Josh Rauh (Stanford GSB Finance Professor and Hoover Senior Fellow) joins the podcast to discuss his distinguished academic career, his research in public economics on taxes and public pensions, his time at the Trump Administration White House Council of Economic Advisors, the legacy of the CARES Act together with other COVID-19 era spending, and the future path of U.S. public debt.
Jon: “This is the 21st Century Podcast, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Today, I'm joined by Josh Rauh, who's the former family professor of finance at the Stanford Graduate School of Business and is a senior fellow at the Hoover Institution. He is also the co-founder of the Global Liberty Institute and the new Liberty Land Sub-SAC. Josh studies public economics, namely taxation, pensions, and many more essential topics and has established himself as a leading expert in the field. Welcome.”
Josh: “Thank you, Jon. Thanks for having me.”
Jon: “Josh, I want to get into your background. How did you first get interested in economics and where did you grow up?”
Josh: “Well, that's a great question. I grew up in the Boston area. I went to a small private school in the Boston area called the Roxbury Latin School, a classically oriented school where students still learned and still learn Latin and ancient Greek. I went to Yale. I initially started out as a natural sciences person, starting out maybe being pre-med or interested in molecular biology, but I took a freshman organic chemistry class that hit me like a ton of bricks and ended up exploring the social sciences because I was good at math and also my fundamental issue with the natural sciences was, I just really didn't like working in a lab. I just was not really a lab person. You were a numbers person. I was a numbers person and a data person, but not a lab person. When I took my first economics course, it was a revelation because I realized that mathematics and data science could be applied to topics that were important and current and they had public policy influence.”
Jon: “Fantastic. You worked at Goldman Sachs for a period of time before you did your PhD in economics at MIT. You studied public economics and were a Jim Prokura student who advised many of today's leading public economists, I think Emmanuel Saez, Seve Sancheva, and yourself. I'm curious, what was it like at MIT in the early 2000s?”
Josh: “Yeah, well, just backing up a little bit, coming out of Yale, I wasn't really very organized about what it is I wanted to do. I had the solid grades in the economics and math classes, but I was not particularly focused and I don't think I would ever have gotten into a PhD program today because, of course, today you need not only the undergraduate background, but a couple of years of having been an RA for some professor, a set of glowing recommendations from very famous people. Also, coming out of Yale, I wasn't really sure that I wanted to get a PhD in economics. I was intrigued by some of the more practical applications of economics, but also wasn't organized enough or focused enough to go on the investment banking market that a lot of my people in my cohort from Yale were doing. I ended up, actually, I lived in Germany for a year and I did a couple of internships that I just put together myself, one of which was with the German parliament, the political party in the German parliament called the FTP, which is sort of a libertarian party. I was intrigued by the idea that there could be such a party because, of course, in America, we have a libertarian party, but it's not really a force. The FTP in Germany has traditionally, historically, been sort of a kingmaker for some of the other bigger parties. Things have changed a bit now.”
Jon: “Like the CDU or the SPD.”
Josh: “Exactly. The CDU or SPD would sort of go back and forth during the 20th century between the government being under the control of one of those two bigger parties, depending on who the FTP was aligned with. That was a really fascinating experience. I ended up in an internship at Deutsche Bank in Frankfurt and working on some macroeconomic strategy stuff at Deutsche. That all happened over the course of a year, and then I ended up at Goldman Sachs in London in their economics research team. That was a terrific experience. I was there in London for two and a half years with those folks, some really excellent Ph.D. economists who were there applying their skills to really market-oriented questions. A lot of what we were doing and a lot of what those groups still do involves macroeconomic forecasting and the interpretation of macroeconomic data for the firm's traders, currency traders and bond traders.”
Jon: “This is like Jan Hatzius's economics research, U.S. economics, global economics research. Maybe at the time, I think, Jim O'Neill in London was perhaps running some of this at the time.”
