baptiste Say talked about how the best way to beat a
recession is to improve productivity. That was 200 years ago. Laws of
economics don’t change; they just speed up as economies evolve.
3.
In a study published in the journal Cost Management[*],
I showed that highly productive companies in the U.S. increased
employment by 45 % between 1998 and 2003, or by 7.7% per year, in
response to the high profits that productivity improvement created.
So, how do we go about increasing
productivity?
Anyone who is interested in the details will find
out by trolling this web site for information:
http://www.TorDahl.com.
As for the U.S. as a whole, we should focus on
the real parts of our economy — real
production, real prices, real wages — and
then fix an unblinking eye on real performance of all
factors that enter the production process. That means more productive
workers; more innovation; more productive use of capital, materials and
technology; better use of land and buildings; and, above all, more
investment in the most productive factor of production of all time: The
Human Resource.
We know how to do it.
Will a fiscal stimulus do it?
Get real!
Did you know that increased productivity is a
substitute for the kind of tight monetary policy that lowers prices
because there is less money around?
It is just that productivity lowers prices
without the painful unemployment and the hazards of deflation that may
follow a dramatic reduction in the money supply.
So we could do without both monetary and fiscal
stimulus.
And two Nobel Prize winners in economics have
already made the case for it.[†]
Milton Friedman found that the main cause of the
Great Depression was a deep reduction in the supply of money. He
suggested that the money supply should be in synch with the real
economy, and that such a policy would be the best way to avoid
inflation.
Finn E. Kydland warned that the temptation to use
fiscal stimulus should be resisted with the same firmness of resolve
that led Ulysses to have himself tied to the mast of his ship, lest he
give in to the destructive temptations of the Sirens who threatened to
disrupt his journey.
It is about people feeling safe in making
decisions about their futures. It is about people knowing that it would
take a catastrophe like Katrina to deviate from a balanced budget, and a
monetary crisis like the Great Depression to make drastic changes in the
money supply. Lacking such crises, the economy should be, “Steady as
she goes!” effectively removing one of the biggest economic
uncertainties from influencing the decisions people make about their
spending and saving.
We, then― like Ulysses ― may focus on a journey
of discovery, of growth, and of contribution. The journey is
challenging enough without large monetary and fiscal shocks to the
system. Yet, it is the rewards to be gained from making that journey
that will lead our country to grow and prosper. And it will
happen, because we shall then be free to chart our journey to the place
we most want to go.
[*] Dahl, T. The Unfreezing of America.
Cost Management. December/January 2004. 8 (6). 16-22.
[†] Milton Friedman received his prize in
1976, "…for his achievements in the fields of consumption
analysis, monetary history and theory and for his demonstration
of the complexity of stabilization policy,"
and Finn E. Kydland shared the 2004 prize,
"…for …contributions to dynamic macroeconomics: the time
consistency of economic policy and the driving forces behind
business cycles."
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