Role of Government Policy Controversial

 

Takeaway

  • Short-term stimulus measures, including tax cuts, could come at the expense of long-term recovery, experts say
  • Supporting emerging industries such as renewable energy is a central component of the government's recovery strategy
  • An insolvent banking system inhibits the development of small businesses

The most visible force behind the recovery effort is the federal government’s role in creating new policy. However, the process has been embroiled in controversy, as officials strain to find a balance between stimulating the economy and controlling spending.

Dr. Michael Granof, professor of accounting at the McCombs School of Business, says these two competing objectives create both short- and long-term problems.

“We have a short-term problem, which is, we’re in a recession right now, even if it's not technically defined as such,” Granof says. “And what do you do when you’re in a recession? The usual approach is to increase spending and decrease revenues. Well, you can’t solve the long-term problem without solving the short-term problem. And yet, if you solve the short-term problem, you’re aggravating the long-term problem.”

The Road Thus Far

So far, the government’s measures have included bank bailouts, tax cut extensions, infrastructure projects, and support for emerging industries such as renewable energy. Many other initiatives in the pipeline will seek to revive job creation, establish a stable financial industry, and put money back in the hands of consumers.

“With stimulus spending, we all want it done quickly, and we all want it done thoughtfully. It’s a paradox, and that’s part of the problem,” says Sandy Leeds, a senior lecturer in the McCombs Finance department. “We were in such dire times that we passed a huge spending bill without possibly having thought everything out the way we wanted. But that’s what the markets wanted, and we gave it to them.”

Most of the recovery policy put forth thus far has provided a short-term patch for immediate needs rather than attempting to address the root causes of the nation’s financial distress, Leeds says.

“What we need to do is convince people that there needs to be a complete change in mindset,” Leeds says. “Everyone is concerned about making the present better: ‘We’ve got to get out of this great recession; we’ve got to get back to full employment.’ I think that’s true, but if you really think about the situation we’re in, we’re going to have some serious pain, whether it’s now or whether it’s later, and I think that part of what’s going on is this myth that it can all be okay. And I don’t really believe that.

“We’re going to have to cut some of the entitlement programs. We’re going to have to cut Social Security and Medicare in some meaningful way. We’re going to have to change what we’ve promised.”

The extension of the tax cuts implemented during the George W. Bush administration has been one of the most contentious maneuvers in the recovery process. In December, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which extended the Bush cuts for two years. The bill applies to all taxpayers, despite a movement among Democrats to let the cuts lapse for those who earn $250,000 or more annually.

Granof predicts that the extension of the cuts, particularly to the wealthiest earners, will have a negligible effect on the economy.

“What we should have done is not extend the Bush tax cuts to the exceedingly rich,” he says. “Those tax increases would not have been a drag on the economy.”

McCombs Senior Lecturer Robert Duvic says the benefits of the tax cuts are vastly outweighed by the consequences of ignoring the deficit.

“If you raise taxes, it would hurt the economy. But if you don’t, you could in effect destroy the credibility of the United States government to borrow, and that would be catastrophic,” Duvic says.

Investments and Subsidies

Another important consideration in rebuilding the economy is determining which industries the government should support. Granof says that ideally, these investments would pay off in the form of jobs and yield benefits for the general population.

“You have to be very selective in how you spend your money,” he says. “I think the federal government should be taking steps to reduce certain types of expenditures, and focusing on those that provide the greatest leverage. You would want to look at construction projects, infrastructure projects, which pour money into the economy and create jobs.”

Government backing of the renewable energy industry represents an effort to pursue that goal. Corn ethanol producers, for example, receive large federal subsidies to produce the renewable fuel, in an arrangement designed to boost investment in domestic agriculture, create jobs, and promote sustainability.

But not everyone agrees with this approach, preferring for the market, rather than government investment, to decide the best course for the future. Duvic says there are a number of other options for sustainable fuel that would be more efficient and cost-effective than ethanol, but political pressure causes the government to play favorites.

“Many people feel that capital, in our economy, is not being allocated well — that the government is coming in and allocating capital for political rather than economic purposes,” Duvic says. “Some people are saying that our venture capitalists and entrepreneurs used to be thinking, ‘What’s the best product?’ And now they’re thinking, ‘What’s the subsidy?’ ”

Best Financial Foot Forward

The financial industry was at the forefront of the economic meltdown, and digging it out of the hole should be among the first orders of business in the recovery effort, says Finance Professor Lew Spellman.

“One target is to have a solvent banking system, and we don’t have a solvent banking system,” he says. “Not only are you not going to get the aggregate numbers of lending and spending, but it also inhibits the growth of new businesses. We have totally inhibited small business development and growth, and that’s your ultimate driver of economic growth. Large businesses come out of small businesses.”

Spellman says too much of the recovery effort has focused on pumping funds into large banks with troubled assets, as smaller banks receive little or no support. The goal was to help the banks start lending again, but that objective has not panned out.

“There are other ways to do it that they’re not doing,” he says. “And that is, encourage new banks with new private capital, new startup money, so right from the get-go, the bank is solvent. It doesn’t have any losing assets.”

Instead, Spellman says, the Federal Deposit Insurance Corporation has made an effort to reduce its exposure by shrinking the banking industry.

Meanwhile, the large banks continue to stay afloat and even grow, as troubled institutions merge together, as in the case of Bank of America and Merrill Lynch. Granof says this approach is counterproductive and could lead to a repeat of the problems that caused the meltdown in the first place.

“We have these banks that are widely acknowledged to be ‘too big to fail.’ We should add that those institutions have been too big to manage, and, from an accounting perspective, I would say that they have been too big to audit,” Granof says. “Instead of doing the logical thing and breaking them up or reducing them in size, we have been combining ‘too big to fail’ institutions and making them ‘super too big to fail.’ ”

 

Faculty in this Article

Lew Spellman

Professor, Department of Finance McCombs School of Business, The University of Texas at Austin

Lewis Spellman received his BBA and MBA from the University of Michigan and his MA and Ph.D. from Stanford University. His research interests include...

Michael Granof

Professor of Accounting McCombs School of Business

Michael Granof received an A.B from Hamilton College, an MBA from Columbia University, and a Ph.D. from the University of Michigan. His research...

Robert Duvic

Distinguished Senior Lecturer, Department of Finance McCombs School of Business

Education
• PHD, University of Texas at Austin, 1990
• MBA, University of Texas at Austin, 1983
• MS, Florida Institute...

About The Author

Rob Heidrick

Writer, McCombs School of Business

Born and raised in Austin, writer Rob Heidrick has spent several years as a contributor and editor at local magazines and community newspapers. He...

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