Obsessed with Saddam Hussein, the Bush administration believes an invasion of Iraq is a winning issue. Meanwhile, the economy continues to drag.
The latest statistics show no job growth and no income growth. Low interest rates and home mortgage refinance have cut monthly housing payments, thus permitting consumers to continue spending. However, the stock market has not recovered. The longer it takes for household wealth and employment to improve, the more cautious consumers will become.
It is possible that corporate profits will turn up once businesses finish writing off bad investments. Rising profits would boost stock prices and business investment, and a real recovery would get underway.
The question is whether the consumer will hold on long enough for profits to turn up. If the recovery continues to drag, consumers might decide to increase their sense of security by saving more. As incomes are not growing, consumers can increase their savings only by curtailing their spending.
The overall effect would be a drop in consumer demand–bad news for business profits and equity values. For the Bush administration to run such a risk is reckless.
What could be done to reduce this risk? Washington could begin with the realization that profits are determined by more than consumer demand and interest rates. Taxes make up a huge component in the cost of capital. Investment income is subject to multiple taxation. Reducing any of a number of taxes–corporate income, personal income, capital gains–will boost profits.
In other words, the investment incentives favored by some of President Bush’s White House advisers make sense.
But what about the budget deficit? Wouldn’t a tax cut just hike the deficit and interest rates, thus canceling out lower taxes with higher interest rates?
The answer is no. When an economy is dragging, deficits have no impact on interest rates. In a booming economy with supply constraints and no foreign lenders, government deficits compete with other financing and can cause a rise in interest rates.
Keep in mind that the war against terrorism and invasion of Iraq is driving up the deficit. The difference is: a tax cut would lower the cost of capital and boost profits and equity values, whereas wars have unpredictable consequences and create uncertainties.
Some people claim that taxes are too low and that what is needed are higher taxes and income equalization. However, higher taxes would accelerate the movement offshore of U.S. manufacturers. U.S. taxes are obviously not low enough to offset the lower cost of skilled and unskilled foreign labor.
Whatever the fate of the current recovery, the U.S. economy faces a serious longer term problem. In a global economy, manufacturers can achieve good bottom line results only by producing where costs are lowest. Increasingly, skilled manufacturing, engineering, research and development jobs are being moved out of the U.S. to China and India.
When these jobs leave our shores, so do the incomes and the upwardly mobile career paths associated with these jobs. Economists who herald the lower consumer prices from “made in China” are thinking with only half a brain. When U.S. companies use Chinese labor to produce for the U.S. market, the incomes are gained by China.
Simultaneously, the U.S. is being flooded with many millions of uneducated and unskilled immigrants whose presence suppresses incomes in low skilled and unskilled occupations. Talk to a general contractor. Many will tell you that they are being forced to abandon their tried and true subcontractors, because they are underbid on jobs by Mexican labor.
Many people claim that immigrants only take the jobs that Americans don’t want, but that is not what is happening. Eight or ten Mexicans sharing a trailer can survive on far less than it takes to run an American household. For the Mexican it is not deprivation; it is a rise in living standards. But for the American it is an unlivable wage.
A country that exports its best jobs and imports poor people is heading for a fall in national income.