Josh: “Exactly. Jan was a young economist as well, like me there. He was in the Frankfurt office, so I knew him back then. Of course, he's stayed with the firm and really done it. He's German. He's German, yeah. He moved from Frankfurt to the U.S. sometime around 2000, around the time that I left Goldman. He's really done amazing things at the firm.”
Jon: “You're fluent in German.”
Josh: “I am fluent in German. That is correct.”
Jon: “Were you fluent in German before you went over to Germany or was that something you just picked up while you were there?”
Josh: “Learned it in college. Was very interested in the politics and economics of the EU and just picked it up while I was over there.”
Jon: “Wow.”
Josh: “Yeah. Yeah. Goldman in London, going to that time period, I was there in the late 1990s, the dot-com boom days. There were a lot of really very, very good people working there. After a couple of years, I got the feeling that the market prediction game wasn't really for me. Actually, people were under tremendous pressure there to make predictions in markets on a pretty short time horizon. People were punished if they were wrong. There was a currency crisis in Asia in mid-1998 that happened right after I joined. The first thing that happened was about half of the people who I had said hello to during the first couple of months that I was there were immediately fired for not having predicted the Asian currency crisis. That gave me a bit of a sense of what working there could potentially be like if you got stuff wrong. After a couple of years, I decided that I wanted to go back and get a PhD in economics and deepen my knowledge and contribute to research and take some more time to do the deeper, longer-form research that we do when we write papers in economics.”
Jon: “Wow. Well, it's fascinating. Forecasting is very difficult in this whole recent inflationary episode in the early 2020s. With the ability to forecast on the part of professional forecasters, if that's any indication, I think you chose perhaps a field that might be somewhat less than possible. You're a very distinguished public economist. You study a number of things from taxes to pensions. Can you explain what your research agenda is and its main ideas?”
Josh: “Yeah. Well, let me tell you a little bit about how I got into it. I was always interested, even from the Goldman Sachs days, in financial markets as a vehicle for long-term investments and finance being about the ability of individuals to move resources and consumption across time and across different states of the world at different prices, depending on what the conditions of financial markets were. That was one set of issues I was very interested in. Also, public policy issues like inequality, the measure of inequality, and taxation, the optimal size of government, what's the right marginal tax rate that should be set, those types of public questions. So, I went to MIT intending to work with Jim Viterbo, who I eventually did become my advisor, but not before a bit of a bumpy start. I think in the spirit of posting your losses, I'll tell you a little bit about the beginnings of my time at MIT. First of all, I was admitted, but not with funding. And I failed to get an NSF fellowship. But I went to the admitted student’s day and talked to Jim Perturb and other professors and was very impressed and looking forward to working there and to being a student there. But the director of graduate studies, when it came to the meeting that I had with him, he said, look, I'm sorry to tell you, but we took too many people this year. And he basically said mistakes were made. And he didn't say you were one of them directly, but that was kind of the implication that I was getting. And he actually said, please don't come here because we have no money for you. And not only are we not giving you money this year, we're not going to give you money ever. So it's tough medicine to take. And I thought about it. And because I had been working at Goldman, I didn't make a huge amount of money at Goldman. I was still a lower-level person, but I had some savings. And I actually said, you know what, screw it. Relative to my next best option, getting a Ph.D. in economics is what I want to do, and I'm not going to let myself be discouraged by this. So, I had to fork over tuition when a lot of other, well, all my other classmates basically had their tuition paid for. And to make things even worse, after I had accepted, I came to learn that actually Jim Perturba, he decided after that that he was going to take a year's leave and go be at the Hoover Institution, actually, a place that I spent a lot of time at in the most recent decade of my career. And so, things were looking pretty rough at that time for me. And I guess in the spirit of, you know, stick with your plan, don't get knocked off your plan, I can say that it was good that I didn't, because what ended up happening was, you know, first year in a Ph.D. program, as you know, John, you know, you're bumping around a little bit. It can be hard to get your footing exactly, and you're going to try out some stuff. And, you know, I worked for a few different people, professors, and did a few different things. I had to do RA work, actually, to pay the bills. And I think I got my footing. And then Jim came back, and I started working with him on the topics that actually come to MIT a little bit.”
