A critique of Ron Paul's "End the Fed"

In the December 29, 2009 TIME magazine article "Visiting Ron Paul's Fed-free utopia," Justin Fox provides a critique of Ron Paul's book, End the Fed.

The comments posted with the link above also provide interesting, but perhaps not erudite, reading.

After being urging to do so by several readers, I finally read Ron Paul's End the Fed. I was about to buy it for the Kindle I got for Christmas, but when I got to work Monday morning there was a package in my mailbox from Gary Howard at Paul's Campaign for Liberty with two copies of the book. I gave one to my colleague Stephen Gandel, and started reading the other. I had told Hunter Lewis that I was going to read his Where Keynes Went Wrong first, but when I saw how short End the Fed was (and how few words per page it contained) I figured I could finish it in a couple of hours. It took about three, and it was worth the time and effort. I didn't learn anything new about monetary economics or the Federal Reserve, but I did learn a lot about the thinking of Ron Paul. It turns out to be a curious mix of the sensible and the delusional. To put it differently, Paul has wrapped a mostly cogent critique of central banking in general and the Fed in particular inside a decidedly utopian view of what a world without central banks would look like. At one point in the first chapter he warns that "ending the Fed is not a magic pill to usher in Utopia." Then, throughout the rest of that chapter and the rest of the book he describes how ending the Fed would usher in a state of affairs that sounds an awful lot like, well, Utopia.

Here's the list of happy consequences that Paul says ending the Fed would bring, with my annotations in italics:

1. "It would bring an end to dollar depreciation." You betcha. Paul wants to replace the Fed with a return to a strict gold standard—in which dollars would be redeemable in gold. If that happened, and we stuck to it, the dollar would indeed maintain its value better than it has since the Federal Reserve was created in 1913. (More on this in item 4.)

2. "It would take away from government the means to fund its endless wars" and its "massive expansions of the welfare state that has turned us into a nation of dependents." Paul is right that governments in the U.S. and elsewhere have often printed money to pay for major wars. They've done that even without the help of central banks (as the U.S. did during both the Revolution and the Civil War), but having a central bank institutionalizes the mechanism for money-printing and thus presumably makes it easier to get away with. As for his welfare state argument, there's surely something to it, but not nearly as much as Paul seems to think. In the post World War II era, Germany has followed much more of a hard-money (that is, Ron-Paulish) line than the U.S., yet it has a much bigger welfare state. So the growth of government can be a political choice, not just the result of the machinations of central bankers.

3. It would "stop the business cycle." Really? Paul utterly fails to back this claim up in the book, because he can't. We've had recessions and depressions in the U.S. both with central banks (the Fed and its two predecessors, the First and Second Banks of the United States) and without them. It's true that Fed backers have repeatedly claimed through the decades that wise central bankers had figured out how to stop the business cycle, and repeatedly been wrong about that. There's also an argument to be made—although the evidence is mixed at best—that central banks exacerbate the business cycle. But saying that we would have no more economic ups and downs if the Fed were shut down is utopian fantasizing.

4. It would "end inflation." Correct. If we returned to a gold standard and stuck to it, there would be periods of inflation and periods of deflation, but over the long run prices would hold more or less steady. Unless we discovered that alchemy worked or the moon was made of gold, in which case we would get raging inflation. Paul also completely ignores all the economic problems that deflation, especially sharp deflation as we had in the early 1930s, can bring with it. He's apparently been too busy with his beloved Austrian economists to ever read any Irving Fisher (pdf!).

5. It would "build prosperity for all Americans." Paul does a pretty good job of explaining why the Fed's money-printing can't build prosperity, but in general this country's record of building prosperity has been about as good in the Fed era as in the pre-Fed era. Which leads me to think that monetary policy may not be the key variable in determining prosperity over time.

6. It would "end ... the corrupt collaboration between government and banks that virtually defines the operations of public policy in the post-meltdown era." He's onto something about the corrupt collaboration, of course, but he's also being either naive or disingenuous. Does he think there wasn't any corrupt collaboration between government and banks in the 19th and early 20th centuries, before there was a Fed?

7. It would "put the American banking system on solid financial footing" and "customers' deposits would be safer than they are today." The argument here is that if banks didn't have a government safety net, they'd be more careful and their customers would be too. Jim Grant makes this case far more exhaustively in his wonderfully cranky book Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken. The flip side is that lots of banks failed and lots of depositors lost most or all of their money in the pre-safety-net days. That's what made the survivors careful. The bank-failure solutions offered up by Washington—the Fed and the FDIC, mainly—have created new problems of their own. But banks are naturally unstable, because they borrow on a short-term basis from depositors and turn around and hand most of that money back out as longer-term loans. Paul nods to this in a brief discussion of the evils of fractional-reserve banking, but fails to acknowledge that fractional-reserve banking predated the Fed and is both a product of and enabler of free-market capitalism. Banning it would thus represent a pretty severe encroachment on the economic liberty he so cherishes. It would probably also be a serious economic downer.

