The economic value of trust in a society

Vijay K. Mathur

Published in Standard-Examiner, May 28, 2011

Trust (confidence), is an implicit contract between entities -- private and public -- including governments and nations. Even explicit contracts are facilitated by trust. As argued below, trust has economic value in a society. Corruption and fraud in any society inflict the most damage to trust.  Almost every day we hear about corrupt practices of politicians, financial brokers and advisers, law enforcement officers, bankers, hedge fund managers and many others groups of people and institutions. Politicians' activities, guided by contributions from deep-pocketed lobbyists, do not create trust among voters who elected them to do the common good.

Those contributions amount to legalized bribery. In fact an International Monetary Fund study by Deniz Igan, Prachi Misra and Thierry Tressel in 2009, found a significant positive relationship between lobbying by financial institutions for special favors from policy makers and the recent financial crisis.  Department of Justice data show that during 2001-2006, 6,899 individuals were charged with public corruption offences and the Justice Department obtained 5,876 convictions nationwide. In 2010, Consumer Sentinel Network of Federal Trade Commission received 725,087 consumer complaints for fraud costing $1.7 billion.  In recent years, Utah has witnessed the rise of "affinity fraud" where LDS Church members abused the trust of fellow members by enticing them to participate in bogus investment schemes.

Corruption and bribery (a hidden price) feed upon each other and lead to dysfunction of markets, private and public institutions, and ultimately loss of confidence and trust in democracy. Kenneth Newton and Pipe Norris, in their working paper at the Kennedy School of Government of Harvard University, would argue that loss of public confidence in institutions representing pillars of the society poses a major threat to democracy. The clear example of this loss of trust in government and its institutions can be found in the recent bailout of the financial institutions during the current severe recession of 2008-09, even though the bailout was necessary to save the economy from the brink of another depression.  In fact, this lack of trust has also spread to our financial institutions. We can see the damaging effects of bribery and corruption on the economies of India, many countries in Africa, Asia, Middle East and Eastern Europe.

How is corruption related to trust in people and institutions? Professor Eric M. Uslaner, of the University of Maryland, states that, "Corruption flouts rules of fairness and gives people advantages others don't have." Since corruption often accompanies bribery either in kind or money, it gives advantage to rich people over people with modest means in the allocation of resources.  Thus, loss of fairness in the allocation of resources and/or income fosters distrust. Economic inequality, according to Professor Uslaner, is the source of corruption, because "corruption and inequality wreak havoc with our moral sense."

The loss of trust in people, institutions and governments imposes high costs on a society. For example, besides the psychological cost to victims of fraud and corruption, people have to spend time and money in drawing up contracts for minor transactions; businesses have to spend more resources to monitor shirking by employees, thus affecting production and quality control; quality of health care will be costly to implement and administer. In the political arena, loss of trust in politicians may be short-lived, but each time corrupt practices and/or political favors to rich lobbyists come into the limelight it undermines confidence in the political process and institutions. In fact, many surveys find that majority of voters lack confidence in Congress.

The loss of trust in government institutions encourages many to engage in the misuse of resources allocated for government programs. Corruption, fraud, bribery and politics motivated by rich influence-peddlers end up in a self-reinforcing vicious circle that ultimately poses grave threats to democratic institutions at all levels of government.

Reviving trust in ethnically diverse and increasingly unequal-income societies like the U.S. poses a greater challenge than in homogenous and more income-equal societies. A recent study for States in the U.S., by Oguzhan C. Dincer in the April 2011 issue of Contemporary Economic Policy, found that after controlling for many other factors' effect on trust, an increase in ethnic polarization and income inequality significantly decreases trust. The finding on the effect of income inequality on trust is especially revealing.  As Professor Raghuram Rajan cogently argues in his book, "Fault Lines," "the most important example of the first kind of fault line, ... is rising income inequality in the United States, and the political pressure it has created for easy credit."

Building trust has to start with the leaders in business and government who recognize the fault lines. We have to move away from easy credit as the path of least resistance, as Professor Rajan argues, to the path of opportunities in education and jobs with a future to Americans.  Short-lived episodes of distrust must not be allowed to become the norm, because distrust is contagious. Loss of trust will impose a high price to free markets and democratic institutions.

