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Follow the Economic Arrows

Economics students should be entranced with the real-world lesson plan unfolding in the news. All economics students get restive when the professor draws those seemingly incomprehensible charts on the board. Still members of Congress should have all paid more attention. All those arrows and curves are coming back to haunt us now with the federal deficit well beyond the comprehension of most taxpayers.

The lesson goes like this. Consumers are savers. They supply capital to the market in the form of savings. Businesses require capital to grow; to produce new products and services. They present the demand for capital. Here the professor draws an elegant upward sloping curve across the board, the arrow pointing toward the sky as if there would be no end to the supply of money. Then there is the demand curve, a flat line, pointing sharply downward and making it very clear that as the cost of borrowing increases, businesses will demand less capital. The meeting point of these two lines, represents “equilibrium” - the place where suppliers of capital and those who require it are in agreement on interest rates.

Now enters the government - an indirect player in the supply-demand conversation. Government is neither a supplier nor a user of capital for investment - only spending to support public programs. Lurking on the sidelines, government claims to be a disinterested party to the capital tug of war. Unfortunately, every fiscal and monetary decision shoves either savers or users of capital to the right or left.

If tax receipts are not enough to support the government’s spending plans, it stamps out its own credit card by selling treasury bills and bonds. We all know this leads to deficits. John Keynes argued that governments should run deficits during difficult times to make up for slack consumer demand. Then the government should run a surplus during flush times. Who could disagree with such a socially responsive view? Well, depending upon the political tides, quite a few.

The problem is that the U.S. government is simply a spendthrift. Some politicians would have us believe that we need to rein in spending on entitlement programs such as social security and Medicare. After all, these categories represent the largest portions of the U.S. budget. It makes sense to cut here first.

Some of the same politicians feverishly argue for making permanent the lower tax rates introduced by the second George Bush. Those with higher incomes benefited the most from this move. Proponents promised that the tax savings would encourage this class to save more, investing in new business and creating jobs. It happened just as the Republican administration promised - the consumers “saved” more money and invested, creating new jobs.

The problem was that at the same time new, lower tax rates went into effect, investment returns were substantially higher outside the U.S. than at home. Even a college freshman can follow that economic arrow. Advances in electronic trading and communications, was making it ever easier for individuals to invest outside the U.S. Corporations were already getting very skilled at “outsourcing.” Indeed, the Bush tax cuts did led to job creation - just not in the U.S.

Can Congress finally follow the economic arrows that to the rest of us seem so clear? In the coming months all taxpayers will have chance to answer that question for themselves... and students of economics in the Fall Semester 2011 will be treated to a real-world workshop the likes of which few have had before.