8. It would "end the way in which our electoral cycles have been corrupted by monetary manipulation." There's no hard evidence of such corruption since Arthur Burns' tenure as Fed chairman in the 1970s, but Paul is right that the risk is always there. Then again, a Fed that was more closely controlled by Congress—which Paul advocates as an intermediate step before the Fed is completely abolished—might be even more prone to election-year shenanigans.

9. "The national wealth would no longer be hostage to the whims of a handful of appointed bureaucrats whose interests are equally divided between serving the banking cartel and serving the most powerful politicians in Washington." Instead, it would be hostage to the ups and downs of the gold-mining industry, because under a gold standard the supply of money is determined by the supply of gold. The economic argument for central banks was that wise technocrats could do a better job of managing the money supply than gold miners could. That faith may have been misplaced, and a lot of people more hard-headed than Ron Paul have been calling lately for at least a partial return of gold to the global monetary system. But returning to gold almost certainly wouldn't be the silver (gold?) bullet that Paul makes it out to be.

There's lots of wisdom in Paul's Fed critique, and his espousal of the virtues of prudence and saving and hard work. But in this book, at least, he succumbs to the temptation of promising an easy way out. Guess he's more of a typical politician than I'd been led to think.

GOP seizes on terror issue - and the post hoc ergo propter hoc fallacy of logic

In the December 28, 2009 Politico article "GOP seizes on terror issue," Glenn Thrush and Martin Kady II explain that Republicans want to make defense against terrorism a political issue. They warn that the attacks may backfire because of the Republicans' own spotty record.

Critics should be especially careful if they want to argue that the Christmas Day security screening failures are the fault of the Obama administration because it was in power when the lapses occurred. By that logic, the September 11, 2001 terrorist attacks should be blamed on President George W. Bush and his Republican administration. The point of emphasis is the fallacy of logic known as post hoc ergo propter hoc in which one assumes that because one event precedes another, the first event caused the second one. In this case, the (erroneous) reasoning is that because the Christmas Day attempted bombing occurred after Obama became President, then his ascendency to power must be the cause of the security failure. That is likely to be no more accurate than an assertion that Bush's ascendency in 2001 caused the 9/11 attacks.

Republicans have wasted no time in attacking Democrats on intelligence and screening failures leading up to the failed Christmas Day bombing of Flight 253 — a significant departure from the calibrated, less partisan responses that have followed other recent terrorist activity.

The strategy — coming as the Republican leadership seeks to exploit Democratic weaknesses heading into the 2010 midterms — is in many ways a natural for a party that views protecting the U.S. homeland as its ideological raison d’etre and electoral franchise.

President Obama’s GOP critics have been emboldened during the past 48 hours by the stumbling initial response of Homeland Security Secretary Janet Napolitano, who spent Monday retracting her Sunday claim that “the system worked” in the aftermath of Umar Farouk Abdulmuttalab’s near takedown of a jet ferrying nearly 300 people from Amsterdam to Detroit.

“In the past six weeks, you’ve had the Fort Hood attack, the D.C. Five and now the attempted attack on the plane in Detroit … and they all underscored the clear philosophical difference between the administration and us,” said Rep. Pete Hoekstra (R-Mich.), the ranking Republican on the House Intelligence Committee.

“I think Secretary Napolitano and the rest of the Obama administration view their role as law enforcement, first responders dealing with the aftermath of an attack,” Hoekstra told POLITICO. “And we believe in a forward-looking approach to stopping these attacks before they happen.”

Sen. Jim DeMint (R-S.C.) went even further, telling FOX News that the Christmas attack proved President Obama’s talk-to-your-enemies approach might actually be encouraging terrorists.

“[S]oft talk about engagement, closing Gitmo, these things are not going to appease the terrorists,” he said. “They’re going to keep coming after us, and we can’t have politics as usual in Washington, and I’m afraid that’s what we’ve got right now with airport security.”

Obama didn’t address his critics during a brief appearance in Hawaii on Monday, saying only that "the American people should be assured that we are doing everything in our power to keep you and your family safe and secure during this busy holiday season. … As Americans, we will never give into fear and division."

A White House spokesman says the administration wants to avoid making the national security and terrorism a partisan issue.

“The president doesn't think we should play politics with issues like these. He hasn't. His response has been fact-based and appropriate and will continue to be as such,” said deputy White House press secretary Bill Burton.

But other Democrats say the GOP’s yuletide political offensive could backfire on Republicans, putting the spotlight on the party’s own less-than-spotless record on homeland security.

Exhibit A: DeMint’s controversial “hold” on Obama’s choice to lead the Transportation Safety Administration, Erroll Southers, which has left the agency leaderless during a critical period of reappraisal and potential reorganization.