Mathur is former chair of the economics department and professor of economics, Cleveland State University, Cleveland, Ohio. He also writes original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Guns are efficient killing machines requiring stricter regulation

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, May 9, 2011

The late Milton Friedman, a Nobel Laureate in economics and the strongest defender of freedom to choose and free enterprise, once remarked, "Every friend of freedom ... must be as revolted as I am by the prospect of turning the United States into an armed camp, by the vision of jails filled with casual drug users and an army of enforcers to invade the liberty of citizens on slight evidence."

Guns, especially handguns, in the hands of people, are the most efficient killing machines ever invented. Like any other machines in industry, they are very productive, if one intends to use it to kill or commit violent acts.

Let me first lay out the facts about the productive power of guns. The National Institute of Justice's data show that in 2005 there were 8,478 homicides by handguns; three times higher than for guns and for other weapons, four times higher than for knifes, and 12 times higher than for blunt objects. The institute's data also show that from 1975 to 2005, 77 percent of homicide victims who died from gun violence were between the ages of 15 and 17. This data not only shows that guns are more efficient killing machines than other weapons, but also are used to kill those who will become the most productive members of society.

What about gun ownership and violence? Data from the Violence Policy Center, a non-profit educational foundation, shows that five states (Louisiana, Alabama, Alaska, Mississippi, and Nevada) which had the highest gun ownership rates (ranging from 31.5 percent in Nevada to 60.6 percent in Alaska), and lax gun laws, also had the highest per-capita gun death rates as compared to the national rate. The states with the lowest gun death rates also had much lower gun ownership rates. The policy center characterizes lax gun laws as those that "add little or nothing to federal restrictions and have permissive concealed carry laws allowing citizens to carry concealed handguns."

A major study by Harvard School of Public Health in 2007 also revealed higher homicide rates among children, women and men of all ages in states where more households had guns. A statistically sophisticated and detailed study by Professor Mark Duggan, published in the Journal of Political Economy in October 2001, also found that, both at the state and county levels, and controlling for other effects on homicides, gun ownership has a significant positive effect on homicide rates. In addition, carrying concealed weapons laws in counties -- where states passed such laws and had the highest pre-CCW gun ownership rates -- had an imperceptible deterrent effect on violent crimes; therefore, "...suggesting either that existing gun ownership did not increase the frequency with which they carried their guns or that this carrying had a negligible impact on the behavior of criminals."

The data indisputably shows that prevalence of guns significantly increases violent crimes. The constitutional protection under the Second Amendment "...to keep and bear Arms..." in the context of "...A well regulated Militia..." does not deny states and/or federal government the right to regulate this right. The question is why are gun lobbies, including the NRA, always fighting stricter handgun control regulations? Why are gun rights different than other rights specified in the Constitution? Like freedom of speech, gun rights are not an absolute right. It stops where it impinges on others' rights for safety and security.

The usual argument that carrying a gun adds more security from crime is not supported by evidence. In addition, if this argument is carried to its logical extreme, it implies that each person is responsible for his or her own security; the role of collective security provided by the police force becomes redundant. It is the responsibility and gun lobby's self-interest to promote stricter handgun laws to keep guns out of the hands of untrained, and violent and/or crime-prone people, and to disrupt legal and/or illegal supply chains that feed criminal elements of the society. One can see the effect of uncontrolled guns-supply chain on the violence in Mexico.

The emphasis on the right to keep and carry guns without sensible regulations to prevent present and future monetary and human costs associated with gun violence does not serve the broad interests of the society, including the gun lobby. In 2001, Professors Philip Cook and Jens Ludwig estimated the cost of gun-related violence, injuries (intentional or unintentional) and suicides to be around $100 billion per year. To put this cost in perspective, the authors stated that $100 billion could cover health care costs of two-thirds of uninsured people or pay college tuition for 27 million people in good public universities. A freedom-loving and democratic society, which focuses only on the right to bear arms, and ignores huge human and financial costs, and loss of freedom from internal safety and security threats to the civilian population, ignores them at its own peril.

