Friday, November 9, 2007


What are the big, basic things that make economies grow?

ECONOMISTS AND POLITICIANS argue about degree and detail—and they surely do—but generally speaking:
  • Encouraging competition
  • Keeping taxes low, and
  • A tight monetary policy
are the three drivers of economic growth.

HERE'S HOW THOSE POLICIES worked for America these past 25 years.

Encouraging competition.

When companies fiercely compete with one another, the result can be lower prices and more innovative products and services. Competition forces companies to constantly innovate—whether through new technology or business models or management processes—to keep ahead of rivals. And key to competition is keeping government regulation as light as possible while also keeping products safe and preventing harmful monopolies.

Starting in the 70s, many American industries were deregulated, including airlines, trucking, railroads, banking, electricity, and communications. This broke down concentrations of market power and unleashed innovation.

Deregulation and increased competition through global trade in many ways have created a more vibrant economy. (London, Paul. The Competition Solution. 2005.)

Established financial institutions such as big New York banks, the New York Stock Exchange, and insurance companies had to compete with junk bond financing, the Nasdaq stock market, and bigger regional banks. Southwest led the challenge to United and American Airlines. And, of course, Wal-Mart challenged locally powerful department and grocery stores.

Deregulation creates flexibility and flexibility clears the way for innovation.

Keeping taxes low.

While the Reagan tax cuts of the early 80s—dropping the top rate from 70 percent to 28 percent and indexing tax brackets for inflation—get much of the attention by economic historians, there was also the capital gains tax cut of 1978 that Jimmy Carter signed reluctantly and the 1997 capital gains tax cut signed by Bill Clinton.

Lowering tax rates does the opposite of what high taxes do, namely, discourage job formation, discourage savings and investment, and encourage tax avoidance and evasion.

As Clinton's Council of Economic Advisors stated in 1994, "It is undeniable that the sharp reduction in taxes in the 80s was a strong impetus to growth."

Tax increases appear to cause a very large, sustained, and highly significant negative impact on economic output. Tax cuts, on the other hand, cause very large and persistent positive effects on economic output. (Romer, David and Christina. White Paper. Univ. of California - Berkeley. 2007.)

All things being equal, lower taxes stimulate economic growth while higher taxes depress it.

A tight monetary policy.

Let's start with the opposite, a loose monetary policy. A loose monetary policy flirts with the prospect of inflation and the dangers it brings. Inflation is bad because it devalues the currency and causes prices to rise. Rising prices cut purchasing power and distort investment decisions. Individuals and businesses look for inflation shelters instead of investing capital where it can be most efficiently allocated.

Inflation seemed out of control heading into the 1980s, but deregulation and tighter monetary policy under Fed Reserve chairmen Paul Volcker and Alan Greenspan helped inflation fall from double-digit rates to today's two to three percent.

Low inflation brings price stability and the two are seen by many economists as essential for long-term growth.

By preventing inflation, a tight monetary policy avoids inflationary spikes that usually leads to recessions. A recession is the natural consequence of an economy wracked by inflation. It's as if inflation sickened the economy and the medicine is recession.

To repeat, a sound monetary policy keeps inflation in check and avoids the danger of a recession.


There you have it! The big three secrets to America's economic prosperity for the past 25 years are:

  • Deregulation that encouraged competition that fostered innovation that made American industry more productive,
  • Low taxes that encouraged beneficial investment decisions back into the economy, and
  • A tight monetary policy that kept inflation under control and avoided a recession that would have contracted the economy.

  • BusinessWeek. "What's Been the Secret of America's Economic Success?" Internet. November 2007

Sphere: Related Content

No comments: