No New Deals

Let entrepreneurs and innovation stimulate the economy

Shikha Dalmia | February 4, 2009

There is one thing that's giving political momentum to the Bush-Obama multi-trillion bailout/stimulus spending spree, and it is not a superior understanding of how to fix the ailing economy. It is fear. "Nameless, unreasoning, unjustified terror," as FDR once said.

The economy is in terrible shape. Financial markets are in a deep freeze. The stock market has lost over 40 percent of its value from the Dow's peak last year and 401(k) portfolios are shrinking. Unemployment is rising to levels not seen in 25 years. Companies—big and small—are downsizing or, worse, shuttering their doors completely. And home foreclosure rates are reaching record highs.

Under such circumstances, the fear is that we might well reach the point of no return—or, as a CNN anchor recently put it, face permanent "economic catastrophe."

But it's as likely that government intervention might well delay the recovery process, just as it did in the 1930s when a combination of spending and regulations unleashed by FDR's New Deal turned a recession into a prolonged depression.

Rather than a time for panicked reactions, this is the time to fully understand a lesson of history: The rubble of every recession contains the seeds of its own regeneration. Physical and human capital of dying economic sectors don't vanish with them. These assets—equipment, property, workers—are re-released into the economy, where entrepreneurs, unless thwarted by taxes and regulations, scoop them up and inevitably find more productive uses for them. In the process, new companies are born and new jobs created—offering, over time, far better returns and wages than before.

This is not idle, theoretical speculation.

On a micro level, consider the Pony Express, which was the UPS of 1860. The company cut down delivery time for coast-to-coast mail from six weeks to 10 days by using horse riders instead of ships going around South America. It was wildly successful, but only for about a year. Then commercial telegraph came along, and the company went belly up. Hundreds of workers lost their jobs at a time when civil war was starting, a major recession was brewing after a European bubble in railroads burst, and unemployment was soaring as immigrants from Ireland and elsewhere were coming in droves. But according to Saddles and Spurs, a rare group biography that traces the fortunes of the laid-off riders, all of them found equal or better jobs, in the burgeoning telegraph industry, rodeos and other shows, and as scouts in the Union Army.

On the macro level, consider the experience of the U.S. steel industry in the 20th century and the tech sector at the start of the 21st century. Both went through brutal downsizings that eventually strengthened the American economy and led to generally higher living standards.

Until about 1945, Big Steel—consisting of companies such as U.S. Steel that produced steel from iron ore in large mills—dominated the world market, producing about half of the global steel output. This hegemony, notes University of Dayton economic historian Larry Schweikart, led the industry to precisely the same vices that are responsible for torpedoing the Detroit-based car makers today: bloated corporate bureaucracies; a pampered, unionized workforce with unsustainable legacy costs; and inefficient production methods.

By the 1960s, Big Steel was facing stiff competition from overseas producers, first from Japan and Europe and then from Third World countries such as Brazil. About a quarter of American steel producers went bankrupt between 1974 and 1987. The industry's global market share shrank to 11 percent and employment dropped from 2.5 million in 1974 to 1 million in 1997. But this fight for survival, spanning decades and several recessions, eventually restored the overall industry to profitability. Led by companies such as Nucor, domestic steel makers discovered new ways to turn scrap into steel in sleeker, smaller factories called "mini-mills," using non-unionized workers and a leaner management team.

The physical and human resources that the steel industry squeezed out in its quest for more efficiency didn't simply go up in smoke. They were utilized by other sectors of the economy. For example, employment in the plastics industry, which replaced steel for some uses, grew over 18 percent between 1980 and 2006.

If American-owned automakers were among the loudest voices demanding a bailout from the Bush administration, American steel makers are among the loudest voices demanding massive stimulus spending (on schools, roads, bridges, rapid transit, and other steel-intensive projects) from the Obama administration right now. But if the industry emerged stronger without artificial measures to boost demand for steel once, there is no reason to believe that it won't do so now.

An arguably more stunning comeback involves the dot-com industry. After the 2000 stock market crash, hundreds of Silicon Valley startups collapsed, throwing thousands of highly paid computer professionals out of work. However, within a few short years the industry began to recover, reabsorbing many of the laid-off workers.

