Economic Policy for Future Presidents

By JD Foster

Ever wonder what politicians and reporters mean when discussing economic policy, and then wish you understood them better? What do they mean by deficits, debt, and tax policy? What is monetary policy or income inequality? What are the economics of climate change—and its remedies?
If you’ve asked such questions, then this book is for you. To make the matter more compelling, it puts you in the Oval Office as the incoming president and walks you through essential issues, presenting the information conversationally, hoping to remain interesting, intending to help you become conversant, not an expert.

• Language: English
• Publisher: Xlibris US
• Release date: Nov 29, 2020
• ISBN: 9781664144729

JD Foster

JD Foster analyzed and researched federal economic policy in Washington, D.C., for thirty-five years, having twice served in the White House, as well as with the U.S. Treasury, for three senators, a senior representative, and at three research organizations. He concluded his career as chief economist and senior vice president at the U.S. Chamber of Commerce. He brings a lifelong curiosity and a passion to federal economic policy because policy directly affects people’s lives and greatly influences the nation’s prosperity and security. Foster received his undergraduate degrees in economics and mathematics from the University of Colorado and his PhD in economics from Georgetown University.

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Copyright © 2020 by JD Foster.

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Rev. date: 11/28/2020

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CONTENTS

Preface

Introduction

Your Team

Back to Reality

Chapter 1: What Is the Economy?

Guiding Signals

Prices and Public Policy

A Tree Grows

Causes of Economic Contractions

About Economic Data

Chapter 2: Fiscal Policy – Spending and Deficits

Spending Time

In Debt to You

Cause for Concern

Fiscal Policy during Recessions

Follow the Money

Debt and the Future

The Debt Ceiling and Default

Chapter 3: The Tax Man Cometh

A Diversity of Purposes – Revenues without the Hissing

Redistributing Income

Who Knows Best?

Taxes and Economic Growth

Horizontal Distortions

Vertical Distortions

The Case of Capital

Taxing Consumption

Supply-Side Economics

Alternative Tax Systems

Value-Added Tax (VAT)

Wealth Tax

Financial Transactions Tax (FTT)

Carbon Consumption Tax

Chapter 4: In Fed Do We Trust?

The Board and Company

Why a Fed?

Inflation Basics

Inflation’s Causes

When Is Inflation a Problem?

Bank Reserves and Open Market Operations

Lender of Last Resort

The Federal Funds Rate

A Neutral Rate

Quantitative Easing

Interest on Excess Reserves

Does Monetary Policy Matter?

Forward Guidance

The Zero Lower Bound (ZLB)

A Word about Cranks and Modern Monetary Theory

Politics and the Fed

Why Is This Business So Hard?

Chapter 5: Exchange Rates and What You Can Do about Them

Three Posers to Ponder

Legacy Beliefs

Flexible Exchange Rates

The 800-Pound Gorilla of International Finance

Recalling the Posers

Chapter 6: International Trade

Comparative Advantage at Work, or Not

Barriers to Free Trade

Existing Trade Arrangements

China

Chapter 7: Putting Security Back into Social Security

Social Security’s Source

What’s the Problem?

Default Reform and Sizing the Problem

But It’s My Money!

What to Do?

Technical Changes

Inflation Indexing of Benefits

Social Security Earnings Test

Modernization Reforms

Eligibility Age

Indexing Wages

Fundamental Reforms

Social Insurance

Means Testing for Progressivity

Personal Accounts

Closing the Loop with Tax Changes

Chapter 8: Medicare and Health Care

Medicare from Thirty Thousand Feet

Medicare in Parts

How Deep Is the Hole?

Reforms from Basic and Essential to Broad and Fundamental

Beyond HI

Broader Reforms: The Uninsured and Medicare for More, or All

Medicare For All Who Want It

Back to Medicare for All

Chapter 9: Going Into Labor

From Normal to NAIRU and the Phillips Curve

Technology, Frictions, and Mobility

Wages and Their Determinants

Creating Jobs

Federal Labor Policy

Paid Family Leave

Raising the Minimum Wage

Chapter 10: Economic Inequality

Helping the Have Nots vs. Hammering the Haves

Measuring Richness

Changes vs. Levels, Gross vs. Net

The Gini, No Bottle

A Poverty of (Sensible) Poverty Statistics

The Unbreakable Law

Chapter 11: Important Odds ’N’ Ends

Health Care

Price Controls

Nixon’s Experiment

Rent Controls

The Economics of Climate Change

A Surprising Question

Transition

Responding to Climate Change

Defined-Benefit Pension Plans

Public Pensions as Financial Sinkholes

Private-Sector Plans

What’s the Problem with DB Plans?

