U.S. Economic Policy

Taxation and Government Spending

As with monetary policy and as discussed in the overview of fiscal policy, legislators have the option to enact an expansionary or a contractionary policy, meaning the nation will either tax lightly and spend heavily or maintain high tax levels alongside a budget surplus (or decreasing deficit). Per political norm, these choices have loose party associations as well as optimal implementation periods in times of economic downturn or over-inflation. While America’s course of action certainly depends on elements such as recent economic events and incumbent president or congressional majority, the various aspects of congress’s choices deserve analysis, including effects on the American public, current and future economic impact, and indicators on global economic well-being.

Congress first must choose whether expansionary or contractionary policy better fits the current economic climate by considering recent economic growth and inflation. John Maynard Keynes, the father of fiscal policy, promoted expansionary policy in order to stimulate consumer demand thereby bolstering economic growth. Despite Keynes’s support, congress may face uncertainty in choosing to follow devout expansionism due to the inflationary problems, as well as the partisan issues regarding government spending and taxation.

The first of two methods for employing expansionary fiscal policy comes in the form of raising government spending to encourage infrastructure growth while putting more money into the hands of consumers. Increased spending on infrastructure would create jobs in the construction and manufacturing industries, thereby lowering the unemployment rate and pushing government money to the public. Alternatively, the government can more directly allocate its money to individuals by increasing transfer payments and subsidizing social welfare. Transfer payments include systems like unemployment benefits and welfare, whereas farm and technology subsidies attempt to stimulate the economy by bolstering production of large corporations, who often proceed to increase their workers’ compensations. Drastic spending increases and budget deficits experience opposition from many classical economists, among other schools of thought, making a perpetually increasing deficit a difficult measure to consistently push through congress.

Congress can also follow an expansionary fiscal policy by maintaining current levels of government spending while decreasing the tax rate at all levels. Lower income tax gives the public more disposable income which will increase consumption at all income levels, whereas a decreased consumption tax will lower the price of all taxable goods, making their consumption more likely and frequent. As discussed, greater consumption generally encourages economic growth, but an effective universal increase in income could simply increase the cost of living, negating the benefits of more consumption. Further, the general income tax rate begins to encroach upon politically partisan issues as opposed to strictly economic considerations; the politically liberal tend to advocate for a varied tax structure with low tax levels for low earners and high levels for high earners, whereas politically conservative tend to argue for lower taxes on the rich to promote increased spending and a “trickle-down” system of wealth. An excessively low-rate tax system could also have a negative impact on general government function since they may receive little funding. Proponents of higher taxation often use this argument to support their contractionary stance.

Generally, congress only employs contractionary policy to control the inflation rate when it begins to spiral upwards. However, prominent Nobel Prize winning economist Milton Friedman argued that expansionary policy would only promote instability and inflationary trouble, therefore leaning toward a contractionary stance. Friedman, alongside other proponents of contraction, values a stable growth rate and an optimal inflation rate over bullish economic growth, which represents a conservative and traditional perspective defined by a balanced budget and ample taxation.

Contractionary policy believes a balanced budget, if not a small surplus, will optimally control both the economy’s and the inflation rate’s long-term growth. By spending little on social programs and infrastructure, the government keeps more money in its own hands, thereby maintaining control over the money supply; this control allows the government to effectively control the average consumer’s demand, thereby giving it control over the average cost of living and inflation rate. While a constant and optimal inflation rate proves valuable in the long term, it also sacrifices current consumption and growth by forcing money from the hands of consumers. The government’s large role in contractionary policy makes it aversive to most republicans, while the lack of funding for social programs conflicts many democrats; these politically motivated factors make debt decreasing propositions infrequent and unpopular in Congress.

As an alternative method of putting more money into the government’s hands, congress could also vote to raise income and consumption taxes. This measure would reduce consumption due to the decrease in disposable income, while also providing the government with more leverage over the cost of living and inflation rate (similar to decreased spending). Many economists hold similar hesitancies to decreased spending on economic growth grounds, but the American population also interjects regarding this issue as a politician running on a platform of drastic tax increases will seldom get elected. The public opposition of higher taxes organically makes this form of contractionary policy largely unemployed, with tax hikes of over five percentage points (~15% of current tax rate) not witnessed since 1993.

