Professor Michael Reich wrote an “open” letter to Californians last week that was published on many websites entitled: Can Californians Trust What Whitman is Selling? I will now illuminate the flawed analysis of the Harvard Business school educated professor.
Professor Reich begins by asking the question whether California can regain the type of growth it has experienced over the last three decades. He refutes Whitman’s claim that growth is being hindered by large government, high taxes, and increased regulation by stating: “until the Great Recession of 2007-2009, California’s performance in the 2000s exceeded the national average.” He then goes on to describe how “California’s unemployment rate is higher than the national rate primarily because the state’s residential construction and associated real estate and finance sectors expanded during the housing bubble to a greater degree than the rest of the United States.”
Later in the letter he laments the idea that Whitman is confusing causality and correlation. The natural question is: was the massive housing boom, spurred by Alan Greenspan’s insistence on leaving interest rates at (what were then) all-time lows, the causality that leads Mr. Reich to cite California’s massive economic growth of the 2000’s? Common sense would say yes. But this answer would be too simplistic for this academic. Instead, he blames the lack of regulation as the reason for the housing bubble. He goes on the cite Texas as a state that had more regulation and today has fewer foreclosures. However, he fails to mention that Texas has no income tax, a lower 6.5% sales tax [vs. 8.25% in California], lower local taxes and a population that is growing from taxpaying individuals moving to Texas. In fact, from 2000-2009 the Census estimates 848,000 people moved to Texas from other states, compared to California, which saw 1,509,000 people emigrate from the state during the same period. Moreover, after the 2010 census is released, it is likely that for the first time in history, California will not gain a seat in the House of Representatives.
Blaming the lack of regulation in the housing market as the sole reason for California’s economic problems, reveals Mr. Reich’s too-narrow analysis of the state and the country’s economic situation. As his letter continues, his argument becomes worse.
For example, Reich states:
“a tentative national economic recovery is underway, generated by action in Washington—including the 2009 American Recovery and Reinvestment Act—as well as a moderate upswing in business and consumer spending and international trade. California’s economy is beginning to recover as well. According to forecasts from the State Department of Finance and from independent forecasters, California should gain 1.25 million jobs by 2015 without any of Whitman’s policies.”
As demonstrated in the prior post, there is no recovery, the stimulus has failed, unemployment is set to move higher (just check weekly unemployment claims which are approaching the recession number of 500,000), and the stock market has fallen off its highs [and is set to fall further]. All the government has to show for its efforts is a debt-to-GDP ratio that is approaching 100%.
Forecasts by any government institution should always be taken with a huge grain of sea salt. Their forecasts are always optimistic because politicians want to be re-elected. Giving a grim outlook would make the general public disdainful of the job that their elected officials have done.
Regarding independent forecasters—Reich refers to Mark Zandi of Moody’s later in the article—these are the same forecasters who only admitted the US was in recession after Lehman Brothers collapsed in September 2008. In fact, Mr. Zandi missed the boat entirely. This is what he had to say in a 2006 NYT article about a possible housing bubble: "Even in the most vulnerable markets, most people just have to look through it and ignore it: ‘Because it's of very little relevance to them.’” Mr. Reich’s use of Mr. Zandi’s forecast’s is similar to the auto mechanic who keeps telling you that ‘your car is fine,’ even though it continues to break down on a consistent basis.
Of course the main argument of a Keynesian like Reich is that the money multiplier-effect creates economic growth. This argument says: one dollar created by the Federal Reserve can multiply itself, using the fractional reserve banking system that banks employ today. Each bank is allowed to loan 90% of each dollar on reserve. Therefore, in theory, the more money that that is held in bank reserves, the more money there is for banks to loan for businesses to expand and grow the economy. This argument ignores the deficit, concluding it is more important to “jump start” the economy, than worry about the occurrence of debt. This policy has been tried in Japan over the past two decades with terrible results. From 1988 to 2008 Japan increased their debt to GDP from 50% to 190%. All the Japanese have to show for this money printing is an economy in shambles, which has taken a terrible toll on its citizenry. (See http://english.caing.com/2010-03-15/100126807.html) What Reich and other Keynesians fail to recognize is that lending does not automatically follow from plentiful reserves held by banks. As America’s current situation demonstrates, if there are few viable opportunities for banks to lend, then the excess reserves sit on their balance sheets and do not move into the economy. Moreover, if one takes a look at the M3 money supply, which tracks the velocity of money in the economy, it is crashing—yet another signal of deflation. The latter is something Japan has been dealing with for twenty years.
One point I agree with Mr. Reich is on the need for a rainy day fund. “Mandating that California put more of its revenue in good years into a “rainy day” reserve fund would go far toward limiting spending growth to sustainable levels…” However, good theory failed to become reality. Over the past several decades, California politicians have shown themselves to be completely incapable of controlling their urge to spend when there is excess cash in their coffers. For this reason I hold little hope of Reich’s ‘rainy day’ theory becoming a reality.
In the following paragraphs, Reich describes how spending cuts to education, healthcare, correction facilities and social services will have a negative impact on the economy. Though this is true, what are the alternatives? These institutions have grown like a cancer inside the state’s body-politic. To suggest that we keep the same policies in place seems benighted. Why not try something different? If the doctor prescribes medicine to a patient for a long-term illness, and the patient’s health continues to decline, a good doctor would change the medication, would he not? In California we need to give a new medication a try.