Enter the PBGC

The Multiemployer Multifailure

Cost-Benefit Analysis

Paperwork Reduction Act of 1980

The Big Kahuna

Socialism vs. the American Experience

Chapter 12: Final Words

Missing Pieces

Glossary of Key Terms

To my

family who patiently endure my animated monologues on

economics and economic policy; to the politicians who strive to

understand economic policy; and to the citizens who strive to do

likewise and sensibly judge the politicians’ actions accordingly.

Preface

Most textbooks define economics as the study of allocating scarce resources across vastly greater needs, or words to that effect. Now you see why it’s sometimes, if inaptly, called the dismal science.

The first problem with calling economics the dismal science is it isn’t really a science. (Most economists reading this are already mad at me, which may reassure you that continuing is worthwhile.) Whenever possible, economists use scientific methods on par with any of the physical sciences, but when reviewing the vast disagreements among professional economists over fundamental issues, to suggest it is a science stretches the word past its breaking point.

Nor is economics dismal. Far from it. Consider as an alternative that economics is the study of how people individually and collectively combine their skills and energies with other resources to produce what other people need and want, along the way prospering themselves and society generally.

Consider the cell phone and the Internet, the wondrous advances in medical science, the progress against hunger and illiteracy, the opportunities available to those who seize them, and more—there’s nothing dismal about any of it. Economics manifests and is the study of a marvelous process of budding prosperity and improving quality of life.

It’s not all a bowl of cherries. We also have to face the dark side. Poverty and inequality persist. Pollution often results. Opportunities, jobs, and wage growth are often inadequate. These are issues to address, often with public policy, but they shouldn’t distract us from the enormous good a well-functioning economy can produce. Dismal? Rubbish.

Which raises another point. This isn’t a primer for college economics. We’re not going to explore consumer surplus, production functions, and oligopolistic competition. If you’ve had a college economics course and those terms send a shiver down your spine, all I can say is, Sorry. If you’re going to be an economist, you need to know these things.

Most everyone else doesn’t need to know the more technical aspects of economics. If you’re the President of the United States or some other government official, or if you’re a staffer, or a reporter covering these issues, or a citizen trying to understand the commercial world around you, then you just need some basic understanding of economics and economic policy. That’s where this little book comes in. This book won’t qualify you as an economic expert in any of the subjects covered; but after reading it, you should have enough background to make some sense of your briefings, the debates you hear, and the articles you read on various common economic policy issues.

If you’re like most people—politicians especially—you probably think you already have a good handle on these matters. If you do, then good for you! Most people have no idea of the vast scope of economics they know nothing about, and policymakers rarely learn of their knowledge gaps until after the need arises.

I have briefed presidents, senators, congressmen, governors, CEOs, and all manner of business leaders and reporters. The vast majority were highly intelligent individuals. Most thought they already knew most of what they needed to know. Few did, and so the briefing would be spent mostly escorting them to first base. Few politicians ever move past first base on a topic, and so they jump to a conclusion they hope is waiting for them at home plate. My hope is you’ll be sitting pretty at first base at your next briefing so your briefing team can knock you home standing up.

This book is written as though you the reader are indeed the president-elect of the United States. Before turning to the piles of complex briefing books your staff has prepared, you need a starting point, an overview, such as the following pages provide. Chances are, you’re not the president-elect; but the exercise may be more interesting if you imagine you are, or perhaps that you’re reading over his or her shoulder. If nothing else, the fiction may make it seem more immediate and more fun. Along the way, you may be surprised to learn that economics can be fun. Well, almost.

Finally, as you ponder your policies and consider your options, you should also occasionally heed the humbling words of the economist Friedrich Hayek, who observed,

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.¹

Thanks for your time.

JD Foster

Introduction

Congratulations, Mr. or Madam President-Elect! Now let’s get to work.

Every person elected to the presidency is imbued with intelligence and ego, likely in roughly equal proportions. Chances are, you’re no different. After all, you survived a campaign to secure your party’s nomination and then prevailed in the toughest competition known—for President of the United States. To quote Darth Vader in the first Star Wars movie, Impressive.

Right now, you’re alternating between shaking fear and a Superman-like sense of being master of your universe. Along with the latter, you likely have a sense you have a good grasp of the issues ahead. Sorry, probably not, as you’ll come to learn.

Along with intelligence, ego, and a large cadre of staff and supporters, you also arrive as president-elect with some knowledge of economics and economic policy. As a candidate, your campaign rolled out a blizzard of policy proposals, many of them dealing directly or indirectly with economics. You had proposals for tax reform and health care reform, for trade policy and energy, the budget, transportation, and infrastructure.