One reason for the industry's quick recovery, according to Todd Zywicki, an economist at the George Mason University, was that it was able to rapidly redeploy its resources away from failing enterprises toward more promising ones. Unlike traditional industries, much of the dot-com sector was financed not by debt from bond holders but venture capitalists with equity stakes. This meant that when these companies started showing signs of trouble, their financiers were able to cut their losses and seed other ventures without getting bogged down in time-consuming bankruptcy proceedings.

What's more, they did so at a time when there was a glut of computer talent, not to mention cheap office space, equipment, and other physical assets—all of which positioned them for future success. "If Washington had appointed itself in charge of saving the industry, it would have declared AOL too big to fail," comments Zywicki. "The net effect would have been to retard the advance of broadband and we would all still be using slow-speed dial up to access the Internet."

These are tough economic times and it is impossible to know in advance where the next telegraphic or broadband revolution will come from to drive us out of recession. But the American economy has demonstrated awesome powers of self-correction when its entrepreneurs are left alone to blaze new trails—without a panicked Washington pushing them off course.

FDR famously proclaimed that we have nothing to fear but fear itself. That, and a government that will get in the way of an economic recovery.

Shikha Dalmia is a senior analyst at Reason Foundation.

Comments

|2.4.09 @ 4:49PM|#

"If Washington had appointed itself in charge of saving the industry, it would have declared AOL too big to fail," comments Zywicki. "The net effect would have been to retard the advance of broadband and we would all still be using slow-speed dial up to access the Internet."

Which is exactly what Washington is doing now. Which means, there will be no recovery as long as we keep trying to "stimulate" one. The only question is will our benighted leaders reverse course before they're forced to default on the dollar (or alternately accept 100%+ inflation)?

|2.4.09 @ 4:53PM|#

No, no, no - you've got it all wrong. The answer is a big fat bloated stimulus bill and if it's full of pork, well - hey, that's unavoidable but THIS IS A CRISIS!!! DON'T YOU UNDERSTAND??? NORMAL RULES DON'T APPLY BECAUSE THE WORLD IS ENDING etc. etc. Newsweek says so..

Y'see, Obama screwed up by allowing Republicans to start questionning portions of the sausage.

I mean, fuck. Just...fuck.

|2.4.09 @ 4:56PM|#

This is crazy talk. What do Americans know about starting businesses or making money? Everything's run by top hat-wearing dudes, everybody knows that.

|2.4.09 @ 5:06PM|#

"Physical and human capital of dying economic sectors don't vanish with them."

the government taxes a trillion dollars from our childrens future wages...buys control of 10 trillion in assets and institutes government regulations on all of the new public-sector workers...then it puts in place new laws protecting the government run companies from competition...this is called Public-Private partnership....


The Reason Foundation is supporting The 5th Annual Public Private Partnerships USA Summit - the government-industry forum on 11-13 March 2009.

REASON because Facism is Freedom

|2.4.09 @ 5:12PM|#

I think in order to save the economy, our representatives in government ought to stop listening to libertarian plutocracy enablers.

Taxes and regulations don't thwart anyone, contrary to your central mythos.

The core cause of the crisis is stagnant wages for everyone but the supperrich for the better part of 30 years. When one income was no longer enough, women went to work (while people like you guys railed against government assistance for their childcare). When two incomes weren't enough, people binged on credit, which was fine as long as house prices were going up. When that bubble finally burst... Well here we are.

The deliberate funneling of money to the supperrich by their puppets in government from everyone else is what caused our crisis. The only solution is a little of what you guys call evil socialism. And the sooner we get to it the less 'socialism' the people will eventually demand.

classwarrior|2.4.09 @ 5:13PM|#

"...where entrepreneurs, unless thwarted by taxes and regulations, scoop them up and inevitably find more productive uses for them"

Absolutely! Those 50-something laid off auto workers will have nothing to fear if the government just gets out of the way!

hmph|2.4.09 @ 5:24PM|#

Tony, enough for [i]what[/i]? A sustainable lifestyle? Perhaps its the lifestyle that needed to be downsized instead of the income being up-sized. It's not just the absolute poor who borrowed too much because they couldn't pay for basic needs, it's EVERYONE. The rich, the middle and the poor all had their share in getting into debt. And for the former two, it certainly wasn't because of basic needs but more for luxuries.

