Juiced by his $1.9 trillion stimulus package, consumer spending is colliding with supply constraints—shortages of semiconductors, most basic materials in construction and manufacturing—and inflation is surging.
Federal Reserve Chairman Jerome Powell tells us this inflation is a temporary phenomenon and monetary policy will continue to accommodate recovery. However, the 10-year Treasury rate TMUBMUSD10Y, 1.465%, which provides the benchmark for everything from credit cards to mortgages, has jumped, since the beginning of the year.
Crowding out investment
Many economists and the financial press say higher interest rates reflect expectations for some combination of higher growth and inflation but whatever happened to supply and demand?
In 2020, the Fed purchased Treasuries and other securities approximately equaling the $3.1 trillion massive federal deficit, but this year its stated policy is to purchase half as many, lessening demand for government-backed securities and other forms of debt. Longer-term interest rate almost certainly had to rise even as the Fed kept the overnight borrowing rate pinned close to zero.
Biden’s majorities in Congress should ensure he will get substantial elements of his infrastructure and social spending proposals and some of his new taxes—even if not enough to cover all his new spending. Some combination of higher interest rates and taxes will crowd out private investment and discourage risk-taking on new products—the driving force behind productivity growth, higher living standards and international competitiveness.
Biden’s public investments are a child’s sugary drink when the economy needs Grade A Fortified. His infrastructure programs do too little—and do it badly.
Progressive think-tank intelligentsia
To catch up with years of underinvestment, more than $2 trillion should be invested in roads, rails and the like. Congestion and delays reduce productivity and output at least $400 billion annually. At best, Biden’s proposals would spend about half that amount—the rest are for industrial policies, social programs, and racial and gender justice.
Hundreds of billions are for electric cars, semiconductor foundries, Green New Deal stuff, and redistribution schemes like affordable housing, publicly funded child care and the like. Those will do much to re-carve the national economic pie but not enough to make it bigger.
Rising interest rates and higher taxes would move dollars for investing from the hands of private businesses and families who save to the progressive think tank intelligentsia that populate the Biden White House. Who would make better choices?
The premise behind industrial policy is that governments can boost capital spending where the private sector faces barriers too large but that would yield enormous social benefits—the Rocky Mountains and the Union Pacific. Or where foreign governments have stolen our industry with high trade barriers and generous subsidies—steel and semiconductors.
Biden’s program would seed a national network of EV charging stations by financing 500,000 units to hasten the transformation of the auto industry and boost a U.S. semiconductor industry at grave risk from Chinese targeting. But so much of what he wants to do will make private investment too expensive.
Higher wages, higher costs
The Davis-Bacon Act effectively requires federally funded infrastructure projects to hire workers at union wage rates and work rules and imposes regulatory burdens that raise costs for public works projects by an estimated 20%. Biden wants to fold into the infrastructure bill the Protecting the Right to Organize Act, which would generalize those burdens throughout the private sector.
Raising the corporate tax rate higher than in Canada, Japan and Germany will reawaken Obama-era tax inversions—American companies moving abroad headquarters, intellectual property and attractive jobs.
The combination of higher federal tax rates for successful, risk-taking Americans on capital gains and estates and state levies in places like California and New York would raise intergenerational tax rates on productive investment to more than 70%.
Older affluent Americans will be taking fewer chances on new ideas and cruising the Caribbean more because if they make smart business decisions, the government will too much of the profits before they or their kids even see it.
When we talk of federally financed child-care, woke journalists piously pronounce every other civilized nation has some version of it—they really dream of a social-democratic paradise in the image of France or the broader EU.
I don’t care to have European ossification, youth unemployment and pandemic paralysis but apparently our president thinks it’s worth the price to maintain the Democratic Party’s hold on power.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.