Currently, Congress chooses to practice an expansionary style with an increasing budget deficit and a relatively stable tax rate, with a small decrease (two percentage points) for the highest bracket under President Trump. In the future, the congresspeople citizens elect will determine whether the economy could see drastic growth alongside a spiraling inflation rate, or steady growth with a stable inflation rate. This makes determining whether you prefer lower taxes and an increasing deficit or higher taxes with a more stable deficit, as the macro-scale preference of the public will determine the direction of the economy for the foreseeable future.

Fiscal Policy

While fiscal policy focuses less on the tangible U.S. dollar than its monetary counterpart, it still has a significant impact on the inflation rate and overall health of the nation’s economy. Fiscal policy consists of congressional regulation of key economic metrics (e.g. unemployment rate, inflation rate, etc.) through tax and budget legislation, opposed to base rates and set by the national bank. Similar to monetary policy, fiscal policy requires knowledge of America’s fundamental economic system, as the mixed economy allows for volitional government spending and arbitrarily chosen and variable tax rates.

Generally, a successful fiscal policy contributes to inflation and unemployment rates approaching their natural and optimal levels (2-3% and 4-6% respectively), while fortifying the relative value of the nation’s currency. Congresspeople and their advisers undertake fiscal policy by analyzing recent economic growth and tailoring legislation to the current situation. Similar to monetary policy, politicians implement contractionary fiscal policy to mitigate over-inflation since this practice forces money into the government’s hands, thereby taking it out of the economy. Contrarily, expansionary policy pushes money into the public’s hands, inducing economic growth due to increased consumption.

Whereas interest rates mostly defined monetary policy, tax policy and government spending constitute (by definition) fiscal policy. Generally, tax hikes and low government spending characterize contractionary policy because an increase in cash flow to the government, which chooses to not spend it, reduces overall consumption and therefore slows economic growth; the only accepted motive for deliberately discouraging growth is decreasing a large inflation rate (>3%) in order to maintain sustainable growth. A decrease in the average tax rate and increase in relative discretionary government spending allows consumers to retain most of their money, which, alongside the government’s increased expenditures, promotes economic growth through increased consumption. Since 2000, America has followed both expansionary and contractionary fiscal policy, with a short contractionary period from 2004 to 2006, but a prompt reversion to expansion with the recession in 2008, then another contractionary period during President Obama’s second term.

Historically, America has experienced somewhat cyclical fiscal policy which occasionally conformed with party expectations or recessions, but often seemed to vary inexplicably. Starting in the 1910’s, America’s highest earners only saw 7% income tax, which signifies the most expansionary period America has seen in recorded history. Counterintuitively, after an expansionary phase in the late 1920’s, America responded to the Great Depression by adopting nearly the most contractionary stance in the nation’s history with between 63% and 79% income tax for top earners. Modern economists largely disagree with this choice and contractionary policy in general, most notably Ben Bernanke who says, “If fiscal policy becomes very contractionary, the economy will I think go off a cliff.” Nevertheless, America continued its contractionary ways following World War II, with a record high of 94% income tax for the highest bracket and a record low government spending deficit of -26.9% of Real GDP. Not until President Lyndon Johnson’s inauguration did America experience its first major expansionary period with a 21.1% decrease income tax rates for the highest bracket, despite the new president’s Democratic stance (Democrats tend to increase taxes, especially for the highest earners). In the 1980’s with America newly following Reaganomics, legislators ushered in a new era of fiscal expansion with an unprecedented 60% decrease in income tax for the top bracket and 120% decrease in government spending per real GDP. Since the 1980s, America has seen cyclical behavior with expansionary policy during Republican presidencies and recessions, and contractionary with Democrats and excessively bull-ish markets.

Policy and period aside, governments intend for fiscal policy to push unemployment and inflation to their optimal rates (as mentioned above), while promoting sustainable economic growth, a relatively uniform compensation structure, and sufficient incentivization for both companies and individuals to invest and innovate. Most economic legislation will consider these goals, but politics often interfere with policymakers’ decisions, leading to sub-optimal policies hurting the public and the overall economy. Citing Venezuela as an economic fascination yet again, the Maduro regime has reached a budget deficit of 46.1% of its GDP, which would represent the largest deficit to GDP ratio of any relatively large (30 million people) nation in recent history. Maduro and his advisers cannibalized their own economy by funding social programs with debt which they intend to pay with worthless money backed by a failing oil supply. Alongside the latter, which falls more under monetary policy as discussed several posts ago, Maduro and company demolished the country’s fiscal policy, which also contributed to over one million percent inflation seen by Venezuela.