“Considering that this group has been playing politics with the TSA for months, their new-found concern about safety seems a bit contrived,” said Rep. Anthony Weiner (D-N.Y.), who acknowledged “legitimate beefs” about lapses leading up to the Christmas Day bombing attempt.

DeMint says he’s blocking Southers because the top cop at Los Angeles International Airport hasn’t vowed to block TSA unionization. And spokesman Wes Denton said the agency is better off headless than with big labor running the nation’s airports.

“This is an important debate because many Americans don't want someone running the TSA who stands ready to give union bosses the power to veto or delay future security measures at our airports,” Denton said.

DeMint isn’t the only Republican raising concerns that Abdulmuttalab was allowed to board the plane despite being placed on a list of potentially dangerous foreign nationals and that he managed to escape detection despite carrying a large amount of explosive powder sewn into his underwear.

Early Monday morning, the House Republican Conference blasted an e-mail offering up a half-dozen GOP lawmakers to discuss national security — and to criticize the Obama White House.

Rep. Peter King (R-N.Y.), the top Homeland Security Committee Republican, criticized the Obama administration for not going public more quickly to reassure Americans that the skies are safe.

Hoekstra, for his part, blamed the president for “downplaying” the threat of terrorism and slammed the White House for failing to provide detailed bipartisan briefings.

Democrats, on the other hand, say they have plenty of ammunition for a homeland security counterattack.

Over the summer, 108 House Republicans voted against the final conference report of the 2010 appropriation bill for the Department of Homeland Security, which included funding for explosives detection systems and other aviation security measures.

The no voters cited a procedural dispute over the appropriations process. They included Minority Leader John Boehner (R-Ohio), Hoekstra and a who’s who of big-name House Republicans: Reps. Mike Pence, Michelle Bachmann (R-Minn.), Marsha Blackburn (R-Tenn.), Darrell Issa (R-Calif.) and Joe Wilson (R-SC).

The conference bill included more than $4 billion for "screening operations," including $1.1 billion in funding for explosives detection systems, with $778 million intended for buying and installing the systems.

“It’s a base political calculation,” said one senior House Democratic aide. “It’s risky to play politics with something like this. The morning after [the attempted bombing], Republicans had already drawn a bright line on this.”

In June, both parties overwhelmingly backed Utah Republican Rep. Jason Chaffetz, who inserted an amendment into the House's massive Homeland Security appropriations bill barring the use of full-body image scans as "primary" screening tools at airports.

The amendment, which died in the Senate, passed the House on a bipartisan 310 to 118 vote, with conservative libertarians joining liberals, all decrying the scans as a major invasion of privacy.

It would also have given passengers the option of getting a pat-down — which might have also detected the Christmas bomb — while banning the storage and copying of the images, which show a virtual picture of a person's naked body.

The measure was little-noticed at the time, but it could have a big impact if the Obama administration follows through on its pledge to increase such imaging, which experts say could have detected the explosives hidden on the body of the would-be airplane bomber.
Chaffetz, for his part, doesn’t regret the amendment, telling the Salt Lake Tribune, "It's a difficult balance between protecting our civil liberties and protecting the safety of people on airplanes," adding, “I believe there's technology out there that can identify bomb-type materials without necessarily overly invading our privacy."

In the coming days, GOP criticism of the administration’s actions may give way to a louder, if more decorous din from Democrats questioning security procedures here and abroad.

A handful of key congressional chairmen have already scheduled hearings to see what did go wrong on that Northwestern Airlines flight.

Sen. Joe Lieberman (I-Conn.), who chairs the Senate Homeland Security and Government Affairs Committee, says his panel will investigate how the attempted bomber slipped through security and screening procedures.

"I view Umar Farouk Abdulmutallab as a terrorist who evaded our homeland security defenses and who would have killed hundreds of people if the explosives he tried to detonate had worked," Lieberman said.

"What we know about the Abdulmutallab case raises two big, urgent questions that we are holding this hearing to answer: Why aren't airline passengers flying into the U.S. checked against the broadest terrorist database, and why isn't whole body scanning technology that can detect explosives in wider use?"

Democratic Party Factions

In the December 22, 2009 Salon article "A progressive divorce?," Michael Lind divides the Democratic Party into three factions: neoliberals, New Dealers, and Greens. According to Lind:

Does the growing rift between most progressives and the Obama administration represent merely tactical disagreements among people who share the same values and goals? Or is there a deeper, philosophical divergence on display?

