It’s no secret that America’s economy hasn’t been growing as quickly as anyone would like since the official end of the Great Recession. The economic recovery has been far slower than recoveries from previous economic downturns. Economist John B. Taylor, senior fellow at the Hoover Institution and professor at Stanford University, believes a change in government policies could help produce better economic outcomes. He shared his ideas in a 2015 John W. Pope Lecture at N.C. State University titled “A Renewal of First Principles.” Taylor discussed these principles with Mitch Kokai for Carolina Journal Radio.
Kokai: We should mention that this speech at N.C. State University [was] tied, at least in some respects, to a book you wrote a few years ago titled First Principles. What’s it all about?
Taylor: Well, when I look at the episodes like you just referred to in the beginning, that the economy is not doing as well as it could, which I agree with, I ask, “Why?” And I think it’s largely policy. It’s actually the kind of policies I teach my students, and that is a deviation from economic policy, too.
So to describe that I wanted to list these principles, the principles of economic freedom, which I think characterizes good economic policy. And when we deviate from those, things don’t go so well, and that’s how it’s been, I think, for the last 10 years or so. And when we’re on track with those things, it’s much better, and that’s maybe the ’80s and ’90s, until recently.
Kokai: For those who have read the book, they will note that there are several principles that are spelled out very easily. Let’s talk about some of them. One of them is a predictable policy framework. Why is that important?
Taylor: It’s essential for anybody deciding on a job, or deciding to start a business, to know what policy is going to be. What’s the tax policy going to be, what’s the inflation rate going to be, what’s the treatment of investment going to be, all those things, and that’s what we mean by predictable. You’ve got to know what’s going to happen.
A predictable policy, I think it’s probably most important in an area which I like to think about: monetary policy. So what’s the Fed up to? Are they going to raise interest rates and how and when? So that predictability helps. Same with taxes. If you keep changing the tax law constantly, you don’t know what to do. You don’t know what the return is going to be. So predictability of policy is very important.
Kokai: You also emphasize the rule of law.
Taylor: It goes part and parcel with predictability. The rule of law is needed to know what’s going to happen when you buy this property. What’s going to happen when you open this business? Are you going to be able to have the rights to that in the future? Is the government going to change its policy? What about the health care law: Are they going to change the health care law to exclude something that I took advantage of?
All those things are so important. And I think what’s also important, it creates a better economy. It’s something that we forget about sometimes. Economists too often don’t emphasize the rule of law. But in certain situations like the fall apart of the Soviet Union, we thought it was going to be great as economists, market economy and all that, but there was no real substantive rule of law. And as result, things have not worked well.
Kokai: Another pillar that you mentioned is strong incentives, and some people listening will think, “Oh, that means we need these targeted tax incentives or targeted tax breaks.” That’s not what you’re talking about.
Taylor: No. In fact, the best way to get incentives, and this is really another principle, is through the market. The market rewards people for making an investment in education so you get a better job. Doing a good job itself so you get a promotion, that’s the incentives.
In a way you want a general set of incentives that applies to everyone. The targeted incentives that apply to some people in certain circumstances, that goes against the predictability principle, where you know what’s going to happen. If you happen to have a different profession which is treated differently, or somehow the government gives a break or requires a license for that, that’s really not predictable and that’s really targeted.
Sometimes it’s targeted disincentives. You have to go through a lot of hoops to get a license to practice, even to be a hairdresser. And that’s not what you want for a good, strong-performing economy.
Kokai: We talked about strong incentives. You mentioned the reliance on markets as a fourth principle, and another one was a clearly limited role for government. Why is that so important?
Taylor: What we’ve learned, I think, from history and just from basic economics [is] that there are a few things that government can do well and government should do those. That’s maybe national defense. It’s the obvious ones that economists talk about.
But there are so many other things that the market does well, or people do well on their own, without the government. And what you have to do is limit the role of government to the things that government is appropriate for. So again, national defense is an obvious one. When government goes beyond that, actually the extreme — runs industries or takes over certain sectors of the economy — then you’re in trouble.
Then you lose those incentives. You lose the ability to improve the economy, to grow. It’s really the private sector that you want to emphasize as much as you can, because that’s where the innovation comes from, the rewards. So that’s why you want a limited [government]. It doesn’t mean you cut it to zero. You limit it to what government is good at. Use cost-benefit analysis.
Kokai: I want to circle back to something you mentioned earlier because people who know you in the economics profession probably know you for monetary policy and something called the Taylor Rule, where you really call for something very different than what we’ve seen in recent years from the Federal Reserve. Why is the Federal Reserve acting in a way that’s contrary to what it should be doing?
Taylor: That’s a good question. In fact, it’s an especially good question since when they acted according to a rules-based policy like this, things worked well in the ’80s and ’90s, until recently. When they deviated, it hasn’t worked well.
I think they’re maybe trying to do too much. Perfect became the enemy of the good, and they deviated from the good policy. And then the crisis came, I think, as a result of this deviation. And once a crisis occurs, then all sorts of changes occur. You figure you’ve got to do this for the special circumstance, special firm, a bailout, an intervention here and there, and suddenly you’re deviating from good policy all over the place.
Kokai: And what you’d like to see is the Fed set up some sort of, or someone, set up some sort of rule rather than have the Board of Governors of the Federal Reserve making decisions here and there and changing their minds, correct?
Taylor: I would like the Federal Reserve itself to set up a process or rule. You know, after all, in the ’80s and ’90s, they came pretty close to that. An economist looked at that period — Paul Volcker was the chair for a while, Alan Greenspan was the chair for a while during that period.
They followed a fairly predictable, rule-like policy focused originally on getting inflation down and then keeping it steady, and, boy, the economy really did pretty well during that period.
In more recent years they haven’t done that. So the idea is, well, maybe we should just require them to choose a strategy, choose a rule, explain it to people. If they want to deviate from it, OK, that’s fine, but tell the Congress why, what are you up to. I think there’s a matter of transparency and accountability.
Kokai: Your book on first principles … the subtitle mentions “a path to better national prosperity.” How will following these rules benefit our economy and kick-start the growth, so to speak?
Taylor: Well, two things. One, it’ll get that recovery we missed in this so-called recovery, which really never got growth at 5, 6, 7 percent like in the ’80s. And it also will get us a longer-term growth rate that I think the economy can deserve. It does that because of the incentives — the incentives to start up firms, the incentive to expand, the incentive to continue in school — the freedom that those polices, this more certainty about what tax policy will be, the greater certainty about what the Fed will do, the less confusion about policy more generally, the fact that the rule of law is holding and they’re not going to deviate from it. All those things, history shows us, [lead to] higher economic growth, more jobs, more prosperity.