The choices legislators make regarding fiscal policy affect the daily life of the nation’s constituents along with the economy as a whole. Congress’s decisions regarding the nation’s taxation and spending influence both the financial welfare and general morale of the nation, making these choices an important consideration for economists and politicians alike.

Inflation and Interest Rates

Realistically, the Federal Reserve has two choices for monetary policy in expansionary or contractionary, but it also has the option to keep inflation and interest rates at their current levels as a more intermediate stance. Each choice would garner support from right or left and would have a unique effect on the American public and the general economy, pushing America towards either socialism or capitalism. This decision depends largely on the incumbent president as well, so we will also take both a time and a party-based approach to analyzing the historical success of various policies.

Most recently, in response the 2008 recession, America has seen a nearly decade-long expansionary push to reverse the economic effects of the burst of the housing bubble. While conservatives typically support expansionary policy, democratic president Barack Obama and Federal Reserve chairman Ben Bernanke had little choice but to try to propagate economic growth through any measures possible. The effectively zero interest rate, yielding minimal total inflation, indicate the government’s attempt to force money back into the market to begin rebuilding the economy.

President Trump alongside Fed chairman Jerome Powell have effected small interest rate increases, but the 2.19% effective federal funds rate and 1.90% effective inflation rate still allow consumers to spend without regard to a significant opportunity cost of saving. Since the effects of the recession have mostly disappeared, the expansionary policy enforced by the current presidential regime exists solely for the purpose of further economic expansion, regardless of the risks associated with extended growth measures.

The economic risk regarding expansionary policy comes in the form of over-inflation from excessive interest rate decreases. By forcing money into the market, consumers may purchase in excess now since saving will not benefit them, thereby forcing businesses to produce more and hire more. To maintain their profitability and customer base, businesses may have to increase prices to offset the demand increases, which pushes the economy into cyclical supply-demand inequality and inflation trouble.

A pure growth, conservative-led economy indicates that an expansionary monetary policy will push America towards a market-driven, business-promoting, capitalistic society. While America has historically favored capitalist tendencies, an economic structure that risks spiraling inflation and battering the lower class may face backlash from the public and left-leaning politicians, making its implementation extremely difficult. Nevertheless, any policy that brings America closer to a free-market system and economic efficiency will promote growth in both the short- and long-term; the social sacrifices for its use may, however, outweigh the benefits.

Contractionary policy, the alternative to expansionary policy, focuses on increasing interest rates to promote saving and force money out of the market. John F. Kennedy, Richard Nixon, and Jimmy Carter most recently implemented this typically democrat supported policy in order to slow economic growth and calm the spiking inflation rate, most likely cause by expansionary policy. President Nixon experienced a special case, similar but opposite to that of President Obama, as the over 6% inflation rate following Lyndon Johnson’s reign forced the republican to employ a “gradualist” monetary policy (effectively a renamed contractionary policy). Unlike President Obama, who most likely would have wanted contractionary policy, Nixon adamantly supported economic expansion, but could not effect this belief until late in his presidency due to economic conditions in the early 1970s.

While America has experienced a bull market for the past decade, many expert macro-economists foresee a downturn within the next few years. This somewhat forces the Fed to push current interest rates into contractionary territory to combat any inflationary trouble imposed by the recent expansion.

To many, contractionary policy seems counterintuitive because it deliberately shrinks the economy, and history has largely justified this belief as seldom has America seen as adamant contractionary pushes as it has expansionary. Further, economic developments over the past three decades have largely tamed Herb Stein’s “hydra-headed monster” of inflation, giving economists a bit more control over monetary policy (i.e. not having to react to over- or under- inflation). Further, former Fed chair Ben Bernanke blamed the Great Depression on contractionary policy, further reducing the public’s and politicians’ faith in the practice.