Jon: “Well, this is incredibly impressive. And it's amazing to me that the best economics department in the world doesn't, you know, provide full funding for its students, or sort of has this expectation that many get NSFs. I mean, that's sort of always been an interesting phenomenon to me. But the fact that you were able to persevere through that, you know, is really amazing. And also, you know, it's totally something I think, you know, worth fighting for. I mean, to be at MIT in the early 2000s, you know, just sort of at the beginning of this wave of, you know, causal inference, credibility revolution, you know, what a great time to be in Cambridge, you know, at MIT or Harvard, for that matter.”
Josh: “Well, that's exactly right. I think, you know, what I got from being at MIT was, first of all, Jim Viterbo is just a tremendously impressive advisor, wonderful advisor who invests a lot of time and energy in really growing his Ph.D. students. We're having a celebration of him next year. Not that he's retiring, but there's just a tradition developing now that, you know, when someone's kind of in their mid-60s, you just kind of get a bunch of people together, students together to celebrate the person at a time when they're still really at their prime and, you know, doing great things. And that's going to be in March 2024. I'm looking forward to going and celebrating him. So, he was a huge, you know, huge influence and was just a tremendous mentor for me, but also at the same time being, you know, being exposed to the ideas of Josh Angrist and John Gruber and other people who were applying the techniques of identification to address causality in economics. So, it was an exciting time to be there. I was known at the time by my classmates as MIT econ's only Republican. I didn't necessarily totally embrace that, to be honest. I think I thought of myself more as sort of a swing voter, and especially because I focused kind of on economics. You know, coming out of the Clinton administration, things didn't look that bad. I mean, you know, there was a surplus, at least on the books, the way that they measure it. There had been some welfare reform, and, you know, George W. Bush had the hallmarks of being and ultimately became a sort of, I guess we think of as being kind of a big spending Republican, with not only the foreign policy things, which you can debate their necessity, but also Medicare Part D and other big government expansions. I wasn't even sure what exactly that meant, MIT's only Republican, but maybe my classmates saw something that I didn't know. Over time, I've come to embrace that.”
Jon: “Wonderful. I mean, it's so fascinating to think how much certainly the policy and political stands have changed since then, just over more than a decade been just over more than 20 years, and how the field has changed over that period of time. So, I want to get into your research agenda. So, you spent, since then, it's been almost, I think, 20 years since you graduated in 2004. What do you think have been your most impactful research accomplishments thus far?”
Josh: “Thanks. Well, a few things. The area that I kind of got known for in the field of financial economics is this topic of pensions, of government liabilities, and pensions in particular. And it's interesting. It's an area that's always interesting to me because it's a topic where all of public policy seem to be making some fundamental basic mistakes in their applications of the principles of finance. And it was an issue that sort of brought together financial markets and government budgeting. So, the big challenge, I think, that goes on in this area is that state and local governments, they always have an incentive to sort of delay costs in ways that future politicians will have to bear. And there is no easier way to do that, and actually no more widely accepted way of doing it, than telling your employees, instead of paying you in current compensation as much as you otherwise would get, I'm going to pay you in pensions. I'm going to promise you a pension, really nice pension years down the line. You got to stay here for 20 or 25 or 30 years if you want to get it, if you want it to be any good. And what was fascinating to me is, in grad school, my fields were public economics and corporate finance. And I think I just, you know, seeing the tension between those two things, the way that we know from financial economics, the way that liability is supposed to be measured, and the way that we model the evolution of assets, you know, as looking across states of the world and over time, and then looking at the way that the government budgeting was done, which is a way that government budgeting essentially just treats these forecasts of financial markets, you know, that say the stock market's going to crank out a return of 10% a year as being a sure thing. They don't adjust that for risk at all. And so, what you end up having is situations where, you know, state and local governments are basically doing budgeting on completely flawed assumptions. So I think one of the, you know, some of the empirical work I got known for was remeasuring state and local government liabilities, using the principles of finance and applying the principles of finance to, you know, to state and local government budgeting, you know, on that topic, and sort of by extension on other things like the retiree health care that they offer, and trying to move the conception of public budgeting more in a direction that aligns with the way that we think about it in finance. So that was kind of one of the big things.”
