Nineteenth-century architect Daniel Burnham frequently expressed the admonition, “Make no small plans. They have no magic to stir men’s blood and probably will not themselves be realized.” He apparently lived those words.
Presidential candidate Bernie Sanders seems to be cut from similar cloth. His bold initiatives caused Brookings economist Howard G. Gleckman to write: “It is hard to grasp the enormity of the tax increases Bernie Sanders is proposing … and what a stunning contrast he presents with Republican presidential hopefuls. Where Sanders backs tax increases of more than $1 trillion a year aimed mostly at high-income households, GOP candidates are proposing massive tax cuts that would largely benefit those same taxpayers.”
For those of you who are not plugged into the economics blogosphere, you have been missing a deluge of Bernie discussion. The dialogue began in late January with the release of a paper by University of Massachusetts at Amherst economics professor Gerald Friedman entitled “What would Sanders do? Estimating the economic impact of Sanders programs.”
Professor Friedman, at the request of the Sanders campaign committee, simulated Sanders’ economic proposals in a macroeconomic model to investigate what would happen if Sanders were given free policy rein.
Sanders’ vision includes lowering the eligibility age of Medicare to birth, expanding free public education to include not only grammar school and high school but also college, reducing the size and scope of our financial sector, raising taxes on the most advantaged, and increasing the lowest wage rates by more than doubling the minimum wage. This is indeed no small plan.
Friedman’s 53-page document has created quite a stir in the economic community. His results for the next 10 years include annual gross domestic product growth of 5.3 percent (current Congressional Budget Office estimates are 2.2 percent), median household income advances of $22,000 (compared with stagnation during the past two decades), sustained real wage growth not seen since the 1960s, a dramatic reduction in the gap between rich and poor (the ratio of the average income of the top 5 percent to that of the bottom 20 percent falls from 27.5 to 10.1), and a government budget surplus. Wow!
Normally these kinds of claims would be ignored and dismissed. If it seems too good to be true … Instead, they have caused quite a controversy. As it turns out, Friedman is a respected economist. His work is not so nonchalantly cast aside.
Several noted economists, including Paul Krugman and Christine Romer, have weighed in on the Friedman work with a high degree of incredulity. Some economic writers could even be described as vitriolic in their attack of Friedman’s work.
As I have read through their critiques of Friedman’s simulation, I have been impressed by what is not said. I have yet to find economists faulting Friedman on the model he employed. He used the type of model all of us use. His multiplier assumptions and arithmetic are not held in question. His integrity is not under scrutiny. (He has already endorsed Hilary Clinton.) In fact, as I waded through the 53-page write-up, and especially the appendices, I was impressed with how conservative his assumptions and multipliers are.
So what is the criticism of his work? It is the outcome. Friedman’s simulation gave the result that real U.S. economic growth over the next 10 years would be a whopping 5.3 percent per annum. This has not been experienced over any 10-year period during the past century, therefore it is assumed to be unreasonable. This is the singular criticism, and it looms large.
However, as a trader, I often quote myself by saying, “History, or that which did happen, is a very small subset of all of things which could have happened.” I never thought that I would see an ounce of platinum trade $315 lower than the price of an ounce of gold. But this past week such did in fact occur.
Let us unpack this 5.3 percent growth claim and examine it more closely.
Economic growth occurs in two ways. First, the labor force increases. This can happen through population growth or through an increase in the labor participation rate: the percent of people who decide to work. Second, and perhaps more importantly, growth occurs when the same quantity of goods or services can be produced by fewer people. This is called productivity growth.
For example, in 1870, 75 percent of our labor force was needed to produce our food supply. Today that number is less than 2 percent. That is real productivity growth!
How then could Sanders’ proposals create an unprecedented amount of growth over the next 10 years? It must come through one or the other means. On March 4, the U.S. Bureau of Labor Statistics released its most recent Employment Situation report. The report bears record that many millions of U.S. workers are either involuntary part-time workers, discouraged, marginally attached, or long-term unemployed. We have quite a bit of labor yet to deploy.
The higher pay resulting from the Sanders’ wage hike has been empirically associated with an increase in the labor participation rate. Further, many firms have been getting by with part-time workers to avoid providing health care benefits required by the Affordable Care Act. Under Medicare For All (Sanderscare?) this issue disappears.
What can be said for productivity? Over the past couple of decades, our health care industry has grown to the point at which it now commands 18 percent of our productive capacity, as compared with an average of around 10 percent in the rest of the developed market nations. If we were to be as efficient as our advanced trading partners, a large piece of our economy would be freed up for more productive activities. Our partners achieve their health care efficiency through a Sanders-like system.
A national health care operation does not waste money on competitive advertising, departments of professionals whose job is to deny claims, high-salaried CEOs, and so forth.
As we have discussed in past columns, Wall Street has also grown beyond the size needed to accomplish its mission of intermediation. Some of the most capable and intelligent men and women of our economy are currently employed to redistribute wealth from corporations and individuals to themselves, without providing any corresponding service. These activities would be taxed out of existence and the individuals redeployed into more productive activities.
So could the seemingly outrageous claims of Friedman regarding Sanders’ economic proposals be, in fact, reasonable? It is a forecast, and should be treated as such. In other words, nobody knows.
Back in 1982, the Dow Industrial Average was around 800. It had stagnated for 20 years. The inflation of the 1970s had held it back. If someone, at the time, had claimed that over the next 20 years the Dow would rise to more than 11,000, he would have looked rather outrageous. He would also have been correct. Paul Volcker came along with a big plan to raise interest rates to 20 percent and squelch inflation. Once Volcker had successfully completed the task, and interest rates began to fall, in 1982, the equity markets began to soar.
Analogously, our economic growth has stagnated for 20 years owing to the rise of an inefficient health care system, a bloated financial sector, and dwindling working-class wage rates. Something big targeted at those inefficiencies might just create an outrageous growth spurt.
After examining Friedman’s work, University of Texas at Austin economics professor James Galbraith said, “When you dare to do big things, big results should be expected. The Sanders program is big, and when you run it through a standard model, you get a big result.”
If Sanders has an economic Achilles heel, it would be on the international side. We will examine that next week.
(Marcus Hutchins is a former economist, treasury bond arbitrage trader, and hedge fund manager. He retired to Southport in 1997, where he resides with his wife, Andrea, and youngest daughter, Abbey. He welcomes feedback at email@example.com.)