 

Despite such hesitation, America has seen spurts of contractionary policy, as mentioned above, but the reservations regarding full-fledged economic slowing have prevented contractionary policy from emerging in any significant capacity. If America spontaneously adopted contractionary policy today, the impending recession would likely come sooner than expected and hit harder as well. While economic contraction has the primary benefit of controlling inflation, the consumption decreases inherent in its use make it a debatable long-term policy.

The Fed’s choice of monetary policy has myriad effects on everyday life, with expansion promoting consumption and contraction encouraging saving. Without regard to political preference, economic policy specifically with respect to inflation and interest can push America towards the free-market capitalism foreseen by founding fathers and early entrepreneurs, or it can pull the nation towards the socialist policies advocated by many equality-driven organizations and politicians. While experts hold both of these opinions, Jerome Powell and his colleagues currently believe in an approximately 2% inflation rate and infrequent but occasional increases in the federal funds rate without approaching contractionary territory. With the options and arguments in mind, I hope you now have the information necessary to make an informed decision on what you believe best for American monetary policy.

Monetary Policy

Two things in particular come hand-in-hand with being the world’s largest economy: a worldwide faith in the value of the nation’s currency  (“reserve currency”)and a relatively standard means for comparison against any other nation’s currency. Domestic monetary policy envelops both of these topics which influence America’s global image, along with other fundamental economic concepts such as the standard interest rate and regulation of federal and individual reserves. Understanding America’s monetary policy depends fundamentally on understanding America’s mixed economic system since all action and regulation regarding macroeconomic monetary decisions involve the government.

An effective monetary policy will encourage GDP and employment increases while stabilizing prices and interest rates to encourage consumption and investment. America’s economic regulation agency, the Federal Reserve Board (the Fed), has defined “[promoting] maximum employment, stable prices, and moderate long-term interest rates” as its driving goals. The Federal Open Market Committee, America’s monetary policy specific council, analyzes consumption and employment trends, among others, to optimize the inflation and unemployment rates. A nation can pursue its monetary goals through an expansionary or a contractionary approach, depending on the economic welfare of the country and its openness to risk. Expansionary methods consist primarily of decreased interest rates, which discourage saving thereby forcing consumption and investment. An increase of money in the market typically boosts an economy, making this approach effective for economies experiencing recession or decline; however, increased consumption also yields increased inflation and cost-of-living which can discourage people from spending even more than low interest rates encouraged them to spend. Contrarily, increased interest rates generally define contractionary policy, which America typically employs to slow the inflation rate and encourage saving in times of economic wellness. Contractionary policy also allows for slower, more consistent growth, thereby decreasing the economic risk of its use.

For the last three years, America has ardently adopted a contractionary approach after employing the most expansionary approach possible (with nearly 0% interest rate) during and for over half a decade following the 2008 recession. These choices uphold the protocol of forcing consumption in economic downturn to bolster businesses profits and drive the nation out of recession then encouraging saving during periods of relative economic well-being. Since 2015, the FOMC has deemed the economic atmosphere healthy and stable enough to try to drive money out of the market and it intends to continue doing so, despite the opposition of President Trump and some prevalent economists. While normative in nature, Americans’ responses to interests rates at Great Depression levels all but forced Powell and the Fed to increase rates as to imply that the nation has recovered from the more recent recession. The Fed currently intends to systematically continue increasing the interest rate, but a 2019 downturn could force levels back to the near-zero mark.

Nearly all economies have seen decreasing interest rates in the past ten years, as well as over the last century. These decreases can indicate a global reluctance to take money out of the market and risk hurting consumption, which would consequently hinder a nation’s trade. Furthermore, decreasing consumption could also damage GDP and unemployment among other fundamental economic metrics. Conversely, these nations also run the risk of inhibiting their inhabitants’ saving to an extent that decreases their well-being. Several experts believe that the declining interest rate has little to do with domestic governance, but rather suggests a worldwide supply-demand discrepancy whose presence casts doubt on the wellness of the economy, even in seemingly healthy periods.

Alongside dictating interest rates, the Fed also manages monetary policy by controlling the supply of currency available, thereby determining the inflation rate. Since the American dollar holds global worth with over half of all reserves worldwide containing the greenback, the Fed must accurately and efficiently determine its value and mandate how much it wants to change that value in a given year. Over the past fifteen years, policymakers have tried to maintain the inflation rate at approximately two percent, with the only significant deviation occurring during the 2008 recession.