Jon: “Does that include like unfunded pension liabilities, which are sort of an increasing issue in certainly our fiscal policy discussions, you know, because that includes entitlements. We'll talk a little bit more about the US federal debt situation later, but in your research, that's encompassing of that.”
Josh: “Yeah, right. I mean,
Jon: “I'm concerned about that.
Josh: “Motivated initially by how, say, you know, the city like the city of Chicago budgets for the pensions that it promises to public safety officials or teachers. And those are when we say the words unfunded pension liabilities, which another great mentor of mine, Professor Ed Glazer, said that his wife told him it was those were the least sexy two words in the three words in the English language, unfunded pension liabilities. But nonetheless, I, to me, I find I find it a very fascinating topic of study, and indeed is that and then, you know, you can also extend these types of considerations to other government programs like Social Security.”
Jon: “Perhaps increasingly the three most important words in fiscal and debt policy.”
Josh: “Yes, I like it. Yeah. The three most important words. Who cares if they're sexy? The point is, they're important.”
Jon: “Exactly. You know, you spend about 15 years as a distinguished professor, and then you decided that you wanted to serve in government. You joined the Trump Administration Council of Economic Advisors in the autumn of 2019, soon before the COVID-19 pandemic hit the U.S. Tell us about what that experience was like.”
Josh: “Well, when I was called by Acting CEA Chair Tom Philipson in fall 2019 to join the CEA, it was a great honor for me, something I'd always wanted to do. And it was a time in my life where it was possible for me to go do it. And it was something that I didn't say no to, and I actually would advise anybody who gets called on for government service to, you know, try to do it and make it happen. I also would advise them to do something that I did, which was to set down for myself in advance the limits of what I would be willing to tolerate as being part of that position. And this was inspired to me by someone who was a mentor of my mentors, a man named Martin Feldstein, a great professor of economics at Harvard University, who had quit the Reagan Administration. He was the chair of the CEA. He quit the Reagan Administration over the issue of budget deficits and over the fact that Congress was proposing, was passing a budget that would have at the time had a $100 billion deficit, which of course, nothing compared to where we are today.”
Jon: “And Martin Feldstein was one of the, famously, I think one of the few deficit hawks in the Reagan Administration.”
Josh: “Exactly. Exactly. And so I was, when I went to the Trump Administration, I was worried about what had been going on with the deficit because it wasn't good. And especially in a situation where, at least for the first part of that administration, you had both the presidency and both houses of Congress controlled by the Republicans. Well, I liked the Tax Cuts and Jobs Act and some of the improved incentives in that act. I was not happy with-”
Jon: “You brought down the corporate tax rate to 21% and changed up the expensing rules. And I guess it was very much a pro-growth kind of tax reform, didn't do too much on the personal side of things. And a number of those things are coming up in 2025.”
Josh: “Right.”
Jon: “Certainly, a big tax discussion is brewing. You came in after that.”
Josh: “Came in after that. Right. Right. And the first few months were good. We were working on, during that cycle of the end of the year and the beginning of the next year, basically working on the economic report of the president. And you are preparing the president for any economics that are going to go into the State of the Union address. And we did a number of things, including taking stock of where the US was on inequality, on income growth at different parts of the income distribution, which is a big topic. Another topic I could talk about all day, because I think that fundamentally the narrative in the press about inequality is based on some research by some other economists out there that I think is wrong. This is the sort of narrative of Emmanuel Saez and Thomas Piketty. And I think that the other economists who worked on it, like Houghton and Splinter and others, have basically figured out that there are some real statistical problems with the Piketty-Saez. There are the Joint Committee on Taxation, or one of the one of the JCP. There are some real statistical problems with the biggity size.”