In a thoughtful essay for the New Republic, "Taking Ideological Differences Seriously," Ed Kilgore of the Democratic Strategist argues that the divide within the Democrats is ideological. (See Glenn Greenwald's comments here). In an earlier Salon column I argued that Obama, like Bill Clinton before him and neoliberals in general, is a practitioner of "creeping subsidism" -- a strategy of subsidizing and incentivizing individuals and corporations to achieve public goals. Three examples of neoliberal subsidism have been in the news: bailing out giant financial firms instead of temporarily nationalizing them and putting them through bankruptcy; taxing Americans to subsidize health insurance companies to cover the uninsured; and deliberately increasing utility bills to indirectly subsidize Wall Street by means of cap-and-trade legislation. I contrasted the approach of President Obama and other "New Democrats" with the New Deal liberal tradition's preference for direct regulation, government social insurance and state capitalism in areas like infrastructure.

While Kilgore is associated with the New Democrats and I consider myself a New Dealer, his description of the contrast is similar to mine:

o put it simply, and perhaps over-simply, on a variety of fronts (most notably financial restructuring and health care reform, but arguably on climate change as well), the Obama administration has chosen the strategy of deploying regulated and subsidized private sector entities to achieve progressive policy results. This approach was a hallmark of the so-called Clintonian, "New Democrat" movement, and the broader international movement sometimes referred to as "the Third Way," which often defended the use of private means for public ends. (It's also arguably central to the American liberal tradition going back to Woodrow Wilson, and is even evident in parts of the New Deal and Great Society initiatives alongside elements of the "social democratic" tradition, which is characterized by support for publicly operated programs in key areas).]

This is accurate, including the point that the neoliberals are inspired by Woodrow Wilson's relatively conservative New Freedom rather than the New Nationalism of Theodore Roosevelt or the New Deal of his cousin Franklin. Kilgore is also right when he says that rival factions are sometimes too quick to dismiss the philosophical foundations of the rival camp:

[But ideology, however muddled, is part of what makes most politically active people tick. And if we don't talk about it -- and about differences in strategic thinking as well, which should be the subject of future discussions -- then all we are left with to explain our differences on this issue or that is questions of character. And anyone paying attention must recognize there's far too much of that going on. "Progressive pragmatists" -- the camp with which I most often personally identify, as it happens -- often treat "the Left" condescendingly as immature and impractical people who don't understand how things get done. Meanwhile, people on "the Left" often treat "pragmatists" as either politically gutless or personally corrupt. This is what happens when you don't take seriously other people's ideological and strategic underpinnings; whatever you gain in ignoring or minimizing differences in perspective or point of view is lost in mutual respect.]

As long as Kilgore's New Democrats treat his social democrats as failed New Democrats who are too naive about politics, and as long as his social democrats treat New Democrats solely as unprincipled corruptionists, there can only be a dialogue of the deaf.

The center-left can learn from the right. Back in the 1950s and 1960s, William F. Buckley Jr. and the circle around National Review tried to promote a "fusionist conservatism" that would unite Cold War hawks, social conservatives and free marketeers in a single philosophy. But the attempt to create a common conservative public philosophy by blurring important differences was a miserable flop. By the end of the 1980s Buckley's so-called movement conservatism had been sidelined by three distinct and energetic schools of thought on the political right: neoconservatives, libertarians and the religious right.

Each movement was willing to focus on some issues rather than others, as the price of being part of a hoped-for lasting Republican majority. The neocons, for example, specialized in hawkish foreign policy, the libertarians in deregulation. But the distinct schools on the right remained more or less internally coherent; they never degenerated into single-issue movements. Neoconservatives to this day, reflecting their Cold War liberal origins, tend to be relaxed about big domestic government and social insurance programs. In the Bush years, for example, the Weekly Standard published a critique of Social Security privatization. And many libertarians and religious conservatives are isolationists who disagree with the GOP's hawkish foreign policy.

Each of the three schools of thought on the right has a comprehensive vision of all of society -- foreign policy, domestic policy, morality -- even if its operatives choose to emphasize only the issues most important to them. Each vision, moreover, is incompatible with the vision of the other right-wing factions. Libertarians would not want to live in a world designed by neoconservatives, who in turn would not want to live in a Christian fundamentalist theocracy. In short, there is no such thing as "American conservatism." There are three rights, which have a shaky alliance of convenience under the umbrella of the Republican Party. Instead of a broad church, there are three denominations.

Is it time to admit that the American center-left, like the American right, is divided into groups of people who may agree on defeating the Republican Party but otherwise disagree on fundamental values and goals? Kilgore identifies two groups -- "New Democrats" and "social democrats." I prefer to call them "neoliberals" and "New Dealers." Perhaps "progressive" could be used for the New Dealers, if neoliberals who call themselves "pragmatic progressives" would agree to surrender the term.

