Professor Glenn Hubbard’s “Connect the Dot” theory
Congratulations to Professor Glenn Hubbard, Dean of Columbia Business School and A-list commentator at the Financial Times, for his outstanding article yesterday in which he develops a new “Connect the Dot” theory of how to turn the economy around. In this groundbreaking article, Hubbard brilliantly brands as “false” the competing logics of stimulus and austerity and then ties it all together with a theory demonstrating that “a different approach is needed, one that ‘connects the dots’ and integrates the sets of economic logic and data employed by the two sides.”
While I can’t do justice to the great wisdom incorporated in the full article, here’s a summary of his three dots, the “three tangible steps to boost growth“:
1) Give a “shock to ‘animal spirits‘ ” via “substantial” incentives to investment. “The US must reduce marginal tax rates on household and business earnings and on savings and investment, while broadening the tax base. By lowering tax rates on corporate profits, dividends and capital gains, equity values and household wealth will rise immediately. It will also promote growth by raising investment.”
2) Cut medicare and social security. Also reduce “excessive reliance on consumption“ and shift toward promoting investment and exports.
3) Ease the ability of borrowers to refinance their mortgages.
These are the three dots which Hubbard warns must be connected utilizing his Connect the Dot theory. There are certainly a few questions which Hubbard understandably wasn’t able to address in the initial rollout but I’d expect these “dots” will be connected in future articles. Here are just a few issues which could benefit from a bit of clarification.
1) Regarding ‘animal spirits’, I wonder first of all what particular animal species should be invoked. Should it be a mammal or reptile? A bull with great balls maybe or some giant lizard or snake? It would be helpful to cite a previous example of an animal spiritual awakening that’s relevant for today. The third world debt bubble and real estate crisis of the 80’s, the dot.com bubble of the 90’s, and of course sub-prime mortgages all come to mind. Also, some may argue that a continued reliance on animal spirits may be inappropriate to this stage of human evolution. Would the theory support perhaps an awaking of the more barbaric side of human spirits? Attila the Hun spirits perhaps, or maybe the spirits of the Wild West or the German blitzkrieg?
2) Sticking still with Dot 1, while cutting business related taxes would probably increase stock prices, it’s not exactly clear it would spur investment. Capital gains taxes are just 15%; it would seem at first glance highly unlikely investment would rise if 100% of profits were retained versus 85%. Is the extra 15% critical to the Connect the Dot theory? Does the theory claim investors aren’t investing because they can’t keep every dollar of profit? This would seem to violate the basics of standard risk/reward analysis which clearly shows tax rates aren’t significant to return on investment at risk. Let’s clarify by comparing two tax scenarios, 0% tax and 50% tax. If an investor wishes to risk $100,000 (a laughably low sum I know) and earn a 10% return, then in the 0% tax regime, he / she will risk $100,000 and if successful earn $10,000, a 10% return. In the 50% tax regime, he / she only risks $50,000 since if the venture doesn’t succeed, the loss is written off against tax ($100,000 loss offset by a tax write off based on the tax rate of 50%, or $50,000). If successful, earnings are only $5,000 ($10,000 – $5,000 tax) but the yield on investment at risk remains 10% ($5,000/$50,000). Hubbard should therefore clarify the means by which investment is spurred by lower taxes.
3) Regarding Dot 2, the theory should address the risk that a further reduction in consumption for a working class with lower incomes today than a few decades ago might awaken their very own animal spirits. If so, in what ways would they conflict with the awakened animal spirits of investors? This could be a particularly large risk for those sitting at Columbia University, a pristine Ivy League campus lying right smack in the middle of Harlem, just one of many places in the United States with rampant poverty.
4) And finally, on what basis can investors expect profits given a world of lower consumption demand? Who will buy the goods generated by the investment? If not the worker, then wouldn’t animal spirits need to be shocked to such an extent they never go back to sleep? How will such shock therapy be applied? With a permanent awakening of animal spirits, would the human race be in danger of reverting back toward the ape? And for exports, which country specifically will be the recipient? Once the Connect the Dot theory becomes global knowledge, won’t every country in the world want to take advantage of its insights and follow the recipe of low consumption, high investment, and exports?
But these are just minor issues compared to the overall importance of Hubbard’s new theory. Hubbard clearly demonstrates the value of non-normative positive science and the clarity of thought one would expect of a Dean of such a prestigious university. Well done, Professor Hubbard!