Jon: “There are the Joint Command and Taxation, or one of the…”
Josh: “One is the JCT, the other... One of the JCT, the other is the Treasury, exactly. So, some of that made its way into the State of the Union Address, so that was kind of neat. And we're also doing a lot of... A lot of what you do when you're at CEA is trying to, you know, make sure that when sort of bad ideas bubbles up from various parts of the government, that you're shedding some solid economic light on what those ideas might actually entail or do. And so, there was a lot of little... There were a lot of little things like that. But what really, you know, things really changed when COVID happened. And, you know, I think the policy response to COVID, of course, really divided the country, in some ways really divided the world. And initially, I think President Trump's instincts were not to overreact, to make sure not to overreact. Initially, and this was also the case with UK Prime Minister Boris Johnson, also initially were saying, you know, we're not going to overreact on lockdowns. We're not going to, you know, change, try to, you know, change our entire society or economic structure here just to, you know, to combat COVID. But things turned pretty quickly in terms of, you know, who the president was listening to. On health policy, he was obviously listening strongly to Fauci and Birx. And on economic policy, when this crisis happened, suddenly my feeling was that the economists in the administration, at least the ones who I knew, weren't really being consulted about the economic policy response. And economic policy response in March 2020, if we sort of rewind and think back to, you know, to the history of this and what was going on then, was the run up to what was called the CARES Act. CARES Act at the end of March 2020 introduced some of these really big new government programs. Stimulus checks for people, big business bailouts, including targeted bailouts to airlines, small business bailouts with the PPP, the Paycheck Protection Program, which was a program that turned out to be rife with fraud. Flat dollar bonuses for unemployment insurance. The unemployment insurance program, it's already a stabilizer. You know, and by doing additional legislation on top of it, it expanded in such a way that made it so that nobody would have an incentive to work for a very long time. One of the aspects of it was these flat $600 bonus amounts. That made for a lot of people the replacement rate of UI for their devices. of UI for their job, 150% or more. I mean, there are studies, you know, a bunch of studies that showed this, and it was immediately apparent. Plus, hundreds of billions of dollars to state in local governments that ultimately, they did not need. Now, I could be nice and say, well, there was a lot of uncertainty we didn't know, but this was a program of government expansion that I just was not, did not want to be part of. And, you know, in particular, I also, as I said, I think, you know, if I felt that, not necessarily me, but that others, other economists at the CEA or in the administration generally were making that point or were around to make that point, that would have been one thing. But as it was, I didn't feel that point was getting made, and I, to this day, very much, strongly disagree with that policy response. And so even though I, you know, this was about five months into my time there when I resigned, and I planned to stay for at least a year, had arranged a year's leave from Stanford and hoped maybe to stay for longer, I ended up returning, you know, coming back to Stanford because they basically crossed the limit that I had set for myself going into it.”
Jon: “Fascinating and certainly commendable to sort of see this coming and to, you know, stand by your own principles and ideas. I'm curious, like, you know, just to take stock on the legacy of the CARES Act. You know, it's fascinating to think, you know, over three years later where we are now. We had the CARES Act, we had stimulus checks, PPP grants, you had massive unemployment insurance. You know, there are expansions and so forth and subsequent bills. And then, you know, we had the additional Trump bill, I think, in the end of 2020, I believe. And then we had the Biden ARP. We had more recently the so-called Inflation Reduction Act. I think there's been over that period of time, like, an increase in the debt to GDP of, like, on the order of 20 percent. Just from those initiatives alone, you know, first and foremost, one, do you think that the inflation that we're seeing today that, you know, started to uptick in 2021, you know, has peaked at around, you know, 8 percent, you know, headline and, you know, a little bit less than that on the core side. Do you think that that uptick in inflation is related to that increase in government spending?”