You talked about many of these proposals at length and defended them against attacks by your opponent and criticism from experts and the media. Along the way, no doubt you gained a better grasp of the economic issues raised by each policy. Now it’s time to dig into the details relating to the vision, practicality, politics, and often the underlying economics. We’re going to leave the first three for your advisors and concentrate here on the last of these—the underlying economics.

Let’s do a thought experiment. Jump forward four years. After innumerable legislative battles, international conferences, and crises, imagine how much more you will know than you know today. If your imagination is good, then you may be astounded at the vast gulf between what you understand today and will understand in four years.

If one assigned a value of 100 to your economic knowledge quotient after four years, what value would you assign yourself today? You probably imagine you deserve something around 50, given your previous life experiences and hundreds of briefings. Sorry, the correct answer is probably closer to 5. No insult intended, but you need to be candid about where you start. If this picture is a bit intimidating, don’t worry. First, we won’t tell anybody. Second, we’re going to start bridging the gulf.

Whether a president-elect or a city councilman, the fact is each starts with a bare-bones knowledge of economics, and much of what they think they know is probably wrong. Yet the knowledge you need to make wise decisions as a policymaker is similar to the knowledge investors, businessmen, and the broader citizenry need to opine on and judge those decisions.

No single volume can provide you as the incoming president with the knowledge necessary to go from 5 to 100. No dozen volumes could do this, but it is possible to make a strong start. It is possible to lay the groundwork, establish the basics you can rely on and retain—basics useful for everyone, from sitting presidents to interested laymen. In short, we’re going to try for 20 on our scale and let your staff and time do the rest.

Thus, the purpose of this book. Not to make you or any reader an instant expert, as though one were just adding hot water to make instant coffee. This isn’t a Hollywood self-help-for-budding-gurus book. The purpose is to help you become conversant with the essentials of economics as it pertains to public policy.

Equally obvious, no single work can do full justice to any specific topic, or even cover all relevant topics adequately. The topics presented here were chosen according to consequence and relevance. For example, every president needs to understand something of monetary policy. However, the economics of climate change and possible responses thereto are more recently important. Issues such as agriculture policies, while vital to those immediately affected, can be left for another day.

Your Team

As president-elect, you need to recognize you’re not in this alone. Your economic team, if chosen well, should provide the guidance and options you need to carry out your agenda. Your most important economic counselor may be your Treasury Secretary, a position of immense gravitas. In quiet times, your Treasury Secretary may just go about his or her business little noticed; but in times of economic crisis, this should be one of your leading voices inside and out of the White House. As most economic crises start with or eventually envelope financial markets, your Treasury Secretary should be someone known and respected by the major financial market players.

Your White House chief of staff may also play a leading role, or not, depending on how you run your operation. A good chief of staff is a workhorse, but even the strongest can only be productively engaged in a fraction of your important issues.

Another of your first-line counselors will be the chair of the National Economic Council (NEC), who organizationally reports to the chief of staff. The NEC has a small staff, which facilitates their agility and quick responses to your needs. When it runs well, the NEC chair will have your full confidence, be widely conversant in economic policy, and be able to clearly explain the most complex issues. Also, when it runs well, the NEC is primarily a policy management tool rather than an initiator.

Next up would probably be the Director of the Office of Management and Budget (OMB). In many ways, OMB functions as the cortex for your administration’s higher policy functions. Because the Director must be on top of so much of what is going on in terms of policy and congressional legislation, and economic and world developments, the OMB Director will almost always be part of your decision process on most issues. It’s not by accident so many OMB Directors eventually become chief of staff.

Whereas the NEC oversees economic policy development and quick-response analysis, the White House Council of Economic Advisors should be thought of more as your in-house economics think tank. The three Council members and its dozen or so senior economists are typically first-rate academics who serve for a year or two and then return to academia or another agency. They know the cutting edges of modern economic research, but may be limited in the political and communication skills necessary to navigate Washington’s perilous rivers.

These are your generalists, but you also have a large team of specialists scattered across the agencies, particularly the Treasury, Commerce, and Labor Departments.

Back to Reality

Chances are, dear reader, you’re not the newly elected President of the United States, so allow me to describe the genesis of this work. Many years ago, I came across Physics for Future Presidents by Richard A. Muller. You might not think it, but physics and economics are just two of the many subjects with which a president must be conversant. Muller’s book, while somewhat dated today, was highly informative and readily accessible to yours truly, a nonphysicist.