Regarding Whitman’s proposed cuts in education, whereby she ambiguously proposes putting more money “into the classroom,” while hair-cutting the administrators’ overhead, Reich again equates total expenditures for K-12, with actual successful education. “According to Next 10, a San Francisco-based, nonprofit research institute, current policies will leave per pupil spending in California $3,200 (23 percent) below the national average by 2015.” By making this statement, Reich infers that the more money one spends on schools, the better educated the children become. Moreover, he seems to indicate that the current public education system, besides its lack of funding, is doing an adequate job.
The education debate is one that could take many pages; alas, I digress. However, I believe that implementing a market-based system (which I do not see Whitman proposing) would have a positive outcome. After all, there is perhaps no other field that someone’s job performance does not directly equate to their compensation. Instead, teachers are paid based on how many years they have been on the job. The end result: too many teachers teach for their incremental yearly raises, and not for the benefit of their students.
Much of this problem can be blamed on the powerful teachers’ union, whose spokesperson famously stated during a budget debate a few years ago: “we don’t care about the state, just give us our share.” In a perfect world, one might disband the teachers union and implement a market-based incentive-structure. This would allow young, motivated and inspiring teachers to embark on a career that they knew would reward hard work and effort with something other than a summer vacation. I speak from experience having attended California public schools from 7th-12th grade. I can remember many teachers, whom students desired to have because nothing was actually taught in the classroom. Students would use these classes as social time, and still get A’s because of the complacent teacher. We need to incentivize young, bright people to go into teaching so that they can motivate the next generation. Only then will we see our education system start to educate.
The arguments Reich makes against cuts to health and human services can be summed up in one phrase: self-accountability. Too much money is spent in these sectors because too many people in this state believe that the government should take care of them. This type of thinking is what led to the downfall of many socialist regimes. People see their neighbors working less hard or not at all, and still getting the same benefits as themselves. Now this is not a Republican or Democrat issue. This is a larger societal issue. And it is at the heart of why there are more registered independent voters in California than those with a party affiliation. Individuals need to be accountable for their actions. Making some cuts in health and human services, though painful in the short term, might actually have a positive effect in the long run. After all, we have tried it the other way.
Perhaps the most obtuse argument Reich makes is claiming that California’s government is not too large. In support of this claim, he states that
“California’s government employment per capita was 28 percent below the U.S. average, ranking 48th among the states, and California state employment per capita has not increased since the early 1980s.” But comparing the size of our state’s government to that of other states is baseless. A more useful comparison would be to compare public compensation to that of the private sector. In the past ten years, the average compensation for a public employee has gone from $76,187 to $119,982. In the private sector during the same period (bear in mind many private sector employees have to buy their own health insurance) compensation on average has gone from $45,772 to $59,909. This might suggest that local, state, and federal governments—and their compensation-programs for employees--have become too large.
This letter by Mr. Reich has gained much attention in the media and online. In fact, if one searches Google using the keywords “Whitman economic plan”, one finds the first page filled with links to websites that support Reich’s argument. This might initiate a whole other debate regarding how Google’s search-crawler censors some links that searchers might be seeking. However, one sample of the public’s reaction to Reich’s letter can be found in the ‘comments section’ of a recent issue of The Daily Californian: http://www.dailycal.org/article/109996/professors_criticize_meg_whitman_s_economic_policy
There one finds that many readers have had enough of the idea that large government is good for all. Of the 23 comments that were made—as of this writing—there is only one in support of Mr. Reich’s writing. Contrarily, 20 comments take aim at his viewpoints in a less than friendly way. This evidence is not scientific, but it gives a glimpse into how upset the public has become with the idea that government cures all ills. This hostility that the public has shown, will undoubtedly rear its head come the November elections. Hopefully, some of the commentators are students in Mr. Reich’s class, and will question his thinking during lecture. However, after checking his ratings at ratemyproffessor.com, one might conclude that his students are not finding his arguments persuasive.
There is a general feeling in America and in California that times have changed—and that the days of large and inefficient governments need to be put behind us. If one talks to small business owners—the ones who supply 65% of the jobs in the country—they tell you how depressed business is right now. Unfortunately, Mr. Reich and his other academics spend too much of their time in their offices, looking at Keynesian theory, which at this moment is being proved wrong, instead of listening to the people who produce the wealth of our economy.
Meg Whitman is not the best suited candidate for governor, and her track record as a businesswoman is spotty at best. The question of who to vote for always is a matter of the lesser of two evils. At this moment in time, I foresee that Jerry Brown will simply continue the same policies that have created the fiscal mess that California deals with on a yearly basis. Much for the same reason that Arnold Schwarzenegger was elected in 2003, Meg Whitman will, I believe, be elected in 2010. I doubt that Mr. Reich’s Keynesian explanations will be of much use to his students at UC Berkeley.
i. Mauldin, John. "Quarterly Review and Outlook - First Quarter 2009 - John Mauldin's Outside the Box - InvestorsInsight.com | Financial Intelligence, Advice & Research / Investment Strategies & Planning for Individual Investors." Email distribution. InvestorsInsight.com - InvestorsInsight.com | Financial Intelligence, Advice & Research / Investment Strategies & Planning for Individual Investors. 20 Apr. 2009. Web. 15 Aug. 2010.