With 1.7 trillion USD outstanding, the American dollar constitutes over twenty percent of global currency in circulation; consequently, large-scale inflation would yield a less reliable and prevalent dollar but no inflation could eventually render the dollar obsolete (i.e. if America never produced money again). Therefore, the Fed has to optimally define the inflation rate by controlling the amount of currency produced and regulating the amount of cash banks carry. Regulators can approach the former in primarily two ways: The Fed can simply produce less currency, which will not make inflation zero but will decrease it significantly; or, the government can put more money in its own hands (and control it from there) by collecting from its debtors or selling debt for cash.

Venezuela presents a current example of poor monetary policy, specifically in the realm of inflation. Under president Maduro, Venezuela’s Bolívar has seen 1000000% inflation (unfortunately that is not a typo, it really is one million percent), with an anticipated additional ten-million percent in 2019; consequently, prices double every nineteen days on average. This exorbitant inflation resulted from Maduro’s socialist policies such as frequent minimum wage increases (34 in the past four months), along with simply poor economic decision making such as linking its currency to an unsteady oil reserve. The Maduro regime’s has sent its economy tumbling to a point where it will require decades of reconstruction, primarily because of its mediocre monetary policy.

Mixed Economy

To properly define the American economy, we had to first discuss the left and right extremes of economic policy. Now that some of the basics of laissez-faire capitalism and complete command communism have been covered and we can mostly understand the intricacies that lead to the implicit benefits and drawbacks from each idea, we can fully evaluate the system upon which America has built its domestic and international well-being: the mixed economy.

To many people, the fact that America does not lie to the far right of the economic spectrum may come as a shocker; however, as discussed in the post on Market Economies, America has never attained true capitalism and only received a score of “mostly free” by Heritage’s economic freedom index. However, this nation’s founders and leaders have propagated a system, which, in its optimal form, has the power to give the government enough control to maintain peace and stability, but not so much as to inhibit the overall “freeness” of the market.

Attempting to uphold these fundamental tenements, nations employing a mixed economy typically have few trade barriers, limited governmental control over wealth, and enough individual rights to facilitate active and abundant trade. Trade hinderers such as price floors or ceilings, excessive taxation, or corporate disaggregation typically only apply to excessively large firms who attempt to disadvantage consumers. Governments may attempt to redistribute wealth on a relative small scale with welfare checks among other things, but these allotments sum to less than a full-time minimum wage job, even for a family of four. Mixed economies also allow for substantial personal freedom, such as physical and intellectual property rights and general monetary freedom, to incentivize both trade and innovation (two historical necessities for a thriving economy).

In accordance with the general freedoms allowed for by a mixed economy, most of the advantages of this type of system mirror those seen in a market economy, just with some of the disadvantages mitigated. Mixed economies see prices and profitability dictated primarily by supply and demand (minimal governmental interference) and productive efficiency. This type of fiscal environment encourages trade by allowing large firms to reduce prices to optimize competition, ultimately improving consumer satisfaction by giving various options at relatively low prices. Furthermore, the potentially lucrative opportunities offered by entrepreneurship incentivize innovation, yielding better technology for both consumers and businesses, which makes consumers happier, firms more efficient, and the inventor very wealthy. Macroscopically, mixed economies allow for resources to flow to the people that need them most since these people will typically pay higher prices. While a mixed economy does see inherently lower prices than other systems, firms still maintain profitability by pricing goods to maximize their own profits, which can mean offering the good at a price where only those who need it most will pay for it. Meanwhile, unobtrusive governmental presence solely as a consumer (which market economies do not see) encourages the production of technologies that improve defense and scientific research; without an indefinite buyer for these products (the government), firms would have little incentive to invent Kevlar or a zero-gravity chamber.

While mixed economies do assume many of their more extreme brethren’s positive qualities, they also suffer several of the same pitfalls. Any system with politics involved sees its share of bureaucracy and nepotism; politics in mixed economies yields issues with monopoly management in that firms friendly with the government run a smaller risk of shut-down than those with a negative relationship. Further, non-economically educated politicians make decisions of widespread economic policies such as welfare, Medicare, and unemployment; if mishandled, these social well-being policies could become a nuisance on the economy that eventually gets revoked altogether, making those who need the services most suffer. Such social-welfare programs also contribute to an inefficient allocation of goods (whose price does not dictate distribution) since the government provides goods to lower-income people at a lower cost than someone else may spend. While a mixed economy can encourage and allow its patrons to accumulate fortunes, it also places the majority of people in the lower and working classes thereby increasing the income and wealth gaps in the population.