Along with the neoliberals and New Dealers, I would identify a third significant faction to the left of center -- ideological Greens. While remaining true to the conservationist heritage of the two Roosevelts, New Dealers need to distinguish themselves from pessimistic, technophobic and antinatalist Green Malthusians. You can't be a New Deal liberal and view poverty in either the American South or the global South as a problem of too many dark-skinned people instead of too little social justice and too little economic development. You can't celebrate FDR's Tennessee Valley Authority as a symbol of economic and social progress and condemn it as a monstrous assault on the purity of an idealized natural world in which humans, unlike other animals, are intruders. And because one of the achievements of the New Deal was to use federal investment to promote electrification, the automobile and industrialized agriculture, you can't be a New Deal liberal and weep for a vanished early-industrial world of steam railroads, trolleys, tenements and locally grown food. (For opponents of coal, Greens seem to share a surprising nostalgia for the densely populated, transit-based cities of the ephemeral steam engine era.)

If we distinguish neoliberals, New Dealers and Greens from one another, then the center-left coalition, at the level of first principles, is not a marriage of two partners but a ménage à trois. It resembles the ménage à trois on the right that unites libertarians, Christian conservatives and neoconservatives. Recognizing that there are indeed distinct and fundamentally incompatible public philosophies to the left of center does not prevent cooperation among the schools for common purposes. The three factions can work together to maintain a Democratic majority, just as the neocons, libertarians and social conservatives disagree on first principles but unite in elections to support Republicans against Democrats.

Democrats should learn from Republicans how to manage a ménage à trois.

Economist Samuelson, Nobel laureate, dead at 94

In the December 13, 2009 obituary "Economist Samuelson, Nobel laureate, dead at 94," Associated Press writer Polly Anderson briefly describes his contributions to the field.

NEW YORK – Economist Paul Samuelson, who won a Nobel prize for his effort to bring mathematical analysis into economics, helped shape tax policy in the Kennedy administration and wrote a textbook read by millions of college students, died Sunday. He was 94.

Samuelson, who taught for decades at Massachusetts Institute of Technology, died at his home in Belmont, Mass., the school said in a statement announcing his death.

President Barack Obama's chief economic adviser, Lawrence Summers, is his nephew.

In 1970, Samuelson became just the second person, and first American, to win the Nobel Memorial Prize in Economic Sciences, created in 1968 by the Central Bank of Sweden. The other Nobels have been awarded since 1901.

The award citation said Samuelson "has done more than any other contemporary economist to raise the level of scientific analysis in economic theory."

A 1970 New York Times profile said his mind "possesses the agility of a Nijinsky and the endurance of a cross-country runner." When he won the Nobel, he said it was "nice to be recognized for hard work."

Samuelson was a liberal, and like many of his generation a follower of British economist John Maynard Keynes, who proposed that a nation needs an activist government that could foster low unemployment by steering tax and monetary policies, even if it meant deficit spending at times.

"In the old-fashioned laissez-faire economy, prosperity was indeed a fragile blossom," he wrote in a 1970 article for The New York Times. "But for a modern 'mixed economy' in the post-Keyensian era, fiscal and monetary policies can definitely prevent chronic slumps, can offset automation or under-consumption, can insure that resources find paying work opportunities."

He was among a circle of JFK advisers, who also included John Kenneth Galbraith and Walter Heller, who led Kennedy to recommend the historic income tax cut that Congress eventually passed in early 1964, three months after the president was assassinated.

"A temporary reduction in tax rates on individual incomes can be a powerful weapon against recession," Samuelson had written in a report to Kennedy in early 1961.

The cut was widely credited with helping foster the 1960s economic boom. When Heller died in 1987, Samuelson said, "In Kennedy's Camelot, he was chairman of the greatest team ever assembled. He was a great policy economist and a witty, phrase-making economist."

Conservative Criticism of Obama's Jobs Plan

Still Killing Jobs
by James Sherk
December 10, 2009 |

In his economic speech yesterday, President Obama made it clear that his administration will take a step forward on job creation. Unfortunately, it's also taking three steps backward -- which all adds up to more unemployment.

The good news is that Obama understands why unemployment has risen so sharply.

Media coverage strongly implies that joblessness has risen because layoffs are up -- but that's only part of the equation.

The number of jobs lost by firms rose 15 percent from the start of the recession to the first quarter of this year. These layoffs are real and painful for the workers involved. But they're not the driving force behind the doubling of unemployment.

The US economy usually loses millions of jobs each month as technology and consumer preferences change. But in normal times, new and expanding businesses create millions of new jobs -- more than replacing those that disappear. Twelve years ago, for example, Google didn't exist; today, it employs 20,000 Americans.

In regular economic times, most workers who leave jobs find new ones in two or three months. On balance, job creation offsets job losses, keeping unemployment under control.

In this recession, however, those new jobs aren't being created. Business startups have dropped 18 percent. Expanding or startup companies are creating 25 percent fewer jobs than before the recession. That represents 1.9 million jobs not created in the first quarter of the year.

Rather than investing in new projects that would create jobs, businesses have retrenched wherever they can.

In other words, unemployment has risen mainly because of the new jobs that entrepreneurs haven't created.