As you imagine yourself as president, you might think you need to know something about nuclear weapons, and you’d be right. But what about the physics of nuclear energy and waste, wind and solar energy, or of climate change or artificial intelligence and quantum computing? What about the physics of launching men and materials into space, of operating in space, and the militarization of space?

Wouldn’t it be better if you knew something of the underlying physics before you as president, or as an interested citizen, processed the related flow of information from the media, conversations, and other sources? Wouldn’t it be better if a future president had a handle on such matters before he or she had to sit through a briefing, weigh options, and make decisions? The same holds for the economic foundations of public policy.

Anyone briefing a public official on matters relating to economic policy will occasionally be surprised and delighted to be able to dive deep into the subject because the audience is well versed. More often, a lack of basic understanding means time spent establishing simple concepts, leaving little time for the meat of the issue at hand and little hope the policymaker, businessman, or reporter will understand, let alone retain, what is discussed.

Typical in my experience was a discussion that arose in the mid-2000s dealing with the employer’s share of the payroll tax. As discussed later in this work, the Social Security payroll tax is collected in two bites. One appears plainly on every employee’s payroll stub as FICA, for Federal Insurance Contributions Act. The second and equivalent bite is not shown. It is euphemistically called the employer’s share, apparently hoping the expression would lead employees and voters to believe the employer, not the employee, bears this tax’s burden. Sometimes the ruse works.

I was serving as the chief economist at OMB when the employer’s share issue came up in discussion. I mentioned the employee bears the burden of this portion of the FICA tax but just doesn’t know it. Absent the tax, the employee’s wages would be higher by the amount of the tax.

Keep in mind, my colleagues were incredibly intelligent, talented individuals, but you’d have thought I’d suggested we dig a moat around the White House and fill it with Japanese koi fish. You could almost hear their thoughts: Great, there goes Foster being an economist again. Eye rolling and smirks were in abundance.

Fortunately, my counterparts in other agencies told their mostly incredulous colleagues the same thing, usually eliciting similar reactions. Over a few days, the economists won over the skeptics. After a few days more, the previous skeptics insisted, as though they’d held this view all along, that the employer’s share of the FICA payroll tax comes out of a worker’s wages.

This sort of thing happens a lot. Aside from some carefully disguised sense of amusement, we economists were just glad we’d advanced the ball by, in effect, doing our jobs explaining economics to noneconomists.

If we as citizens want government to pursue wise policies reflective of our views, then we need to become sufficiently knowledgeable of matters to render sound opinions and to express them in whatever manner appropriate. Among these matters are the economic dimensions of a wide variety of policies. I hope this small volume will be of use in this regard.

Economists spawn many jokes. They earn them most of the time. One particularly apropos here is the observation that if you linked every economist in the country from foot to head, they couldn’t reach a conclusion. This is somewhat analogous to President Harry S. Truman’s plea for a one-handed economist because his economists tended, in explaining a subject, to employ the on the one hand . . . but on the other hand method, leaving the president searching for answers.

In general, the issues discussed herein are not laid out to present the state of play in economic research. To do so would hardly serve the purpose of moving you from 5 to 20 on a scale to 100. Rather, the issues are presented to be intelligible to a layman, reflecting a fairly commonsense and consensus view, knowing, of course, that some economist can always be found to object to just about any statement. To help along the way, many of the key terms are presented in bold type and are described in the glossary.

So let’s get to work. On to 20.

Chapter One

What Is the Economy?

Toward the end of every month, the media reports that the economy grew or contracted by a certain percentage. These reports are based on the latest estimate by the Commerce Department’s Bureau of Economic Analysis (BEA) of the change in gross domestic product (GDP) and its constituent parts. GDP is the total dollar value of all goods and services produced over a period, typically three months or a quarter. These media reports reflect a necessary shorthand but are misleading in at least two respects. First, the BEA’s estimate will undergo repeated, and sometimes substantial, revisions in the coming months and years. One shouldn’t be so definitive in declaring a result when the underlying information is subject to change.

More importantly, the BEA is reporting its estimate for a snapshot of one aspect of the economy, not of the economy writ large. GDP is an important gauge of aggregate economic activity, but it is not the economy.

Here we see already an issue to resolve regarding terminology. By economics, do we mean the institutions, people, and processes involved as described above, or the study thereof? Yes. We often mean both, but they differ. One is reality; the other is our attempt to understand reality. This potential confusion is hardly unique to economics. For example, if we refer to physics, we could mean matter and its behavior through space and time, or we could mean the study of these topics.