Mathur is former chair of the economics department and professor emeritus of economics, Cleveland Sate University, Cleveland, Ohio. He also posts original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc /

Health insurance markets and health care

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, April, 3, 2011

This year, on March 23, was the first anniversary of the Affordable Care Act. Experts of different stripes from conservative think tanks, conservative politicians, media pundits and editorial writers of conservative media outlets are on the bandwagon of criticizing the law. The column on ACA by Wisconsin Republican Sen. Ron Johnson in the Wall Street Journal on March 23 caught my attention. He heaped praise on the medical care his daughter got. He had insurance through his employer. His praise was sprinkled by highly critical remarks on ACA.

According to Senator Johnson, ACA will destroy the quality of care and innovations in medical care, and implement bureaucrats' take over: I wonder where he got that information about ACA. He had nothing to say about the imperfections (concentration of economic power) in the insurance markets, lack of health insurance to almost 47 million people now and increasing rapidly over time, denial of insurance based on pre-existing conditions and other hardships people face in getting and continuing their health insurance coverage.  

Similarly, Sen. Orrin Hatch in columns, including one in the Standard-Examiner, on March 27, tried to make the case for repeal of the law. The ACA, according to him, will increase insurance premiums, increase unemployment, taxes and deficit. It was not clear where he got his data to make such unsubstantiated claims contrary to other analytical evidence. He praised Utah's health care system. However, if Utah has such a good system, why such a high growth in enrollment during 2009-2010 and in the expenditure, and why is Utah Health Exchange plagued with low enrollment and high premiums? Moreover, the claim that ACA is a government takeover overlooks the fact that UHE, as in some other states, is a government-organized market place, just like ACA requires.

The column by Doug Olson, a small business owner, in the March 24 Standard-Examiner, points out the problems he faced in getting insurance from varied insurance companies in covering his wife's surgery-related medical bills. His experience is indicative of the problems ordinary people face in getting insurance, especially those with preexisting conditions. Sometimes insurance companies refuse coverage on the pretense that the doctor-approved treatment is experimental. A former health insurance executive, Wendell Porter, describes such an incident in his book, "Deadly Spin," which resulted in the death of a child.

Utah politicians do not have to worry about their lifetime taxpayer-paid coverage after only 10 years of service in the Legislature. I am sure federal government employees and politicians will not willingly reduce or do away with their generous taxpayer-provided coverage. Why do the politicians think that other people have to fend for themselves and be deprived of the opportunity to obtain lower priced group coverage if their employers do not provide insurance?

I understand that medical care in the U.S. is among the best in the world for those who have access to it at an affordable price. But those who are priced out of the market for any reason do not even have the opportunity to access the second-best medical care. As Professor David Cutler at Kennedy School of Government at Harvard states in "The Economists Voice," "Substantial empirical evidence shows that the major issues influencing insurance take-up are price and accessibility." The subsidies to low- and middle-income persons under the ACA will go a long way for many Americans to afford insurance and hence adequate medical care.

The access to medical care and its cost not only depends upon insurance markets but also on the pharmaceutical drugs markets and medical care markets in various regions of the country. For example, if medical care industry increases prices, it tends to increase insurance premiums. The cost of drugs, profit motive, monopolistic practices and diversified insurance pools also affect premiums.

The study by Leemore S. Dafny in American Economic Review's September 2010 issue finds that controlling for other effects, health insurers charge higher premiums to more profitable firms, and within an insurance company premiums escalate in the most concentrated (indicative of market power) markets. This study challenges the notion prevalent among many faithful but misinformed supporters of free competitive markets that health insurance markets are highly competitive. The Wall Street Journal, March 26-27, reports that the Justice Department has opened its antitrust probe into the Blue Cross-Blue Shield insurance plans' anti-competitive behavior in several states.

It is hoped that cool heads will prevail in the health care debate. The debate should be guided by factual information and solid objective analysis of the consequences of ACA, rather than ideology. If the ACA has certain deficiencies, then the responsible action will be to remove those deficiencies and substitute them with policies, which assure adequate health care for all Americans.

Mathur is former chair and now professor emeritus of economics, Department of Economics, Cleveland State University, Cleveland, Ohio. He writes original blogs for the Standard-Examiner http://blogs.standard.net/economics-etc/

Is lobbying to buy political influence bribery?