Obama understands this: "We are not creating jobs at a [sufficient] pace," he said yesterday; to reduce unemployment, America needs to "accelerate the pace of private-sector hiring."

So he announced one small step toward doing that: eliminating capital-gains taxes on small businesses and extending write-offs for small-business investment. Both these moves will indeed encourage entrepreneurs to take the risk of investing in their businesses -- and thereby create new jobs.

But then there are those three large steps back.

First, the president announced another stimulus (though without calling it that). He wants to use hundreds of billions in unspent TARP funds on more government spending: more highways and "cash for caulkers" home-weatherization funds.

And, despite Obama's rhetoric, most of his "pro-employment" proposal consists of such government spending to create more taxpayer-funded jobs.

This government spending doesn't make new businesses more likely to succeed. So it won't encourage entrepreneurs to invest, unless they receive the federal contracts. Bigger government doesn't encourage entrepreneurs to create jobs.

Worse, it discourages them. The more resources Washington consumes, the fewer entrepreneurs have to invest in their own projects.

The academic research is quite clear that government jobs are created at the expense of a greater number of private jobs -- with the one reliable study (Algun et al, in Economic Policy, April 2002) suggesting that for each 100 jobs "created" in the public sector, another 150 private-sector jobs vanish.

So it should surprise no one that private-sector hiring has remained low -- and unemployment has kept rising -- since the last stimulus became law.

Second, Obama reiterated his support for the health-care reform bills before Congress. But a trillion-dollar government health-care takeover won't create jobs. Indeed, these bills would raise taxes on employers and make providing health coverage (i.e., employees) more expensive while penalizing employers who don't offer it. Such laws would make businesses more likely to fail.

Yet the president yesterday signaled his determination to press forward with health "reform" no matter what it does to business prospects. How are entrepreneurs likely to react?

The third step back came Monday -- an administration action that's guaranteed to make businesses fear the future. The Environmental Protection Agency announced it had classified carbon dioxide as a pollutant under the Clean Air Act. Unless stopped, the EPA will start regulating CO2 -- giving it enormous power over every business in the country. Energy will grow far more expensive, and business costs will rise -- and no one knows just how bad the damage will be.

Obama yesterday did nothing to relieve the confusion or assure businesses that EPA's actions won't destroy jobs en masse. Waiting to see what the EPA does is the rational choice for many entrepreneurs. Why risk millions on a business project that might become unprofitable under new regulations?

Unemployment has risen because private-sector job creation has fallen. It won't fall until private-sector investment and hiring return to normal rates. Obama's tax breaks for small business are a small step forward. But his plans for spending hikes and health-care "reform," plus the EPA's impending carbon regulations, are three large steps back.

James Sherk is Bradley Fellow in Labor Policy in the Center for Data Analysis at The Heritage Foundation.

First Appeared in the New York Post

Fed Up With Federalism: How U.S. commitment to states' rights is undermining its economic recovery.

In the December 2, 2009 American Prospect article "Fed Up With Federalism," Harold Meyerson explains "how America's commitment to states' rights is undermining our economic recovery."

By accident of its birth -- a collection of separate colonies that slowly came together to form an independent union and revolted against the remote power of the British government -- the United States has an enduring bias toward localism, an aversion to centralized government that is part of its DNA. For some on the left, this has been seen as a positive. "It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country," Justice Louis Brandeis once wrote.
Even though progressives such as Brandeis have celebrated our federalism, it's important to remember that Brandeis lived and worked at a time when the federal government was icebound in conservative orthodoxy and the cause of social justice could be advanced only in a small number of states and cities. Segregationists like George Wallace and Richard Russell have celebrated our federalism, too, arguing for states' rights at a time when the national government was moving to abolish the Jim Crow laws throughout the South.

Conversely, liberals have argued for the right of the nation to move beyond its federalist constraints during those periods when they controlled the national government (the 1930s and, especially, the 1960s). And during the late, lamentable Bush presidency, conservative justices on the Supreme Court frequently forbade the states from enacting stricter regulations on business than those that Bush's administration had put in place.

The love of federalism is a sometime thing; its critics and champions switch places depending on who is in power at which level of government. But the problem with our allegedly ingenious federal system is not simply that half the time, if not more, it is an effective way to protect all that is biased and unfair in the American nation. The problem is also that federalism inherently subverts a coherent national response to many fundamental challenges the United States faces, at a time when other major nations -- our competitors in an increasingly global economy -- face no such structural impediment.

Given the sheer size of America and the distinct cultural identity of its many regions, federalism has always made a certain amount of sense. The abolition of the slave trade and the legalization of gay marriage had to begin somewhere. As the rise of national government, transportation, and media have eroded regional identities, traditions, and isolation, however, more conservatives than liberals have found a refuge in federalism.

But even though federalism is more often the refuge of reactionaries than of visionaries, it has an even deeper flaw: setting the nation at cross-purposes with itself, and never more so than during a recession.