So what is the economy? It is all of the following:

• the American worker putting in a day’s work for a day’s pay

• America’s businesses large and small, serving their customers, paying their workers and suppliers, and trying to make a buck for their owners

• government at all levels when engaged in activities supporting America’s businesses and workers

• the commercial markets on which consumers and businesses exchange their services and wares

• the financial markets accepting cash from those who don’t need it immediately and making the same cash available to others who need more cash at the moment

• the prices that appear in markets to guide all these decisions

• the assets accumulated by individuals and businesses storing wealth and generating future income

No one piece of data can provide a complete picture of the economy’s state or how well or poorly it fares. GDP roughly shows the value of net production and may be the best single measure of economic activity, but it still only captures a piece of the picture.

For example, another datum reported alongside GDP is gross domestic income (GDI), which is the total net income generated from the nation’s production. GDP is often referred to as the demand side of the economy, or aggregate demand. GDI records the income earned from what is produced and could be referred to as the proceeds accruing to aggregate supply. If GDP and GDI were measured perfectly, then GDI would always be equal to GDP, but measurement errors and timing issues mean they usually differ somewhat. BEA reports both in the same release but GDP grabs all headlines. Even so, GDI is equally valid as a measure of activity. To gain a clearer picture of the economy’s performance, average the growth of GDP and GDI.

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Gross Domestic Product

GDP is often called aggregate demand because it sums up total net production as measured by total purchases. Let’s unpack that. If you want to understand how something functions, the natural first step is to break it into what appears to be its major constituent parts. The biggest such part on the economy’s demand side is personal consumption, which we will designate by the letter C. In turn, personal consumption can be broken down by major types of purchases: durable goods like cars and dishwashers; nondurable goods like gas, groceries, and various items not expected to last long; and services such as haircuts and doctor visits.

The next big piece of aggregate demand is total investment net of depreciation, whether by individuals or businesses, which we will designate by the letter I. This would include new homes, structures, machinery, and inventory.

Next comes federal, state, and local government outlays and taxes, which we will designate with the letters G and T, respectively. The net combined government budget deficit is then denoted as G – T.

Finally, we have to account for international trade flows, which we designate as X for exports and M for imports. The net trade surplus is then denoted as X – M.

Thus, we can show aggregate demand as

GDP = C + I + (G-T) + (X-M)

This is an intellectually powerful and extremely useful expression. Notice it’s just an accounting of sources of demand. This is important to remember because economists are often beguiled by this simple expression into thinking all they need to do is increase government spending (G) or reduce taxes (T) to make GDP rise. As discussed in chapter 2 on fiscal policy, this just isn’t so, as so many governments learn over time to their regret.

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To see how labor and capital relate to production and income, imagine a woodcarver who shows up to work in the morning. Over the course of the day, he uses his knives to carve a couple of beautiful bowls. Payday may arrive every two weeks, but he earns a full day’s wage through his shift. He provides a day’s effort (the supply side), producing two bowls (production), for which he earns a day’s wage (income, or the value of his services supplied).

It’s hard to capture the full meaning of an economy with only one person. After all, a central component of an economy is the markets in which goods and services are exchanged. So now imagine a baker who shows up to work in the morning. Over her shift, she bakes bread using her mixer and oven, providing a day’s effort for which she earns income.

When the carver and the baker meet to exchange wares, bread for bowls, their mutual production is recorded via the exchange at the mutually agreed prices paid for each good. Putting it all together, we see labor and capital earning income by combining to produce items of value, which amounts to supply, which are exchanged, establishing demand; and the exchange generates the income to pay the labor and capital employed.

Economic activity occurs over time, and therefore many measures, such as GDP, summarize the activity from one point to the next. Even in this simple economy of a carver and a baker, the total economic activity over a period can be described either in terms of the resources used in production (labor, capital, energy, land, etc.), the amount produced, or the income derived from production.

This discussion presents a suitable place to introduce another useful concept, which is the distinction between flows and stocks. (Beware, the word stock used here differs from the common use of the term when referring to a share of corporate equity.) All four measures of activity just described—resources used, income earned, production generated, and demand—are flows, because they represent something that occurs over time.

We accrue income over time—a paycheck every two weeks, for example. In contrast, we also have quantities that can be measured at a point in time. Consider a car dealership. The car dealership receives new cars from the manufacturer. Those cars go into the dealership’s inventory for sale. Sales then occur over time. The receipt and sales of new cars are flows, while the inventory is a stock, a fixed quantity at a point in time.

Households, firms, and the nation have certain stocks of assets and liabilities that are also part of the economy. A household may own a home worth some amount at a point in time. The household may also own various forms of wealth (bank account, 401(k) pension, investments). All these assets individually and collectively represent a stock value.

Likewise, a