Josh: “I think absolutely it's related to that increase in government spending. And, you know, I know, I mean, some people who I respect and work with draw a line between the spending that happened in 2020 and the spending that happened in 2021. And they say, well, you know, in 2020, it was necessary. We had to do this. But then ARPA in 2021, that was unadvised. I don't agree with that at all. I also I think that the lockdowns of COVID and the spending increases were really kind of two sides of the same coin. And in fact, I would go so far as to say that all of that spending was a way for the government to essentially tranquilize the American people into accepting these destructive lockdowns. And to say for a lot, you know, a lot of people say, well, you know, this isn't so bad. I'm getting I'm still getting my, you know, getting my stimulus check and I'm getting my PPP loan and I'm getting my UI and, you know, accepting something that ultimately, I think is going to be extremely destructive, not only because of the new baseline that it sorts of reset on the economic spending side, but also, of course, what we've done to our younger people who we essentially locked in their homes for a year and a half and thought, well, this will be fine. At least in some states, we did that. And, of course, it's not it's not at all fine. And so, in terms of inflation, I think some of the evidence of this is that savings rates spiked up to over 30 percent during this time. By definition, that almost means you're sending out money, the federal government, money that people didn't need. Why? Why do you have to boost people's savings rates to that level? And of course, then when all that money came flooding back into the economy on the demand side, the supply side, labor supply was still very, very limited. So, I absolutely I trace a pretty continuous line. I agree that, you know, I'll agree that ARPA and the March twenty one legislation was, you know, was perhaps the least necessary of all of it. But I also I also blame the people in charge during 2020 in both Congress and the administration for going in that direction. I also you put a debt to GDP. I mean, another figure that I just, you know, I think is worth bearing in mind. What is government spending to GDP? I like to ask my students before telling them anything or giving them any readings, what do you think the ratio of government spending is to GDP in this country? And I explain what that means. For every dollar of spending in the U.S. economy, what percentage of that is spent by the government? And during 2020, in the United States of America, which people usually think of as this bastion of free market capitalism, that number went up to 48%. 48%. And it subsided back a little bit to around 44% the following year, and I think it's settled into about 42% this year. But this is the United States of America. Do people feel that they are getting the government services, the quality of services that that amount of money would buy, should buy? And by the way, this is federal, state, and local combined, the numbers that I'm giving you here. And so I think the inflation is one of the symptoms of what it is that we've done. But I really think that we need to step back and ask, is this the appropriate size of government?”
Jon: “I just want to like let's rewind it to 2020, March 2020. You are Secretary of the Treasury. And let's go like piece by piece here, like how a response with obviously the benefit of hindsight could have been a better one. And obviously, at the time, it wasn't totally known how bad the pandemic was, how legal it was, and so forth. And that was something that was sort of learned over time. But looking back, with 2020 hindsight, I think it's fair to say that the lockdowns certainly didn't really prevent transmission and perhaps cause further economic losses. I'm curious, like in terms of like fiscal policy response, we don't need to get too much into the Fed policy response and the sort of lender last resort stuff. But on the fiscal policy side of things, obviously, there's a lot of QE as well. And this was in part a joint effort on the fiscal policy side of things. Like, okay, so, you know, we think, you know, unemployment insurance, it's fair to say that maybe we should have done a percentage of wage replacement instead of like, you know, $400 a week. That doesn't play with the marginal tax rates. It may create the kind of distortions that, you know, having over 100% marginal tax rates can create. But I'm curious, like how would you rethink something like, you know, the stimulus checks or something like that, you know, the PPP? I mean, it's just there was so much government infrastructure that was sort of used, you know, they were using the Small Business Administration to work with the banking system and a lot of smaller banks. And, you know, there was certainly a lot of uproar when certain businesses, hedge funds were taking out PPP grants. I mean, they weren't loans. Given is a loan, but it was a grant. And it was basically just money to largely small businesses. But there's been a lot of controversy about certainly, you know, how much waste, how much fraud was there. And I'm curious, like, you know, do you think that maybe the stimulus checks alone would have been enough? You know, what should we have done for small businesses? And going forward, you know, say we have a pandemic in the future, how do you think, you know, we should handle such a fiscal policy response to that kind of, you know, recession?”
