The principle of homeopathic medicine is to “let like be cured by like”: treat an illness by giving patients minute quantities of medicines that produce the same symptoms. But treating indigestion with a 10-course meal is not a good idea. This is why throwing borrowed funds at the current economic crisis, which was caused by excessive borrowing in the first place, has failed to set the U.S. economy on course to a lasting recovery. Such policies are likely to make matters worse — as the government debt crisis in Europe has demonstrated.
Jobs will need to be created and consumer demand revived as a prerequisite for renewed economic growth, but it will have to be done by tapping underutilized sectors of the economy. In other words, economic stimulus should be provided not by the government, which is already dangerously in debt, but by those who are sitting on a pile of cash, notably U.S. corporates. The challenge is to encourage them invest this money.
The 2008 crisis marked an end of an economic era. In 2008, the sources of growth powering the U.S. economy since the early 1980s suddenly disappeared. The economy went into a free-fall. It was arrested by massive government spending, a rescue package for banks and relentless printing of money by the Federal Reserve, but those measures could not restart the economy. After three years of anemic growth, signs of another recession emerged in August 2011.
This situation is not unique. It was seen twice over the past hundred years. Economist Nikolai Kondratieff identified long-term cycles, the so-called Kondratieff waves lasting a number of decades and ending in a depression. The economy ran out of sources of growth in the late 1920s, triggering the Great Depression. A similar situation arose in the 1970s, except the result was stagflation, an unprecedented combination of no growth and double-digit inflation. The Great Recession of 2008 featured a contraction followed by a weak recovery that could yet turn into a double-dip slump.
The early 1930s and late 1970s saw many proposed economic fixes. In both eras, there was a do-nothing school of thought, contending the economy was fundamentally healthy and in time growth would return on its own. Herbert Hoover, who was in the first year of his administration when Wall Street crashed, spent the remaining three years doing nothing. His approach was later validated by economist Milton Friedman, who believed that the only mistake had been made by the Fed, which failed to pump in enough liquidity for the banks to resume lending.
In the second half of the 1970s, Jimmy Carter similarly failed to offer any new ideas to revive the stalled U.S. economy. On the contrary, the Democrats were opposed to Ronald Reagan’s economic agenda, which created a new growth paradigm for the economy and was instrumental in building economic prosperity over the ensuing 30 years.
In the 1930s, the Roosevelt administration alleviated the effects of the Depression by public works. But its more lasting contribution was to put into place a socioeconomic framework that ensured that the U.S. economy would continue to grow long after the end of World War II. FDR tapped the underutilized resources of the federal government, which before the Depression had played a relatively small role in the U.S. economy.
However, the system bore the seed of its own destruction. Aggregate demand was sustained by various government programs and consumer demand was sustained by redistributive programs such as Social Security, unemployment insurance and welfare. At the same time, though, supply was constrained by a tangle of regulations. Eventually, too much money ended up chasing a set quantity of goods and services, spurring price increases that further dampened investment and inhibited economic growth.
The success of the Reagan reforms was also based on the fact that they tapped underutilized economic resources. Reaganomics scrapped regulations, freed up the labor market by reducing the power of the unions and unleashed the American entrepreneurial spirit. Underpinning the revolution on the supply side was the deregulation and the rapid growth of the financial services industry. The revolution in finance funded the information technology revolution in the 1980s and the 1990s and created an entrepreneurial boom of the past two decades, while at the same time financing demand growth among American consumers.
For all its anti-government rhetoric, the Reagan revolution failed to reduce the size of the government. Taxes were cut, but government continued to grow in size and scope, becoming more and more costly. Starting in the early 1980s, government debt began to expand. In a sense, the government contributed to the consumer boom of the past 30 years by returning cash to taxpayers in the form of tax cuts and replacing the lost revenue with borrowing.
When the financial bubble burst in 2008, triggering the deflation of the housing bubble and eliminating millions of jobs, consumer credit dried up as well. Many people were no longer creditworthy, and those who could borrow suddenly turned cautious. The government stepped in, since it was still able to borrow, and boosted aggregate demand by running budget deficits in excess of $1 trillion annually.
But piling up more debt with no obvious end in sight is bad economics and bad politics. It is immoral, as it saddles our children and grandchildren with a crippling burden. It is politically untenable, as the Republicans showed over the summer by refusing to raise the $14.2 trillion debt ceiling. Finally, it is a financial disaster waiting to happen: it is like the current Greek debt crisis multiplied many times over.
Where’s the Money?
The consumer and the government having been tapped out, economic policy should turn to the underutilized sectors of the economy. It is easy to spot such sectors: just look at who has the money. Fortune 500 companies had a $2 trillion hoard of cash as of end-2010, the biggest in half a century.
The reason why companies have so much money is well-known. They have nothing to invest it in. Consumer demand growth is slack, unemployment remains high and the housing market is flat. No corporate executive is going to invest into new capacity, spend much on R&D or hire new employees.
While companies don’t have any reason to invest in supply, they will certainly benefit a great deal by investing in demand. The problem is that while each company looks after its own supply, it can’t do much to stimulate overall demand in the economy. This is why they need guidance, legislation and policy stimulus from the government.
The government should start by setting up private/public partnerships at the state, municipal and local levels that will act as a network of economic stimulus agencies. The agencies will undertake infrastructure projects, invest in job training, fund local entrepreneurs and act as micro-lenders in local communities. Such agencies should be set up as self-sustaining, for-profit operations working under contract with local governments and local employees, and taking equity stakes in infrastructure projects. Businesses investing in such projects and local governments should have equity stakes in development agencies, which they should be able to sell in the stock market. At the same time, the tax code should incentivize companies to invest in such agencies rather than keep cash on their balance sheets.
Once businesses see signs of increased unemployment and increased demand, they will start investing into their own productive capabilities as well, thus spurring economic growth further and creating a benign cycle.
There has been talk in recent months that corporates will soon start returning cash to shareholders by boosting dividends and repurchasing shares — or else that they will deploy their cash holdings to purchase other companies. This is unlikely to happen. A period of strong profits growth may be coming to an end. On the contrary, if a recession looms, corporates will need cash cushions to stay afloat.
Recent rounds of layoffs and cost cuts have been driven not by the need to boost efficiency but to safeguard profitability. A number of mergers have been postponed or canceled due to economic uncertainty. Unless a way is found soon to deploy excess corporate cash to stimulate demand, the $2 trillion cash hoard will be dissipated uselessly in defensive action.
Alexei Bayer is an economist and author based in New York City.