Saturday, January 31, 2009

The Trickle-Down Fallacy

I was highly bemused yesterday to hear Rudy Giuliani, a recent contender for the Republican presidential nomination, defending exorbitant Wall Street bonuses:

“I don’t know if they’re 19 billion, 20 billion . . . those bonuses, if they’re reversed, is [sic] gonna cause unemployment . . . .”

Let’s examine this statement.

Under the current economic system, bloated Wall Street bonuses coincide with a vibrant economy. But in terms of cause and effect, Giuliani’s got things backwards: healthy economic growth results in spending, tax revenues—and incidentally, bonuses (especially for corporate managers whose enterprises have contributed to the economic growth).

At least, that’s the way it’s supposed to work.

I think most of us assume that bonuses should be rewards for work well done, for economic success and, by extension, for contributions to the general welfare. They should be incentives paid from profits to all whose efforts contributed to the general financial well being. In the world of high finance, however, they’ve too often become entitlements for obscenely rich and privileged executives who may have failed in their efforts or even behaved irresponsibly.

If “bonuses” are handed out regardless of results, where’s the incentive to improve performance? And if such bonuses are derived from tax revenues—your money and mine—why shouldn’t we be outraged?

Giuliani went on to say that when Wall Street workers get bonuses, New York profits because “that money gets spent. That money goes directly into the economy.” Hello! The money gets spent either way.

Here’s an analogy. Let’s say that a homeowner defaults on his or her mortgage or credit card debt but wants to buy a new car. By failing to take care of routine financial responsibilities, this citizen is hurting the economy—the mortgage or credit card companies. But by the same logic that seems to apply to the financial industry, the government should give this poor citizen the money to buy the new car—because buying automobiles stimulates the economy.

And if the government does that, where’s the incentive for the homeowner to pay bills and become fiscally responsible?

What we’re talking about here is a basic difference in philosophy. There are those who feel that money given to (or, ideally, earned by) big companies and corporations automatically stimulates the economy by creating jobs and stimulating financial growth. This requires entrusting a few individuals with the financial well-being of the many—which is how we’ve arrived at the state we’re in today.

Then there are those who believe that by helping individuals and families, we can stimulate the economy from the bottom up. Some money will still go to greedy, irresponsible people, because they are among us. But those individuals won’t have the power to upset the whole system. And for the most part, spending is spending.

We’ve tried “trickle down” in this country for a long time. I think it’s time we tried a little more “trickle up.”


Idna said...

I agree that bonuses should be given out to people who have earned them.

But as far as your "trickle up" theory, show me one example of a poor man giving a rich man a job.

Citizen Jane said...

The rich man doesn't need a job. As for the rest of us, there are many ways to stimulate jobs other than entrusting billions to the questionable judgment of a few CEOs. Money to schools buys jobs for teacher aids. Money to museums and arts organizations buys jobs for curators and secretaries. Money to states buys jobs for road workers and family counselors. Money to cities buys jobs for bus drivers.

Idna said...

Dear Jane,

All the "stimulating" jobs that you mention are paid for by Taxpayer money. None of these jobs are truly a "created" job by a business that actually grows the economy in the longrun.

The government does not MAKE money, it only TAKES money. And the money it takes, it redistributes to others. In contrast, a business actually creates something new. It doesn't rely on a hand out from the government using other people's money.

This is why the whole stimulus thing is all together a really BAD thing for our economic system. Companies that are run poorly, that are run unethically, or greedily (to use a favorite adverb these days) ought to be allowed to go out of business.

You don't think that the failed companies' managers should receive huge bonuses? Well, neither do I. But I also don't think that government should throw money at failing schools year after year.

I also think that labor unions shouldn't be allowed to use their mafia-like control over businesses to force them to pay higher salaries and benefits if the workers haven't earned it by improving the company's bottom line.

I know that "the bottom line" is a nasty concept these days. Sorry, that's the way our economy works. You want touchy-feely economics, go to Cuba. See how well the "Trickle-Up" works there.

Hope said...