Also, please show an example where socialism stayed "a little."

|2.4.09 @ 5:44PM|#

Perhaps its the lifestyle that needed to be downsized instead of the income being up-sized.

Okay, I'll agree with you as long as that applies to everyone, and not just everyone in the lower 99+% income bracket.

At one time in our history one so-called middle class person could provide an income to support a reasonable lifestyle for his entire family. That is not only not as feasible now, it's now difficult for 2 parents to provide for their family.

This has nothing to do with buying too many luxuries (welcome to the conversation, ye mythical Welfare Cadillac Queen), but with a growing economy benefiting only the wealthy and not benefiting the lower classes. This is not the market working its magic, it is deliberate economic policy championed by Democrats and Republicans alike.

My only goal in being here is to try to convince at least one libertoid that Reaganomics has nothing to do with liberty, or the free market.

|2.4.09 @ 5:51PM|#

And socialism-lite does? Ha!

tarran|2.4.09 @ 5:52PM|#

Economic growth benefits the lower classes most of all:

Donald Trump would always have a portable phone, regardless of whether it cost $5,000 or $20. The working poor? Not so much.

Kreel Sarloo|2.4.09 @ 5:53PM|#

Keep believin' Tony.

Ah yes, the good old days.

The good old days sucked, Tony. And not just for the uppity negroes who were kept in their place.

Mike M.|2.4.09 @ 6:06PM|#

Obama just imposed salary controls on any executives who receive direct bailout money.

Not that I believe they deserve any bailout money at all, but this is one of the biggest steps towards socialism in our nation's history. Get read for the market to really start plummeting now.

|2.4.09 @ 6:12PM|#

"FDR's New Deal turned a recession into a prolonged depression."

Dalmia is try to replace one myth with another. Before Roosevelt was elected the US was in its worst depression ever. In 1932 unemployment was 23.6%. From 1929 to 1932 GNP fell by a third. It would be reasonable to claim he prolonged the depression but to claim Roosevelt caused a depression is absurd.

|2.4.09 @ 6:13PM|#

well tony:
30 years ago: most houses were smaller (easy to verify just look at an older housing area) , most people had 1 late model car & 1 old one.
And if you wanted new furniture or a new car, most women went to work at least for while to pay it off.
My younger brother & his wife live like that now.

|2.4.09 @ 6:20PM|#

I recently attempted to explain, to a very intelligent librarian who's at least 10 years older than me and well educated and who should not need to be told, that there has never been, at any time or on any patch of dirt on this sphere, and I'm including all of our ancestors and all stone age tribes still extant, any society in which some people had more, and some people had much more, than everybody else. Never. Anywhere. Not in North Korea, not in Cuba, not in Sweden, not in Vietnam, not in the fifties and not in Sumer or Babylonia or the Forest Primeval. Never.

This isn't like particle physics, this is like gravity - observable and verifiable and self-evident. And yet.

Jordan|2.4.09 @ 6:25PM|#

Absolutely! Those 50-something laid off auto workers will have nothing to fear if the government just gets out of the way!

Considering their exorbitant pay and benefits, they ought to have one hell of a nest egg built up. If not, then it's their own fucking fault.

|2.4.09 @ 7:01PM|#

Mike M.:

When you can demonstrate how the market provided CEOs with 500 times average employee wages, perhaps you'll have a point.

Orange Line Special|2.4.09 @ 7:06PM|#

I wrote something similar to what Shikha Dalmia wrote, albeit much less wordy: here.

And, because we're slightly on the same page, I now feel a little sick. However, I'm taking solace in the fact that my plan would put American interests first, whereas Reason's ideas would just put a small number of Americans' interests first.

Maybe Reason could recalibrate their plans so they'd be in the national interest, and people might listen to them.

Jordan|2.4.09 @ 7:10PM|#

When you can demonstrate how the market provided CEOs with 500 times average employee wages, perhaps you'll have a point.

Um, the market provided it because the CEOs and their employer agreed to it.

DannyK|2.4.09 @ 7:12PM|#

It's kind of sleazy comparing the Pony Express and Dot-coms (both with relatively small numbers of highly skilled employees and not much fixed capital) with big business like auto manufacturing and steel.

If you look at the Rust Belt, it's not easy to see how entrepreneurs have sucked up the extra labor and resources there.

