Fewer 'animal spirits' and more citizen disincentives imperil economy

Of the many pitfalls this nation faces, there are few that are as fraught with more danger than the fiscal path being plotted by President Obama and his White House staff.


Our politicians are simply not aware of the importance of stimulating private investment -- this after over two years in the doldrums, offering instead further threats to any risk-takers' economic well-being. Nor are they aware of the unpleasant consequences that current laws have on creating voter incentives to forgo citizen responsibility to control government expenditures.

Our automatic stabilizers have helped natural business-cycle dynamics and monetary policy halt the economic decline. Natural business cycle dynamics include, at their core, emphasizing the importance of strong economic incentives in a free, and always risky, market economy, with the institutions of private property, the law of contracts and the ability to contract freely as vital supporting elements.

John Maynard Keynes was well aware of these factors, but he swept them under the rug with his unfortunate catch-all term "animal spirits" -- as if establishing the conditions for aggressive risk-bearing to flourish was of minor importance. After a sufficient period of deficit spending, he virtually implied, these spirits would be ignited, ensuring a strong economic revival.

Consequently, many of today's economists, especially those in the White House, mistakenly regard "animal spirits" as a given. Quite the contrary -- they must be aroused, and are the key to recovery and of much more importance than stimulus programs.

THESE ECONOMISTS, while adept at suggesting new ways of redistributing wealth and income, are weak at developing incentives for stimulating the private risk-taking required to replace the wealth taken by their wealth-transfer programs. Instead, White-House spokespeople constantly threaten risk-takers with higher taxes and even more onerous regulations, leaving them wondering what the next ominous threats will be.

The lack of positive tax incentives, in combination with even more threatening political actions, is bound to produce restrained private investment spending and low employment.

Experience has taught us that the single most effective way to arouse "animal spirits" is a tax cut to business (recall the Kennedy, Reagan and Bush cuts and, in particular, the fact that arousal of "animal spirits" was an essential ingredient of supply-side economics.) Further, academic research repeatedly has confirmed the importance of taxes in elevating private investment spending.

In the past, many colleges offered undergraduate courses on "business cycles" using a textbook such as Prosperity and Depression by Gottfried Haberler, which focused on the grinding adjustments a free-market economy incurs in a recession to adjust capital values, imbalances (excessive inventories and pools of manpower, for example) and other distortions, and the long and arduous re-contracting process, necessary to provide a durable foundation for a strong revival.

In modern academia, these kinds of analyses have been supplanted by courses on macroeconomics, where the emphasis is on fine-tuning the economy and growth. In fact, some of my colleagues felt so confident in their econometric refinements of the business cycle that they told me, half-jokingly, that they had worked their way out of a job. Five recessions later, they are still working.

THE STUDY OF MARKET incentives and the price system has been sacrificed to the worship of "aggregates." In removing virtually all such studies, we have thrown the baby out with the bath water. Explanation of how a market economy works, including the powerful role that personal incentives play in the face of risky investments, has become a lost art.

Of equal importance to the question of arousing robust private investment are several, often overlooked, but serious voter financial disincentives. How to encourage the motive to undertake risky private investments in the face of both onerous tax burdens and restrictive government and union regulations is, indeed, a problem.

But it is exacerbated by a growing citizen indifference to escalating government expenditures. This behavior stems from 1) the growing fraction (more than 40 percent) of citizens who pay no income taxes, and hence have little or no financial incentive to reduce government expenditures, but instead have a perverse incentive to increase them; and 2), a growing proportion of citizens who receive more cash flows from the government than they currently pay in taxes.

Given this evidence, is it any wonder there is a conspicuous decline in citizen interest in wanting to curb the expansion in government expenditures?

These overhanging problems, if uncorrected, imply that government expenditures can easily continue to grow at an unbounded rate, breeding an additional range of unpleasant possibilities -- outcomes that are now reasonable consequences of escalating citizen disincentives.

(The writer is a University of Georgia professor emeritus of financial economics. He lives in Aiken, S.C.)