Citizen Jane, you list all kinds of jobs government can offer but you miss an important distinction. When government provides jobs, the taxpayers must pay more and more to fund those jobs. Government jobs do not create profit; they do not improve the economic strength of our country.

Small business is the main source of jobs in our country, and higher taxes to pay for more government jobs will stifle small business growth and thereby limit job creation.

The "trickle up" theory is bogus. Those in economic hardship do not use their government handouts to create liveable, sustainable jobs for other people!

Citizen Jane said...

Idna, we're not talking about the government creating jobs that have to be maintained by the government. We're talking about "stimulus," which the economy needs right now like a blood transfusion. Let me give you an example.

My part-time job, which is helping families in crisis and is funded by the state, has been cut back. Without federal help to the state, it will disappear by summer. I'm fortunate enough that in my case, my main job is secure. (I hope.) But on a daily basis, I'm not putting money into the economy that I would if I were fully employed, as before.

I'm cutting back on investments. I'm not ordering books from I'm saying no to ideas about buying new clothes and other nonessentials. We don't eat out as much as we used to. Small businesses are closing all over our town, and even though I live in an area less impacted than most by the economy (thanks to reliable federal spending on regional projects) business at local mall is on a par with the national average--way, way down.

The proposed stimulus bill will infuse money right where it's needed--into the hands of American families and individuals, who can then support the prosperity of their local communities.

Let's get on with it.

Citizen Jane said...

Hope, help me out here. You say that "higher taxes to pay for more government jobs will stifle small business growth."

First, who's said anything about creating more "government" jobs? The stimulus plan isn't creating some new national infrastructure in which everyone works for the government. Rather, it's designed to support the employers already out there (from business franchises to state governments) who employ people.

Secondly, what could help small businesses more than making sure people (real, flesh-and-blood ordinary folks, not just big business managers and entrepreneurs) have jobs and money to spend?

Concreata said...

Let me respond this way, not all spending is good for the economy. The big difference between having government spend a trillion or giving private enterprise a trillion in the form of tax cuts is this. This huge level of Government spending doubles the deficit, threatening the value of our currency and trillions of bonds held by foreign central banks. If they start dumping US treasury bonds because of expected inflation, it alone could cause world meltdown. But there are also domestic reasons: government spending is a political act and by its very nature an inefficient allocation of capital. Why? Just look at the current stimulus bill - all pork no beef. Its the Jimmy Carter stagflation years deja vu all over again - low growth, rising inflation from all the wasted government spending. Only the politicians, the stilted media or the truly delusional would think this anything close to a panacea. Now lets give the same trillion in the form of tax cuts. What would happen. Well Fred Smith of FEDEX said he would buy 3 more 777's from Boeing by changing IRS depreciation schedules allowing companies to immediately expense capital expenditures. History shows this one law has huge impact on capital spending which drives jobs and higher productivity. How about reducing maybe even eliminating the capital gains tax to get the 4 trillion sitting on the sidelines back into stocks? History shows even a 5% reduction can boost both stock prices and tax revenues (because more investors are in the market paying taxes, albeit lower rate). Rising stock prices means companies don't need TARP and companies can plan expansion and job growth once again. Most importantly, tax cuts do not increase the deficit, so inflation and currency devaluation risk is improved. Plus, the tax cuts spur growth that replaces at least 75% of reduced revenues (based on studies of tax cuts during Clinton and Reagan years). So even our politicians only have to sacrifice a little in the interest of spreading a little of the wealth around.

archibald wilberforce said...

Concreata - your points are a little esoteric, could you give explain why govt spending is inflationary? Frankly, I am dubious that companies that got us into this mess could really help pull us out?

concreata said...

Let me try and clarify. When Government gives you a dollar to spend and you buy a car, that is good in one sense, it does create consumption spending. Problem is government had to borrow to get the money to give you. It becomes inflationary because productive capacity did not increase (sometimes called GDP Gross Domestic Product) just the spending increases. This imbalance if large enough can cause inflation. If companies get tax cuts for same amount to create production accompanied by increase jobs ie personal income and spending, the producers and spenders in the economy are in equilibrium, in balance, and inflation is tame. It is fashionable to bash companies for our problems today. But the problem companies who started this mess - Fannie and Freddie - were subsidized, regulated and protected by democratic leaders in government. The record is clear and many economists agree, had we reined them in, our problems today would be much different, a normal recession many say. So its not companies, but the overreaching of government that creates economic distortions and unintended consequences that become political battlegrounds. Right now decisions are primarily political not economic based. Tax cuts are the proven remedy - they have worked in the past - but Congress and the President resist these measures for political reasons and spew discredited Keynesian economic theories to justify massive spending which will come back to haunt - probably very soon.

Citizen Jane said...

Concreata, we've been over all this again and again--"we" being the whole country. We need new ideas, not the same old arguments, assertions, and innuendos. The failures of Fanny and Freddie were symptoms of the mess we're in, not the cause. But that's beside the point.

The point is that the old tactics of tearing down anything suggested by "the opposition" is counterproductive. As in interpersonal relationships, we have to look for things we can agree about and constructive steps we can take now.

Bush's bailout didn't work. Let's get going with something that may. Treading water while businesses continue to fail and millions lose their jobs is not a responsible option. We as a nation have to quit working against each other and start working together.

Idna said...

Dear Citizen Jane,

It's very troubling to me that you just want to ignore historical facts about the results of various economic policies.

You dismiss sound arguments put forth by others on this blog as "the same old arguments, assertions, and innuendos." These same "old arguments" may just be voices trying to get back to sane policies of capitalism, private enterprise and small government.

Some of your wistful "new ideas" that you alude to are ones that may be new to our country, but have been tried by other governments to dismal results.

You say "as in interpersonal relationships, we have to look for things we can agree about." This is no time for a Kumbaya moment. There are right ways to go about it and wrong ways. And I hope to God that those with the right ideas don't cave just to reach "consensus."

What we need are people who know what they are talking about when it comes to the economy. Not politicians and community activists who have only been on the "taking end" of taxpayer funds most of their lives.

And finally, a question for you ... if you don't believe that the mortgage crisis, fueled by Fannie & Freddie were the cause of the "mess" of today, then what do you think was? No copping out with a blanket statement that it was all Bush's fault. Please get specific. What was it?

Citizen Jane said...

Dear Idna,

It’s very troubling to me that the Republican spin machine is so engaged in the effort to write history in such a way as to deny all responsibility and blame Democrats for the world-wide economic catastrophe.

Here’s an example. Somewhere between 300 and 400 bills each year make it all the way through Congress and are signed by the president—many of them having to do, directly or indirectly, with the economy. For some reason, those fixated on blaming the Democrats for the world’s economic woes have singled out the Community Reinvestment Act (CRA) of 1977. On the face of it, the notion that this one bill (greatly revised, distorted, and weakened under the Bush administration) is to blame for the lending fiasco (and, hence, for the current economic depression) is absurd. Of course, those wishing to bolster the argument of either party can find dozens of arguments to support their claims. (Here, for example, is a fairly cogent argument supporting the notion that the CRA had nothing to do with the crisis:

When it comes to history, it’s often not that easy to decide which “facts” should be extracted from the total fabric of reality and treated as important. I don’t believe either side can pull out one thread and say, “This is what caused the financial crisis.” However, Bush and his colleagues had eight years to monkey with the system (following a long period of Republican domination in Congress), and he didn’t even see it coming. Clearly, the Republicans don’t have all the answers.

As for listening to those who “know what they’re talking about” in terms of economics, which of the Bush administration officials should we listen to who touted the “strong economy” right up until it crashed? Obama has stacked the deck in his administration with many centrist economists (Geithner, Orszag, Romer, and others) who have been praised by their colleagues for having sound and innovative ideas. Let’s quit shouting out the old slogans and give them a chance.

Because I have a “day job,” I am now finished debating the minutiae of economic policies—including what role F & F played in the disaster (which is highly debatable). Instead, I’d like to focus on philosophy—which is, after all, the core of all policies. It really boils down to what role government should play in the lives of its citizens, and that’s what I will be focusing on in the coming weeks. If we—the collective American “we”—could agree on that, I think many of our differences would be resolved.