***
There is a classic algebra problem in which water pours into a bathtub from the tap at a specified rate but also exits the tub at a different rate because someone has neglected to stop the drain. If you know the rates, you should be able to figure when the water will rise to a certain level. During a recession, the United States becomes a version of that bathtub. The federal government is the tap. The state and local governments are the drain.

That's no way to fight a recession. When investment, production, and consumption are all in decline, the only way to keep the economy from shrinking is for the federal government to deficit spend and create a stimulus. But while the federal government pours money in, the state and local governments, which cannot deficit spend, see their tax revenue shrinking, so they cut spending, raise taxes, or both -- taking money out of the economy. America's distinct brand of federalism inherently impedes an economic recovery.

Consider the state with the biggest tap and the biggest drain: California. The sum total of the federal tax cuts for Californians included in last year's Bush administration stimulus legislation and this year's Obama administration stimulus came to $15.5 billion for the years 2008 to 2010 -- money desperately needed to boost consumer spending in the midst of the worst downturn since the Depression, says Jean Ross, executive director of the California Budget Project. But the sum total of state tax increases enacted by the California Legislature and signed into law by Gov. Arnold Schwarzenegger in 2008 and 2009, Ross says, came to $12.5 billion for the years 2008 to 2010 -- money desperately needed to keep public services in California from grinding to a halt in the midst of the worst downturn since the Depression. "The state negated 80 percent of the feds' tax cut," Ross says. "And the cuts and the increases pretty much targeted the same lower-income groups."

Nor were the negations limited to tax cuts. Ross calculates the federal government's direct aid to education, its block-grant programs and other education-related expenditures for California total $9.5 billion from 2008 to 2010. The state government's cuts to K-12 schools, community colleges, the California State University, and the University of California add up to $17.4 billion for the same years.

California leads the fiscal--disaster pack, but it is anything but alone. A September paper from the Center on Budget and Policy Priorities reports that since the recession began, at least 41 states and the District of Columbia have slashed their budgets for a wide range of services -- 27 for health care, 25 for aid to the elderly and disabled, 26 for K-12 education, 34 for higher education, and some states for all of these. Forty-two states have reduced wages to state workers through layoffs, furloughs, and salary cuts. At least 30 states have raised taxes during the same period. "All of these steps remove demand from the economy," the center concludes. They "reduce the purchasing power of workers' families, which in turn affects local businesses."

Without the Obama stimulus, which appropriated roughly $140 billion to the states to reduce their budgetary shortfalls during 2009 and 2010, these numbers would be even worse -- though keep in mind that $140 billion in federal funds isn't engendering growth; it's merely offsetting state cutbacks. The center estimates that the federal bailout enabled states to reduce their budget gaps by 40 percent. But with state financial shortfalls in those two years coming to a whopping $350 billion, that leaves $210 billion in unrecompensed state budget shortfalls, which the states have to make up by cutbacks or tax hikes or financial gimmicks. Dean Baker and Rivka Deutsch of the Center for Economic and Policy Research estimate that the cutbacks and tax hikes of cities, counties, and school districts in 2009 and 2010 will come to an additional $15 billion.

So how much does the government's stimulus come to when we subtract the amount the states and localities are taking out of the economy from the amount the feds are putting in? The two-year Obama stimulus amounted to $787 billion, of which $70 billion was really just the usual taxpayers' annual exemption from the alternative minimum tax, and $146 billion was actually appropriated for the years 2011 to 2019. That leaves $571 billion that the federal government is pumping into the economy during 2009 and 2010. Subtract the amount that state and local governments are withdrawing from the economy (they have a combined shortfall of around $365 billion, but let's say they do enough fiscal finagling so that the total of their cutbacks and tax hikes is just $325 billion), and we're left with $246 billion.

At $787 billion, the stimulus came to 2.6 percent of the nation's gross domestic product for 2009 and 2010 -- not big enough, but a respectable figure. At $246 billion -- the net of the federal stimulus minus the state and local anti-stimulus -- it comes to just 0.8 percent of GDP, a level lower than those of many of the nations that the U.S. chastised for failing to stimulate their economies sufficiently.

But other major nations don't have federal systems that turn them into unstopped bathtubs in times of recession. They have states and municipalities, to be sure, but either the responsibility for funding most functions of government resides with the national government, or, as in Japan, state and local governments are not required to run annual balanced budgets. In China, which probably has had the most robust recovery of any major nation, taxes and spending for everything are set in Beijing (including the lower tax rates for provinces in which manufacturing for export is the main economic activity). In France, taxing and spending has been controlled by the national government at least as far back as Louis XIV. In Britain, funding for local government also comes from the national government; "local taxation," says Thomas Barry, first secretary for economic affairs in the British Embassy in Washington, D.C., "is a very small fraction of the total tax burden in the U.K."