Vijay K. Mathur

Published in Standard-Examiner, March 19, 2011, Ogden, Utah

In governments, bribery is when someone pays, in kind or otherwise, for something of value from a politician or public official who willingly accepts or solicits payment (directly or indirectly) for public services and/or political favors. Bribery is mutually beneficial to both the giver and the receiver. Bribery breeds corruption and is a crime under the laws and 38 countries are parties to the Anti-Bribery Convention of OECD (Organization of Economic Cooperation and Development).

According to Wikipedia, Transparency International rated 22 countries in 2008 on the Bribery Payment Index on a scale from 1 to 10, where 1 means that bribery is an accepted norm and 10 means that "bribes are unknown." Even though the U.S. is one of the leaders in spearheading efforts to stamp out bribery and corruption around the world, its own rating on the bribery index is not very encouraging. The index for US was 8.1, and it ranked 9th where eight countries were less bribe-prone than U.S. The Foreign Corrupt Practices Act, enacted in 1977, prohibits businesses from bribing foreign officials to obtain business favors. However, the U.S. Chamber of Commerce is pushing to weaken the law, according to the website The Raw Story. On the annual Corruption Perception Index published by Transparency International, the U.S. is ranked 22 out of 91 countries; it is not an admirable showing.

Bribery is a hidden cost of doing business, and therefore it is passed on to the consumer in the form of higher prices. But it breeds inefficiencies because it directs resources to those who may not be able to compete in open market competition, and hence it adversely affects economic growth. Bribery results in general in the retention and enactment of regulations and laws contrary to the general welfare of most people, in corruption in governance, and it makes corruption contagious.

The question arises, is lobbying for favors from public officials and politicians the equivalent of bribery? Lobbyists are guided by their self-interest, just as in bribery. They represent business groups as well as non-business groups. Businesses lobby to gain contracts, secure market shares, tax breaks, subsidies and favorable regulations and laws. Non-businesses lobby to retain and/or pass laws and regulations, which may benefit only a selected group of people while imposing costs on the majority. But business lobbying dominates the total lobbying dollars. According to the Center for Responsive Politics, the top 20 lobbyists' spending ranged from $107.27 million (Pfizer Inc) to $738.8 million (U.S. Chamber of Commerce) during 1998-2010. In addition to spending on political campaigns, the total spending to lobby Congress and federal officials increased from $1.44 billion in 1998 to $3.49 billion in 2010. In 2010 there were 12,964 registered lobbyists spending on average $267,664 each, whereas the top 20 lobbyists spent an average of $26.23 million each.

Conceptually, lobbyists' spending on politicians and public officials is legally sanctioned bribery protected by increasingly stretched umbrella of the first Amendment of the Constitution; this protection is further stretched by the recent Supreme Court ruling in Citizens United v. Federal Election Commission. An outrageous example of lobbyist's influence is found in Utah where a legislator introduced bill SB231, which would have benefited his big donor at the expense of local zoning laws.

Congress has the power to regulate lobbyists' spending as well as legislators' and public officials' conduct at the receiving end, for example closing the revolving door between governmental services and lobbying. But so far lobbyists have the upper hand. Lobbyists argue that they perform valuable service to politicians and officials by providing issue-information. Even though their role in providing information is laudable, the corrupting influence of lavish spending by lobbyists overshadows their role as conveyers of information. For example the 2009 study by Deniz Igan, Prachi Misra and Thierry Tressel of the International Monetary Fund shows a significant link between spending on lobbying by financial institutions and high-risk lending and securitization practices. Such practices, motivated by financial gains, resulted in the most severe financial crisis and recession in recent memory.

The U.S. credibility in fighting a war on bribery and political corruption around the world is at stake if we do not "clean our own house." Perhaps an incentive system with penalties could focus more attention on receivers than on givers of financial favors; it is cost effective to monitor and discipline receivers. Like bribery, lavish uncontrolled spending by lobbyists to gain favors from politicians in the name of free speech has a corrupting influence on the politics and economics of free markets. It is more acute when there is lack of transparency in governance. Professors Jacob S. Hacker and Paul Pierson appropriately state in their book "Winner-Take-All Politics," "Markets are inevitably shaped and channeled by political forces, dependent on the rules that are created and enforced by those who control the coercive power of the state."

