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April 10, 2002
Economy doing fine by itself
By James W. Coons
The economy is on the mend, and a key to keeping it growing is avoiding policy mistakes. Economic activity grew to a new record in the fourth quarter, more than recouping the small third quarter decline. Employment and factory output are rising, and leading indicators are looking up. The greatest risk is that unwise economy policy actions restrain the expansion, not that it self-destructs.
Reactions to unfavorable economic events often have made things worse. For example, gas lines and rationing in the 1970s were created by the policy responses to the oil embargoes, not by the embargoes themselves. Similarly, the Great Depression was lengthened and deepened by policies designed to combat it.
Until the strength of the economy is widely recognized, reasons to tinker will resonate especially well. The secret to making the most of this economic expansion is to avoid overreacting to four economic pitfalls.
• First, Enron has the potential to do great damage, because of policies that it might elicit. New rules soon would be as inadequate as the old ones that inspired such innovative finance in the first place. And they will impose costs on all companies with prudent and law-abiding management.
Mother Market makes more laws and regulations unnecessary.
When I was a child, the instantaneous wrath of my mother was far more
effective at influencing my behavior than policies imposed by my father
when he got home. Likewise, as soon as Enron’s troubles surfaced,
the market summarily executed the next likely suspects while Congressional
hearings were just warming up. Corporate governance suddenly became a
high priority among investors, directors, and managers without any legislative
encouragement.
An equal danger is that tighter regulations would breed renewed complacency, thereby contributing to the likelihood of future Enrons.
• The second pitfall to avoid is a trade war. The
new steel tariffs will result in a shift in the mix of consumption away
from foreign product to domestic and a higher price for all steel.
The tariffs jeopardize the cooperation needed to advance international trade,
and the stakes are high. During the fifteen years ending in 2000, U.S. exports
grew three times faster than the rest of the economy. Approximately one-eighth
of U.S. output is now sold overseas, linking the country’s present standard
of living and growth prospects to foreign trade.
Even if the tariffs somehow avoid poisoning the international trade climate, they undercut the U.S. economy just as it is starting to recover. Studies claiming that more jobs will be lost than saved ring true. After all, the price of steel will be higher than it otherwise would be and the United States consumes more steel than it produces.
• The third pitfall to avoid is counterproductive economic stimulus measures. The recently passed bill is too late and too light on actual stimulus to boost the economy. Avoiding additional such efforts to aid the economy will help it grow.
True and lasting economic stimulus arises from relentless enforcement of property rights, a tax structure that makes implications of decisions clear in advance, low marginal tax rates, and regulatory policy grounded firmly in cost-benefit analysis.
None of this was in the bill. Instead, at least two provisions work against economic growth. First, extending unemployment benefits increases unemployment. One might argue the merits of jobless benefits on other grounds, but not as economic stimulus. Secondly, changes made to the federal corporate tax code by the bill will intensify pressure on already weakened state tax receipts.
• The fourth pitfall to avoid is waiting too long to raise short-term interest rates. The Federal Reserve cut interest rates to historic lows last year in response to the slump in the economy. Now that expansion is underway, rates must not be prevented from rising in step with economic growth.
Think of interest rates as the temperature of the economy, naturally falling when activity declines and rising when it picks up. The Fed needs to raise its target rate in sync with this natural rate just to achieve and then maintain a neutral stance. Leaving rates artificially low for too long will sow the seeds of a costly rise in inflation down the road.
Sometimes, avoiding mistakes is more important than making the right moves. For economic policy, this is one of those times.