Such is obviously not the case in the U.S. The national government alone funds defense and the two great social programs, Social Security and Medicare, created at moments (1935 and 1965) when liberals controlled both Congress and the White House. But state and local governments, which can't run deficits, remain the primary funders of education, transportation, local infrastructure, and public safety and split the cost of health care for the poor with the feds. What this means is that the governmental impediments the United States encounters during a recession are far greater than those encountered by the other major nations with which we compete in the ever more global economy. What this means is that our federal system is, in this very significant particular, massively dysfunctional.

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This September, the Los Angeles County Metropolitan Transportation Authority, the agency that runs LA's growing subway system and its far-flung bus lines, struck a novel deal with an Italian rail manufacturer. In return for its purchase of 100 light-rail cars from the company, the MTA got the company to agree to locate a unionized factory in Los Angeles. Problems with the manufacturer caused the deal to collapse, though, and the MTA is now searching for another company that will build the trains in Los Angeles. The agency's attempt to bolster local industry with a Buy-LA policy has encountered opposition, however, from the Los Angeles Times, which noted in an editorial that federal funds available for buying clean, green rail transport are denied to states and cities that insist on making the product locally. To be sure, the Obama administration has allotted billions of dollars to incubate an electric-car industry. But it is not insisting on domestic content, nor has it cut a deal with a foreign manufacturer to locate a factory here, as Los Angeles is trying to do with rails and as Southern states have done for years with foreign automakers.

The federal government doesn't do that. Well, our federal government doesn't do that. Foreign federal governments do that all the time. China has spared no expense to attract foreign manufacturers, routinely abating their taxes, holding wages in check, offering help to construct new facilities. In the U.S., states and cities woo foreign and domestic investors with an array of tax and zoning incentives; right-to-work states promise to hold down wages, too. But the kinds of sweeping guarantees that national governments can offer are beyond the capacity of states and localities to promise, much less deliver.

China, for instance, is halfway through a stunningly ambitious project to build 100 university science parks roughly modeled on North Carolina's fabled Research Triangle. On average, the parks, according to the testimony of attorney Alan Wolff to the U.S.?China Commission, are 150 percent the size of North Carolina's triangle. "China has taken our model and expanded dramatically on it," Rick Weddle, CEO of the Research Triangle Foundation, testified to the commission. "We toured a research park in Suzhou that is a joint venture between the Chinese government and Singapore. We wouldn't even think about that."

The industrial policies of American states are dwarfed by those of foreign nations, while the one entity with the resources to compete with foreign nations -- the federal government -- stays out of the game. States seek new factories while the federal government shuns domestic content requirements. As with stimulus policy during recessions, state and federal industrial policies seem totally at cross-purposes.

Federalism also enables federal and state governments to punt the responsibility for funding politically contentious programs to each other -- a pretty good way of ensuring that the programs will end up underfunded. A quick way to grasp the contrasting levels of political power wielded by the elderly (considerable) and the poor (negligible), for instance, is to look at how the government funds their health care. Medicare, for seniors, is entirely federally funded. Medicaid, for the poor, has the responsibility for its funding split between the federal government and the states. Despite the fact that Medicaid is nominally a national program, the levels of financial support that states allot it vary considerably. During the current recession, many states have opted to slash Medicaid benefits, even as federal Medicare benefits have largely stayed intact.

The perverse consequences of this hybrid funding have seldom been clearer than during the health-care reform battle, in which the Senate Finance Committee's bill to open Medicaid rolls to more Americans without pledging full federal funding for the program has presented recession-wracked states with a problem they could do without. After Gov. Schwarzenegger stated that the increased cost to his state could amount to $8 billion annually, Sen. Dianne Feinstein of California, who backs the health-reform efforts, announced that she couldn't support a bill that increased the state's costs. (In the House bill, the federal government picks up almost all of the states' increased Medicaid costs.) Federal mandates on states that must balance their budgets during recessions are problematic policy, and they illustrate the buck-passing that is inherent in the federal system. Historically, the price for this feature of federalism has been paid neither by the federal nor state governments but by the poor.

In regulatory matters, the gap between federal and state standards can work as Brandeis thought it should, but it can also enable businesses to comparison shop for the lowest level of regulations. While federalism is an effective way to create multiple governmental power centers in a nation, it creates a system that powerful private players can game. The diffusion of power inherent in federalism works best when power in the private economy and civil society is also diffused, so that, for instance, business will get push-back from labor when it attempts to arbitrage the gaps between state and federal law.

The boundary between federal and state functions in the United States has always been a flexible one, and one that has moved slowly and haltingly toward the federal level throughout most of the nation's history. By the standards of nearly every other major nation, however, and increasingly by the standard of common sense, the United States retains a system of government that frequently subverts its own policies and enables federal and state governments to negate each other's endeavors. Federalism has its points, but in a growing number of ways, and especially during a recession, it makes no damn sense at all.