Mathur is former chair of the economics department and professor emeritus of economics, Cleveland State University, Cleveland, Ohio.  He writes original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Elements of socialism part of free enterprise economy

Vijay K. Mathur

Published in Standard-Examiner, February 28, 2011, Ogden, Utah

We hear a lot of negative talk about socialism from Utah legislators and other conservative groups like the Tea Party Express. However when it comes to their actions and/or proposals for legislation, they forget that their agendas can also be deemed socialistic.

Let me first explain socialism. In socialism the government controls means and quantities of production, as opposed to communism where, in addition to production, government also determines quantities of consumption. Just like the U.S. economy, Utah is a mixed economy where private markets, by and large, function in most private goods (a generic term which includes services as well), but the government plays a significant role in the provision of public goods and in other areas. For example, it fosters competition in markets, regulates damage and promotes beneficial spillover effects.

Private goods are those goods in which consumption primarily benefits the consumers who pay for those goods (no externality of benefits in consumption). But public goods, if provided in the market by some, benefit all, even those who do not pay for them (externality of benefits in consumption); hence no one will have the incentive to provide those goods. Therefore, economic efficiency requires that public goods be provided collectively (by government) using taxes to pay for them. That is not socialism, because the price system in markets fails to allocate resources and output. National defense and environmental quality are examples of public goods.

Even the 19th century intellectual and a classical British economist John Stuart Mill, the greatest defender of free markets, liberty, property rights and a severe critic of socialist thought, recognized the important role of government. Robert Ekelund, Jr. and Robert Hebert, in their book on the history of economic thought, state that Mill considered administration of justice, establishment and enforcement of property rights including environmental protection, protection of interests of minors and incompetents and provision of public goods like roads, canals, dams and other infrastructure projects as necessary functions of government. Mill also favored equal distribution of wealth (not income). In his view people are entitled to the income they earn from their own labor, but wealth is not an "end of itself."

Even Andrew Carnegie, according to David Nasaw in his book on Carnegie, an ardent supporter of capitalism, believed in and practiced wealth redistribution. Warren Buffet, Bill Gates and many others are also following the footsteps of Andrew Carnegie. Perhaps lawmakers, working on estate taxes, should read "Gospel of Wealth II," an article by Andrew Carnegie published in 1906 in North American Review.

In modern times, as Ekelund and Herbert state, "Every capitalist economy today possesses some socialist elements or institutions and vice versa." In fact we even have some programs that do not meet pure free enterprise test. For example, subsidies to ranchers, farmers, oil and gas producers, as well as many other spending and tax incentive programs do not meet the pure free market test, but we have them, supposedly, for the general welfare of the people. In fact, Article I, Section 8 of the Constitution even recognizes the role of government in promoting general welfare of the people.

In Utah, legislators are proposing legislations to control curriculum, giving control of public schools and higher education to the governor, to teach that the U.S. is a constitutional republic and not a pure democracy, and to eliminate tenure at public universities. Are these examples of socialism? In one sense such legislations do interfere with freedom of thought of educators and organizations, which Mills strongly defended. The irony is that the same politicians and conservative groups cry socialism when the federal government passes regulations that the state has to comply with, while ignoring socialistic leanings of state regulations.

Appropriate rules and regulations are a significant part of the free enterprise system. Food safety regulations benefit both producers and consumers, drug regulations are essential part of markets in pharmaceutical products, patent laws and enforcement protect innovations and hence businesses, financial regulations protect financial industry and consumers from fraud, environmental regulations protect people and businesses from health hazards and environmental damage. There are a host of other regulations that are essential for smooth operation of markets. Bloomberg Government Insider, Winter 2011, reports, "In a Bloomberg poll in December, that found 70 percent said government regulation is needed 'in most cases to protect public interest'..." But surprisingly 53 percent "of the respondents agreed that 'most American businesses' can not be trusted to act in public interest."

It seems that many media pundits, political leaders, bloggers, and media talk show hosts misguide the people when they label federal and state programs as products of socialistic agenda without understanding socialist thought and intent of regulations and laws in a mixed economy. Perhaps they need to be educated in the workings of the market economy, its limitations and the role of government.

Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He also posts original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/ .

Monopolization and the costs of drugs

Vijay K. Mathur

 Standard-Examiner, February 11, 2011, Ogden, Utah

 The patent system in U.S. has existed since 1790, but it has expanded substantially since 1836. It is designed to protect new inventions by establishing property rights to holders. On one hand the patent system is designed to encourage inventions, but at the same time it confirms monopoly power to the inventors. Since uncontrolled monopoly power is an inefficient market structure, Congress has to balance it with the incentive for inventions. At present this right is generally granted for 20 years.

After the 20-year brand-name monopoly is over, pharmaceutical companies have to face competition from generics. A recent news story in The Wall Street Journal, Jan. 13, points out that, "Brand-name drug companies are fighting to weaken a provision of the health care overhaul that was designed to open up generic competition in biotechnology medicines and save billions."

Biologic drugs are biologically synthesized, as opposed to chemically based drugs. The health care law of 2010 made the entry of generics relatively easy in the market place for generic biologics (biogenerics) to provide effective competition to brand-name biologic drugs. Biologic drugs are very expensive and thus have a very high profit margin. A February 2008 study by economist Dr. Robert Shapiro (Chairman of Sonecon, LLC, a private consulting firm and former undersecretary of Commerce for Economic Affairs) and his co-authors, shows that across all treatments the average cost of biologics is $16, 425, which is 20 times the average cost of traditional drugs. Therefore, drug companies like Genentech, Amgen, and Merck are very much concerned about losing their market share and profits with the advent of generic biologic drugs.

At present, fortunately for brand-name drug companies, Food and Drug Administration has not come up with an evaluation process for biogeneric drugs. Hence, in the meantime, biologic drug companies, who control close to 20 percent market share, are working on two fronts to maintain their monopoly power and profits. They are partnering with other companies to develop "biosimilar" drugs, which are copies of their brand name drugs. They are also engaged in intense lobbying efforts to convince FDA to grant them exclusivity rights for 12 years; it is a cheaper way to preserve monopoly power. Sens. Orrin Hatch of Utah and Kay Hagan of North Carolina, both Republicans, sent a letter to FDA requesting, " to interpret the law in ways favorable to the brand-name makers." These efforts to block the entry of biogeneric drugs is in addition to barriers to entry posed by complexity and cost of developing bioglogics as opposed to developing traditional drugs.

Biologic name-brand companies are asking FDA for 12 years of exclusivity rights to market their drugs, as opposed to five years pushed by counter groups like insurance companies and generic biologic companies. Drug companies argue that exclusivity rights will permit more inventions of these complex drugs. However, this argument is not supported by convincing evidence on their research and development efforts in relation to profits. Supporters of generics would argue that the development of generics would save patients billions of dollars. At present many patients cannot afford these lifesaving drugs. The research by Dr. Robert Shapiro and his co-authors shows that competition from biogeneric drugs across 12 treatments will result in an average price discount of 35 percent and will save a total of $378 billion over 20 years. Sen. Hatch, who claimed that health care legislation would be very costly to the nation, is now trying to push FDA to maintain the monopoly power and profits of these large biologic drug companies. Government action is the cheapest way to acquire monopoly power to control output, prices and profits.

According to Kaiser Family Foundation Americans spent $234.1 billion on prescription drugs. The pharmaceutical industry is the third most profitable industry. Prices of prescription drugs have increased at the average rate of 3.6 percent per year, much higher than the general inflation rate during 2000-2009. The average brand-name prescription drug price was four times the average price of a generic and manufacturers received almost 78 percent of the retail price. A Congressional Budget Office study in 2006 found that median return on assets of pharmaceutical companies was close to 12 percent, almost double the return for other Fortune 500 companies.

It is about time that politicians, including Sen. Hatch, pay attention to their voter-patients' concerns about high drug prices, health insurance cost and medical care cost. Protecting exorbitant profits of drug companies by promoting monopoly power does not benefit this nation, given the very high fraction of spending on prescription drugs by private and public sectors. Efforts should be made to open the drug market for all types of drugs for more competition, including importation of drugs from Europe and Canada.

Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He also blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Senator Hatch, balanced budget amendment is misguided

Vijay K. Mathur

Published in Standard-Examiner, January 30, 2011, Ogden, Utah

 Sens. Orrin Hatch, R-Utah, and John Cornyn, R-Texas, are attempting to push once again the balanced budget amendment; Senator Hatch thinks that this time most people are frightened by the deficit and the debt.

He did not succeed previously, but this time most in Congress will join their hands in harmony to tackle this supposed threat to national economic security. However, the senators do not realize that their amendment will increase economic and political insecurity. It seems that Sens. Hatch and Cornyn are not familiar with the way fiscal policy works and the real affects of public debt.

In his column in this paper on Jan. 27, "Balance the budget," Senator Hatch states that Washington spending is leading the nation into bankruptcy. However CBO's estimates on President Obama's budget show that the actual deficit was 9.9 percent of the GDP in 2009. It is projected to be 10.3 percent in 2010, and is expected to decrease continuously through 2020, when it would be only 5.6 percent of the GDP. This data does not show that we are on the path to bankruptcy.

Senator Hatch claims that Congress cannot be trusted to remain on the path of fiscal balance. However, he forgets that budget deficits have been with us since the 18th century. They have been generally on an increasing path since 1932. The deficit during 2002-2009 (including recession years) has been increasing at the average rate of 36 percent per year. Most of this period consists of President George W. Bush's years, when Senator Hatch voted for the discretionary war on Iraq and the Bush tax cut. He could have made a serious attempt to balance the budget and propose a war tax to pay for the war during this time period when the average economic growth was 5.9 percent per year.

After WW II, the federal debt (excluding debt held in federal government accounts) reached its lowest points at 23 percent of the GDP in 1974 from the high of 108.6 percent of GDP in 1946. After a slight increase in late '70s, there has been generally an upward movement in public debt as a percentage of GDP since 1982, irrespective of the political party in power. Senator Hatch is frightened by the increase in debt, not realizing that the economy has gone through a very severe recession, one not seen since the Great Depression. The CBO's debt forecast of 90 percent of GDP by 2020 should be viewed in proper perspective. Like us, most developed nations faced severe recessions during 2007-2009.

Therefore, for example, Euro area debt was 92 percent of GDP in 2010 and is not expected to be less in 2011; our debt will be 63 percent in 2011. We are fortunate that our economy is bouncing back with positive growth, partly because of the fiscal stimulus and assistance to the financial market, and it shows in the CBO's deficit forecast.

Senator Hatch exaggerates the burden on future generations. Most of the public debt is held domestically, and therefore to that extent domestic bondholders are asset rich. There is a transfer of income from non-holders of government bonds to holders. It does not affect the income of the country. Even if our children and grandchildren inherit debt, they will be asset rich. To the extent foreigners own our debt, there is a leakage of interest income from the U.S. But if foreigners get rich they will spend it somewhere, including imports from the U.S. To take advantage of high-income foreigners' demand, we have to become more competitive in the world market. It also requires that we save more and consume less, so that we have enough supply to meet foreigners' demand for our products. There is no convincing evidence that public debt reduces national saving or reduces our competiveness.

The real problem arises when the increase in public debt is beyond our capacity to service it and deprives us in meeting our other public demands for security and other services. Estimates show that interest payments in 2010 would be 2.9 percent of GDP, which would decline with increasing growth rate. Also, in the current environment of low interest rates, we have not seen any crowding out of private investment.

The effort on the part of private and public sectors should be to direct spending which helps develop new technologies, infrastructure, human capital and futuristic products so that we could compete in the world market.  Future generations will thank us for the real assets they will inherit, and at the same time we would generate robust growth and revenues in the current period. We need a sensible and stable tax structure and spending priorities, which encourage productive entrepreneurship.

Politicians should not think of the federal budget like state and local budgets. The federal budget is one of the most effective tools of fiscal policy. The amendment would deprive the federal government the use of that tool to manage the economy. Unless Congress can outlaw business cycles, the balanced budget amendment should be permanently buried.

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He offers original blog posts for the Standard-Examiner at http://blogs.standard.net/economics-etc/. He resides in Ogden.