Josh: “Well, let's take each of these in turn. So first of all, on the unemployment insurance, any expansion of the unemployment insurance program, whether it would be with a flat dollar amount, which creates really perverse incentives, or more preferably with some kind of percentage of wage bonus on top, if that was even necessary. Because again, the UI program is already in place. It's not clear there was a need to expand UI. But if there was going to be an expansion of UI, the point that I always make is this is an opportunity also to try to fix UI for the long-term future. You know, the unemployment insurance system, I won't go into too much in the details, but every state is supposed to maintain a balance at the treasury. It's sort of like a precautionary balance. It's supposed to be sort of the equivalent of three really bad years. They're supposed to have that in precautionary holdings at the treasury. And about half of the states comply, and the other half don't comply. And there's no teeth to it. There's no punishment for not complying. And what ends up happening is, and this is going on now, is that, well, California and other states that were not complying, they had to take big loans from the federal government to pay the UI during COVID. And now they're supposed to be paying those loans back, but they don't have the money to pay them back because now there's a deficit, and so they're passing those costs on to businesses and higher state UI taxes. Okay, that was a bit of a detour. But the point is that the entire UI system had a very flawed architecture. And so, the way to get a compromise in place is to say, yeah, all right, maybe we need to expand UI a little bit for this crisis, but let's also fix the future to say that if states want to have generous UI, they actually have to have those precautionary savings on hand. They actually have to have a fiscally sound system. And so, the general philosophy is if you're going to do an expansion today for a crisis, let's make sure we do something to sort of fix the future. And so that's what I wish would happen with that, and with a lot of government programs and other things, sort of bailout type things. Any system where you're going to pump in money, you should be thinking, okay, in exchange for this, what kind of reform are we going to ask for the long term? For something like the big business bailouts, I mean, bailing out airlines was something that was just – I guess it cost about $25 billion, which I don't know. I suppose now we're supposed to think that's small. I didn't think it's small. But you've flown on any of the three major airlines in the last couple decades. I mean, you've flown on an airline that was in Chapter 11 bankruptcy. We have structures in place so that when companies can't pay all their debts, that the creditors who bought bonds in the company end up – they take over ownership from the stockholders. Stockholders get wiped out. And so, one of the things I think also about the policy response that really bothered me is that it bailed out shareholders, equity holders, most of whom voluntarily took risk to buy equities in these companies, buy stock in these companies. The idea being that if the company had a bad realization, they get wiped out, and then the creditors get to take over the company. And by stepping in and removing that entire mechanism, we basically – we took the entire system of shareholder capitalism and risk-based capitalism, and we said, we're not going to let anybody lose a dollar. And the irony of all this is that shareholders, equity holders, came out of COVID doing great. Look at what the stock market did in the year from – there was a dip in 2020. People started getting scared.”
Jon: “It came roaring back very quickly.”
Josh: “It came roaring back very quickly and then way surpassed its initial level. So, I think making use – I think my general principle is number one, make use of existing structures and programs that we know work. And if you have to – some colleagues of mine at the GSB and I, after I came back, proposed something that we thought would be more useful than a lot of the other facilities and programs that are being proposed, which is a sort of support for debtor-in-possession financing, which is the kind of bridge financing you need to have a bankruptcy process, a financial restructuring process. It would have kept airlines and other companies operating, but it would have not just bailed out shareholders, and that would have let the normal course of financial markets do their job. I'll give you one other example. It's also the money that was directed unconditionally to state and local governments. CARES Act, I think, $500 billion to state and local governments, and there were some attempts to try to place restrictions on what they could do with that money.”
Jon: “More recently, also, the bailout was from public sector unions.”