In our future discussions of American economic policy, we will regard the right-leaning mixed economy as the benchmark for the American system. With its exorbitant social-welfare and military spending, we cannot realistically call America a market economy; however, because of the property rights, financial freedom, and trade freedom among many other things, we cannot call the nation communist, or even socialist (theoretical midpoint between communism and market economy).

America’s policies have historically fit the mold of an effective mixed economy with left-leaning legislation like the Sherman Antitrust Act and the implementation of Medicare and Unemployment, along with capitalistic tendencies such as the trickle-down approach (Reaganomics) and an inherently inefficient government that has difficulty interfering in the economy even when it wants to do so. Therefore, in future posts when we discuss how to best manage America’s money, we will regard all issues in the frame of a mixed economy.

Communism

The logical next step in our discussion of economic theory and its pertinence to American policy and society has fostered a bit of controversy in the past century, and while many nations hesitate to use the word directly, the world still sees quite a bit of this concept today. Despite its (debatably) negative history, we must regard this harshly connotated idea with ambivalence and respect to fully consider its implications on and applicability to American culture.

With that said, lets dive right into the far-left economic theory and the brainchild of Karl Marx and Vladimir Lenin: Communism. Unlike the free-market theory discussed in the last post, true communism has, in fact, existed in the world’s history, most notably in the Soviet Union during the better part of the twentieth century. Under Lenin’s successors, Joseph Stalin and Nikita Khrushchev, among others, the USSR functioned under complete government economic rule and provided the first detailed case study into the effects of communism on an economy and a society. Communist nations still exist today, and some argue that they have become even more communist than their predecessors who created the idea. Politically, socially, and economically, North Korea in the mid-to-late twentieth century may have surpassed its liberator in communism through the notion of distributed goods, the complete lack of property rights (both physical and intellectual), and the stature determining songbun-kyechung labeling system. North Korea has maintained its position as the least free nation (despite improving in recent years) with a 5.9/100 economic freedom ranking; for comparison, it attained nearly the lowest possible value of 1.0/100 throughout three consecutive years from 2010-2012.

The components pushing Communism so far to the left of the politico-economic spectrum define its structure and implementation. Typically, communism comes alongside tyrannical regimes, whose comprehensive power allows for governmental control of resource production and distribution. This economic structure has also been called a “command economy,” a title whose appropriateness stems from the lack of individual rights and ownership regarding consumption and property due to the overarching governmental intervention. While its originators intended for the system to benefit the lower-class and reduce the gap between the top and the bottom, most countries failed to achieve success under communism because of a lack of desire to partake in international trade.

Despite its failures, communism does have some positive attributes integral to understanding its place in history. Besides the idea’s theoretical end goal of complete equality, a successful communist regime will also have a well-educated and well-employed public. A communist regime needs people to work every job in every sector, and theoretically, each profession will return equal reward. Since every positions needs filling in order for society to function, the supply of labor rarely exceeds the demand, which yields a low overall unemployment rate. Accordingly, communism demands a highly skilled labor force since these positions need filling as well. The lasting presence of demand for skilled labor encourages competent people to pursue higher education at little-to-no cost, ideally resulting in a large percentage of the population attaining above a high school degree.

While communism theoretically has the best interest of the working-class in mind, the system has not fared well in the past, and it also has several fundamental issues that makes the theory itself somewhat flawed. In the twentieth century, communism contended with a poor, ignorant public and strictly violent revolts. In a command economy, everyone likely has a job, but the quality and purposes of these many jobs suffered; the lack of earning and inability to save money led to a significantly expanded lower class. As a nation, communist Russia had less than half the GDP per capita of America (at the same time), and it had a predicted Gini Index of 0.229 (very little data has come out of the Soviet Union, so economists estimate many of these numbers). The Gini Index measures wealth dispersion and the USSR achieved a score lower than any other nation in history with Slovenia coming the closest at 0.24 (theoretically, a successful communist society would have a Gini index of 1.0 since no dispersion in income would exist). Furthermore, due to the tyrannical nature of communist regimes, citizens could rarely protest or assemble legally, which led to violent revolt as the only form of rebellion. Adam Smith expresses the primary theoretical objection to communism by saying, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from regard to their own self-interest.” When no incentives exist for someone to work hard, few people will do so making productivity and consequently a nation’s overall economy suffer.

