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Deconstructing the American Fairytale

The concept of the American Dream, first espoused by James Truslow Adams in 1931, defined the dream as “a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement “.

The term morphed into a symbol of American opportunity and the possibilities that awaited all those willing to pursue success in the region. For Americans, torn between the democratic ideals of equality and the pursuit of independent wealth, the American Dream was irresistible in its allure – it allowed them to have their cake and eat it too.

It’s funny, but people often group capitalism and democracy together; while they do in fact have a symbiotic relationship, they are actually on two opposite sides of a spectrum. Capitalism is the freedom for an individual to pursue his or her own dreams, while democracy enables the majority to restrict that freedom.

Today, in the effort to have our cake and eat it too, or in some cases, fight bitterly on how to manage the cake, we are missing a key point – it is not only unquestionably the case that we need a balance of imperfect democracy and imperfect capitalism – but the current balance is creating tremendous deadweight loss. We are overly democratic in our willingness to hand out entitlements and raise taxes on businesses, and far too libertarian in our lack of oversight in the financial sphere.

Both increases in taxes and increases in government spending have a strong negative effect on private investment and spending.

Recent works by Gregory Mankiw and Martin Feldstein at Harvard indicate that the total cost to the economy of an additional $1 of tax for the government to spend can be as high as $5 and is almost always at least $2 – in other words, direct government spending may not be the most efficient way of accomplishing goals.

Alberto Alesina and Silvia Ardagna, also from Harvard, recently completed a comprehensive  analysis of the issue. Looking at large changes in fiscal policy in OECD nations since 1970, they compared the policy interventions that resulted in growth with those that did not.

The results indicated that successful stimulus is contingent on cuts in business and income taxes -increases in government spending are far less effective.

The human animal, like all other animals, is controlled by its wants and desires. Because the human is the animal with the greatest level of sentience, he or she can be motivated by longer term desires or fears – particularly when shorter term needs like food or shelter have been met.

And, humans have proven their ability to act in pursuit of the accumulation of wealth – at times even when it conflicts with their short-term desires. However, their behavior behavior is based on a combination of the perception of the risk, cost and potential payout of the activity, along with their unique tolerance for risk.

When the government adds additional entitlements for the unemployed, state and federal taxes for businesses will typically increase – reducing labor supply. Firms experience a higher cost of adding an additional employee and see lower benefits of the gains in productivity that stem from that employees work.

On the demand side, workers are less eager to join the workforce when the marginal gains of working relative to collecting government employment are low.

Additionally, among those that have been unemployed for a significant time period, there is a much greater number of people who simply stop trying. Today the “official” unemployment rate in the US, which looks only at those unemployed who have attempted to seek employment in the past 4 weeks, is at slightly over 10%, while the the real unemployed workforce actually stands at over 17%.

Greater Democratic Oversight of Regulators in Financial Markets is Needed

In contrast to the creation of entitlements and growth of taxes, our focus on libertarian ideals has lead to poor regulation of financial markets in which public interests are underrepresented in an imperfect market where investment information is tightly concentrated among a small number of large investors.

With the exception of the independent regulator – who has little incentive to act in the interest of the public rather than large investors – few policies challenge the influence and power to distort that larger investors are afforded under independent regulatory systems.

Nicholas Dorn, Professor of International Safety and Governance at the Erasmus School of Law, argues that “networking between regulators and those they regulate results in a convergence of global regulatory thinking. This creates groupthink, common blind spots, and deepens systemic risk.”.

In other words, a lack of outside input can lead to missed risks and a tendency for chameleon-like behavior. Poor regulation offers individual regulators excessive temptation – in terms of both financial reward and desire for peer approval – to go along with the crowd.

Diversity in thinking – and greater accountability to public interest – could be achieved by democratic steering of regulatory agencies in order to ensure that public interests were indeed met and blind spots were reexamined by those outside the field.

Abandoning the Goal of the Impossible will Allow Policy Makers to Better Optimize the Imperfect

Karl Marx understood that perfect capitalism would lead to anarchy; he missed that a perfect democracy (aka communism) would accomplish exactly the same result. Both would erode the hope of greater economic gains for the vast majority of people. And, it is the individualistic quest to accomplish greater things – not the collective desire to remain on equal footing with one’s neighbor – that is most effective in enabling the government to have any measure of control whatsoever.

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Posted in Business, Culture, Economics, Investing, Politics, Psychology. Tagged with , , , , , , .

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