Obama Administration’s Keynesian Policy Invites Economic Downturn (Part 1)
The global financial crisis was followed by a great recession. Dr. Laffer explained the recession in America and its root cause from the end of the Bush administration extending to the Obama era.
Interviewer: Hanako Cho
Cho: A global financial crisis took place during the transition period from the George W. Bush administration to the Obama era, and the U.S. economy experienced a downturn. What is your take on that event?
Dr. Laffer: Let me describe the environment.
Bush was not a popular president. He was popular for a very short period of time following September 11, 2001, when the attack on New York occurred.
His popularity rose very sharply, much like his father experienced with Kuwait. Then, once the attacks on Osama Bin Laden in Afghanistan and the Iraq War happened, his popularity fell very sharply.
At the end of his two terms in office, in late 2007 to 2008, the Democrats were then working as to whom they would have as their nominee. The most radical left-wing Democrat they thought was Obama. As Obama’s popularity rose and his likelihood of being the next president arose, people in the stock market became afraid.
The stock market crashed very sharply in 2008, all of it in anticipation of an Obama presidency that will not be business-friendly or prioritize economic activities. It is my opinion that the market players reacted at once, as Obama’s chances of becoming the next president rose.
As the stock market crashed, the presidency was still with George W. Bush. As the market crashed, capital value of companies fell sharply, and this put financial pressure on all sorts of companies and industries all over the country. The bankruptcy of Lehman Brothers triggered a financial crisis in September 2008, which panicked Bush and the people around him. They all played a role in the takeover of Bear Stearns (*1). The financial intervention done by government was totally the wrong thing to do.
Then, Bush signed a stimulus package of about $1 trillion.
But in the 2008 presidential election, the Republican nominee John McCain lost the election to Barack Obama by a wide margin.
By the way, John McCain was one of my dear friends. In fact, I did the first fundraiser for McCain when he ran for Congress in Arizona. My godfather Justin Dart was his campaign chairman. I just loved McCain and thought he was a wonderful man, but he lost the election to Obama.
Unemployment Rate Remains High Against Forecasts
Dr. Laffer: When Obama entered office, it was in the heart of the crash in the market. The first thing Obama did was his own stimulus package. It was planned by Christina Romer, the chairman of the Council of the Economic Advisers, and Jared Bernstein, the chief economist of Vice President Joe Biden, at the time. They published this white paper on how the Keynesian stimulus plan would work. They claimed the government spending on goods and services through this American Recovery and Reinvestment Act would create jobs, output and employment, the perfect Keynesian example. They spent about $1 trillion on the stimulus plan that was signed by Obama in February 2009. They called them “shovel ready projects” and it was aimed to maintain and create employment as quickly as possible.
Those people who were now producing goods, that otherwise would not have been produced had it not been for government spending, would have higher incomes. They, in turn, would spend more of their new incomes, creating more output and employment. The stimulus times the multiplier would equal the increase in GDP caused by the stimulus package (*2). It would be spread out over a year or so.
The white paper included a long discussion as to the size of the multiplier and how this would lift the economy out of basement.
But they made a mistake that they shouldn’t have made. They published what they thought would happen as a result of the package versus no package at all. Their message was that if we didn’t do anything, the unemployment rate would be 8.8%. Then, they claimed that if we do his package, the unemployment rate would be 7%, publishing that the stimulus spending will lower the unemployment rate dramatically.
The stimulus package passed, and it became law. What actually happened was the unemployment rate went up much higher than they thought it would be without the stimulus package, from 8.8% to 9.9%. In other words, using their model, the actual unemployment results were much worse than forecasted unemployment without the stimulus package.
It was a catastrophe.
You cannot just have the market crash and let everyone go under. But a financial panic is not the end of the world. A lot of people lose money, but others make money. Some people do well, some people do badly. Every car on the road is still a car on the road after the crisis as it was before the crisis. Every building, all the technology, all the libraries, nothing physically changes with the world when you have a financial crisis.
All that happens in a financial crisis is the ownership of assets changes.
After all of this whirling around of a financial crisis, when the dust settles and the smoke clears, you have new owners and they will go right back to the old production as quickly as possible. A financial crisis is financial, but it does not affect GDP (*3).
What does cause the damage is the government’s intervention to try to stop the crisis from doing damage, the very thing Romer and Bernstein were advocating. If you try to prevent losses, you will perpetuate the bad incentive structures and force the crisis to become permanent. When you take money away from people when they work and give money to people when they fail, it doesn’t increase work. You will lose overall production and employment. The capital stock will decline. People will lose their skills. Technology will start to disappear, and you will end up in a much worse place.
Aim For Economic Resurgence Through Tax Cuts, Not Distributing Money
Cho: What would you have done?
Dr. Laffer: I would let it go. The government will print money anyways, so instead of spending all this money on a stimulus package, I proposed a tax holiday. Bush and Obama spent $2.5 trillion, so I would have executed a $2.5 trillion tax cut. This amount was about a year and a half’s worth of taxes at the time, so for the next year and a half, there would be no federal taxes: no income tax, no corporate tax, no tariffs, no payroll tax, no employer-employee payroll tax, no excise tax, no capital gains tax, no death tax. All federal taxes would be exempt for a year and a half. Government discretion creates corruption, but tax cuts are free from corruption.
What do you think would happen if there were no federal taxes in the U.S. for a year and a half?
Cho: Maybe there will be economic recovery.
Dr. Laffer: We would have the biggest boom that has ever occurred on Earth. That was my alternative of a “stimulus package.” They want to spend money to stimulate demand, and I want to reduce taxes to stimulate supply and demand.
Of course, my tax cut proposal did not make it far with the Obama administration, but it did with Trump and Reagan. It was successful.
Reagan understood the problem with government intervention very well. When we had a crisis, Reagan said, “Don’t just stand there. Undo something.” In other words, he said, “Don’t spend money. Cut taxes.”
In the U.S., historical presidents are evaluated on economic growth. In the eight years of Obama, real GDP growth never exceeded 3%, and the eight-year average of real GDP growth rate was only 2.2%. On the other hand, under the Reagan administration, the average real GDP growth rate was 4.7%. That was more than double the growth rate under Obama.
The Obama administration’s low growth rate is unheard of in U.S. history, especially when you think that we had the big downturn. Usually, after a very sharp recession, you get a very big boom. But that did not happen under Obama.
‘Secular Stagnation’ Claim was an Excuse
Cho: The notion of secular stagnation was widespread during that period. Why did this notion dominate?
Dr. Laffer: The Wall Street Journal sponsored a debate between Jason Furman, who was Obama’s chief economist, William Gaston and me.
I asked, “Is it possible for the U.S. economy to grow at 3%?” Mr. Furman argued, “No, it’s virtually impossible for the U.S. to grow ever again, even at 2%. We have secular stagnation.” He even said, “Well, by luck it could happen that we grow at 3%, but if we did happen to grow at 3%, it would not be because of your economics.” Of course, that was just not true. We did get the growth surpassing 3% under the Trump administration. But they say, “Ah, he was just lucky, not skillful.”
The same thing they said with Reagan. They said the tax cuts, monetary policies, strong dollars in the foreign exchanges, tariff cuts, none of that will work. When all of it worked, they explained that the reason he was successful is plain luck. They said Reagan was lucky because of the basic intrinsic economics of the world happened to be pro-growth when he was elected, that it had nothing to do with him.
They do that with presidents. The reason Reagan was successful is he was lucky. The reason Obama was unsuccessful is just bad luck.
Cho: So they never reflected on their bad achievement?
Dr. Laffer: Let’s imagine you believe, with all of your heart, that paying people not to work stimulates the economy. Then, you find out that when you did pay people not to work, the economy stopped growing. How would you explain it if you know you’re right? “It has got to be something from the heavens that stopped it from happening. The reason it did not work is because there is secular stagnation.”
Cho: So they are using secular stagnation as an excuse.
Dr. Laffer: Exactly.
They never use data to evaluate their own policies. I use the following as an example: Everyone loves their mother beyond belief. Now, not all mothers are the most wonderful people on earth. That’s got to be true. And what are the chances that your mother is not a wonderful person? But they say, “Not a chance. Not my mother. My mother was pure and fresh and clean, an angel.”
There is no amount of evidence you could have that would convince you that your mother was a bad person. These economists are fixed in the same way on their economics.
They believe this to be true, no matter what the outcome of the world is. If more spending didn’t work, it is, “We didn’t spend more. We need to spend even more than that. Then it will work.”