America has never really even approached a communist structure, the closest being a very small push in the 1930s by the communist party of America, gaining over 100000 presidential votes (still well under 1% of the population). Unless some drastic alteration in the American belief system occurs, it seems likely that communism will not influence American society for a long while, if ever at all. While some believe that the “American dream” is dead, the majority of people still have faith in the founding ideals and economic potential of America, making a communist uprising doubtful (at least in the near future).

Free Market Economies

“The American free market system is the greatest engine for prosperity and opportunity that the world has ever seen. Freedom works.” ~Ted Cruz, Hillsdale College commencement 2013

Well not exactly since America does not have a true free market (more on that later), but Cruz’s commentary on one of the best known economic structures emphasizes what makes the system so appealing. A free market economy has several key characteristics, the most notable of which describes an environment in which the government has no influence on trade or business. Realistically, the modern world has never seen a completely free-market economy; Hong Kong comes the closest in 2018 and America has seen spurts of seemingly boundless economic freedom in periods like the Gilded Age, but never has a nation achieved complete laissez-faire capitalism. People ultimately use the terms “true free-market” and “laissez-faire capitalism” interchangeably since a government without influence on the economy effectively equals the hands-off government and demand driven prices described by laissez-faire. Expanding on this a bit, laissez-faire directly translates to “let it go,” or more loosely to “let it be”; when considered economically, this approach allows prices to fluctuate naturally and settle at the true equilibrium point, as opposed to having government dictated floors and ceilings that restrict prices from reaching the optimal point for both consumers and suppliers.

The primary benefits of a hands-off system lie in the market’s ability to accurately and, idealistically, instantaneously reflect both the supply and demand for a good in its price. Letting a good’s price settle at the equilibrium point ensures that suppliers produce no more of the good than consumers demand. This eliminates shortages and surpluses, as well as the economic inefficiency that comes alongside these inorganic developments of external intervention. In addition to basic firm-by-firm and consumer-by-consumer optimization through price accuracy, a free-market economy also limits entry barriers into all industries thereby allowing for greater competition and innovation. New firms in an industry necessarily increases supply which not only decreases prices for consumers, but also fosters market competition. Competition increases lead to more productive firms and technological innovation (to a point) as those companies that fail to innovate and work efficiently fall behind and fail.

 

While helping boost individual firms to prosperity, technological innovations also uniformly improve economic conditions because they increase productivity by allowing a firm to spend resources on new problems that could not have been pursued otherwise. Less noticeably, economic deregulation also allows an industry to flatten out, meaning lots of small firms control it, or to spike, meaning a few small firms control it. While consumers typically find oligopolistic and monopolistic tendencies undesirable, certain industries benefit from companies being able to take advantage of their large size to offer lower prices or higher quality items. For example, a smaller airplane producing company could most likely not produce planes at the same price and quality as Boeing and Airbus simply because this small company would lack the human capital base and advanced supply chain necessary to produce planes efficiently.

Opponents of free-market capitalism typically argue that the system gives too much freedom to big businesses which will lead to higher cost of living, decreased lower- and middle-class pay (and therefore a larger wage gap), and questionable ethical decisions. The primary concern of uniformly increased prices alongside decreased pay arises from the notion that without government regulation, monopolies will arise in every industry and they will have so much power that they can charge whatever they choose for their products which inflates prices while also paying their workers next to nothing for their labor, because no better alternative exists. People effectively fear a reversion to early 1900s working and living conditions, where over half of America’s wealth belonged to the top 1% and only a tenth went to the bottom 50%, industrialists stayed at the top through unjust (but smart) tactics that ultimately hurt consumers, and only the popularization of books like How the Other Half Lives and The Jungle could induce the government to do anything. People also fear that businesses will choose to overlook other ethical decisions, such as amount of pollution released during manufacturing or general employee safety, when the government does not regulate their behavior.