Jordan|2.4.09 @ 7:28PM|#

If you look at the Rust Belt, it's not easy to see how entrepreneurs have sucked up the extra labor and resources there.

And yet, unemployment isn't rampant there, either.

jk|2.5.09 @ 2:53AM|#

The core cause of the crisis is stagnant wages for everyone but the supperrich for the better part of 30 years.

Wages have risen over the last 30 years, but not buying power, maybe that's what you're talking about. What the government has done is to create an unstable feedback loop on payroll taxes. When the government senses that there is inflation in wages, it raises the earnings that are subject to FICA and Medicare taxes. Taxes drop dramatically when you get over the hump, but the government keeps moving the hump. IIRC, the hump was about $75k ten years ago, now it's around $105k. The government is a full participant in feeding inflation, it's just not indexing on it.

|2.5.09 @ 12:57PM|#

Tony, we already agree that reaganomics isn't the answer. You know he doubled the payroll tax and more than doubled government spending right?

|2.5.09 @ 2:31PM|#

Gabe,

Yes, all that while cutting taxes at the top end, which no matter your economic philosophy is just incomprehensibly regressive.

My argument, which probably won't go anywhere here, is just that cutting taxes and spending aren't necessarily the be-all-end-all of a philosophy of liberty. And Bushonomics, wildly increasing spending while not raising any taxes, is even more perverse.

I suppose you could say I agree with the president. The size of the government is an arbitrary measure; it's whether the government is doing useful things that matters. One of those useful things should, in my opinion, be raising taxes and spending public money in ways that maximize fairness and liberty.

|2.5.09 @ 2:32PM|#

*by raising taxes I mean collecting taxes

Paul|2.5.09 @ 7:19PM|#

These assets-equipment, property, workers-are re-released into the economy, where entrepreneurs, unless thwarted by taxes and regulations, scoop them up and inevitably find more productive uses for them.

Except now, unlike the 30's, you need a license to sell pencils on the street.

economist|2.5.09 @ 9:49PM|#

Sausages and legislation have a lot in common...except that sausages are also delicious.

economist|2.5.09 @ 9:50PM|#

"One of those useful things should, in my opinion, be raising taxes and spending public money in ways that maximize fairness and liberty."
There's a contradiction somewhere in here. I know it...

economist|2.5.09 @ 9:53PM|#

"Maybe Reason could recalibrate their plans so they'd be in the national interest, and people might listen to them."

Bugger off, Chris. Shouldn't you be doing your homework, or something?

|2.6.09 @ 4:37AM|#

I think you need a history lesson on the first 100 days of FDRs presidency.



http://www.whyy.org/podcast/020409_100630.mp3

|2.6.09 @ 4:42AM|#

I guess it was WWII that "rescued" us from The Great Depression. Sure, take all the unemployed people and give them civil service jobs - DRAFT THEM! Then, spend huge amounts of money, with respect to GDP, on guns, ammo, tanks planes etc.

So, giving people jobs, and spending huge amounts of money got us out of the depression. Can we do that now without having a war?

|2.6.09 @ 5:22AM|#

Is it government's role to serve the people, or to force people to serve the mighty corporation? Let us not forget what got us into this mess. Mortgage backed securities, credit default swaps, derivatives, and leveraging. And on top of everything we have 'ol Bernie M. and an SEC that had their faces shoved in the pile of shit that he created, and couldn't see, smell or taste it. And is anti-trust enforcement still in commerce or is it back in judiciary? What good are free markets if the government can't provide fairness and real competition? How many more buyouts and mergers will it take for their to be only one corporation for each sector? What good is small business when all it does is serve the needs of the corporations?
Why should I trust the financial system when banks can't even trust each other?

Corporatism is destroying Capitalism, and democracy. However, there are those that would like us to believe that it's social programs that are the destructor.

|2.6.09 @ 2:51PM|#

On CNN, I saw some similar ideas written by a libertarian from the Cato Institute. Then I read the comments and realized how truly surrounded by idiots we are. It was mostly a bunch of stupid nonsense about libertarians not caring about the little guy, and corporations are evil, and blah blah blah. As usual, I am left with the sad realization that we have precisely the government that "the people" elected, dullards that they are. And as usual, I start wondering where I can find that island ...