As previously mentioned, a complete free-market economy does not exist, and it never has. It simply exists as a piece of economic theory for researchers and politicians to consider when advocating for changes to policy or administration. Despite Senator Cruz’s statement on the topic, America’s “prosperity and opportunity” has been generated by the relative freeness of our market structure, not by the “free-market system.” Laissez-faire capitalism represents the theoretical extreme in the direction of complete deregulation and governmental passivity regarding economic affairs; next week we will consider the antithesis of the free-market and delve into economies under complete governmental control.

Overview of America’s General Economic Policy

The American government and the economy typically get along pretty well. The government is that parent that hangs around a little bit, not too close but close enough to help if anything goes wrong. Every 10 years or so the economy rebels against its ever-present government, but the parent steps in and the relationship eventually goes back to normal and typically strengthens again with time. A lot of people like to yell at this somewhat protective parent, arguing that the child will thrive on its own and the government can only hinder its growth when standing so close. Others scream the opposite and tell the government to assume an even tighter grasp on its child, controlling it so much that it can never do wrong. And some people think the government has reached the pinnacle of parenthood, finding the perfect mix of involved but not overbearing which has let the child grow and prosper with only a few falling outs along the way.

I hope you enjoyed that extended parent-child metaphor for the American economy (if not, it’s over now anyway). Realistically, the somewhat overbearing but typically sidelined parent comparison fits the U.S. government’s role and policy regarding the economy pretty well. For the past hundred years or so, America has mostly fit the mold of a mixed economy. In the next few blogs, we will dive into some other types of economies and their arguments, but for the moment it is enough to understand that a mixed economy has foundations in capitalism yet undergoes governmental adjustment and imposition to promote public benefits.

Regarding the true “freeness” of the American economy, the government keeps its hands off, called laissez faire economics, to a large extent, but it does tax, subsidize, place tariffs, and control certain things, making it an imperfect version of capitalism. Nevertheless, the public can find satisfaction in many of the government’s economic dealings, such as funding road improvement, subsidizing oil (to lower the price), and discouraging the use of cigarettes through heavy taxation. While the government has not resolved to follow the lead of Hong Kong and Singapore, America still falls in the top twenty worldwide in economic “freeness.”

Accordingly, the 2018 Index of Economic Freedom recognizes America’s “mostly free” nature, and this best describes the economic policy. Some of the intricacies that makes America a mixed economy, however, come in the area of the government’s socialistic tendencies. While the government funds “positive” projects like infrastructure improvements and general health concerns like tobacco and other even more harmful drugs, it covers the cost of these programs through often large and potentially burdensome taxes on the public. In fact, America ranks among the bottom quarter of “free” and “mostly free” economies in tax burden, making this a primary debate regarding American economic policy. The government currently argues that people prefer to fund programs that will benefit them in the future, regardless of whether their taxes increase by marginal amounts in the present. We will explore this tax issue more when discussing overall economic “freeness,” as well as the equally pressing of government spending and financial well-being.

While America does fall in the middle third in government spending per GDP among economically “free” and “mostly free” nations, the yearly budget for governmental expenses averages over 3 trillion dollars for the past decade and this continues to rise again under the new administration.

These extravagant spending numbers in combination with national debt’s reaching over 20 trillion dollars puts America in relatively poor fiscal standing, notably in the bottom three among fellow “free” and “mostly free” states. These statistics throw into question the entire foundation of American monetary policy and beg the question “Can we change something to make America fiscally better off?” While we cannot presently do anything about the 7% interest the government has to pay on its astronomical debt, we could take a look at the funding of Social Security, Medicare, and Medicaid, which comprise 75% “mandatory expenses,” or military and “other” expenses, which make-up just under 75% of “discretionary expenses.” Analyzing current government spending and searching for policy changes to reduce the current expenditure figure could help improve America’s financial health.

In the next several posts, we will discuss the three predominant types of economic system and analyze the potential benefits and pitfalls of each for America, both economically and socially. Later on, we will take one post to look at American monetary Policy and some potential ways to handle the issues that come with the production of currency and the management of credit in the country. The final five posts will more specifically discuss the United States fiscal policy, then will dive into each of the potential raise/spend options for America regarding its current financial standing. Including this post, which broadly overviewed the type of American economy and some issue it currently faces, this blog should give a holistic view of American economic policy, the intricacies within it, and some potential methods for handling the problems it need combat.