Josh: “Yeah, union pension plan is also a big thing. With the state and local governments, state and local governments, they borrow from the public. They issue municipal bonds. That's a $4 trillion market. Municipal bonds are mostly owned by households, actually, by high-income households. They certainly have higher yields than, say, treasury bonds, the better savings vehicles for households, because you're taking on some risk. You're taking on some risk that the city might run into financial trouble or the state might run into financial trouble. You get a tax break that tends to lower the yield relative to other types of debt, but because of that default risk and maybe some liquidity, there may be a little less liquid in treasury bonds. They end up getting higher yields. Why was it that no municipal bondholder lost a single cent during this episode, but the taxpayers came in and just bailed out every state and local government? It's true money debt. These municipal bonds, these are owned by, again, largely high-income households. It's not like something that has a huge amount of systemic risk. I wrote an op-ed during 2020 where I said if there's going to be any more, and I wish they had done this initially, but any more bailout funding to state and local governments, they should have to haircut their municipal bonds outstanding, meaning that if an investor owned a municipal bond and that bond was worth $1,000, maybe they have to haircut that thing down to say, okay, now that's only going to be worth $900. You took risk, and you're going to have to bear the downside, some of the downside, when that downside happens. That's what, in the European Union, when Greece was defaulted on its municipal bonds. It's that the European Commission negotiated a bailout package for Greece. Bondholders had to take some kind of loss on that. They weren't bailed out 100% in their entirety. They weren't sent all the way to zero. But to me, a lot of these things really just violated the principles of capitalism that I feel that our country and our economy are built on. And so as we think about what's the right way to deal with crises, sure, if you feel that there are some vulnerable parts of the economy that need support, go do it. But use this crisis. Use crisis as an opportunity to reform systems like the UI system that was sort of broken to begin with. And secondly, don't do bailouts when you don't need to do bailouts. Why should taxpayers have to always support big corporations? It just makes no sense to me.”
Jon: “Absolutely. And then certainly some of that, I think, violates Badger's dictum, which is having some penalty in these sorts of emergency lending or bailout-type events. I'm curious, do you have any thoughts on just the Biden administration, House Republicans, they just came to an agreement on the debt ceiling, suspending it until January 1st, 2025, exchange for about $1.5 trillion in reduced spending, according to CBO. Any thoughts on the long-term prospects for the U.S. debt and government spending?”
Josh: “Yeah. So, this deal recently has gotten some criticism from some of the more fiscally conservative corners of the Republicans in Congress for somehow not doing enough or not going far enough. Speaker McCarthy didn't get enough concessions, enough spending cuts, in exchange for the authorization of raising the debt ceiling. And while I understand where that is coming from, because I think that we are saving, at CBO's estimate, we're going to save $1.5 trillion over the next 10 years. I mean, that's nice. But, I mean, that's pretty small. It's a percentage of the total debt or of the total deficits that we expect to have over the next 10 years. So, I understand where it's coming from. Politically, you know, I don't think that much we could have expected much more. And the reason I say that is that, you know, the Democrats have the Senate, Democrats have the presidency, and the Republicans have a razor-thin margin in the House. And what really has to happen, if the long-run picture for the U.S. fiscal situation is going to improve, is that there has to be a party in power where there is agreement among the different branches of government, so alignment of the parties. I'm thinking it's probably going to be the Republican Party, but maybe it will be a new party. I don't know. And where voters have been convinced that they need to actually vote for the party that's going to be fiscally responsible and try to fix the debt and deficit mess. I just think, you know, when you have such a razor-thin margin of people, you know, the mandate is just not strongly enough there. I wish it were. You know, if I were a benevolent dictator, I would say we need to do this for the future. You know, we need to put the future on a solid footing. But, you know, the votes just otherwise weren't there. So, I think probably we did as well as we could have.”
Jon: “Yeah, I mean, it's such a strange thing, I think, the debt ceiling. You know, it's this weird thing where the U.S. possibility of default being sort of a part of the, you know, negotiation, obviously not ideal. I mean, it creates all this excess volatility in financial markets. But, I mean, on the flip side, it's like the one tool, as bad as it is, that actually seems to bring about some conversations about government spending and debt. I remember back over 10 years ago in 2011 when there was the debt ceiling standoff then and the S&P or S&P downgrading U.S. debt and that caused, you know, big sell-off in risk markets. Ironically, it actually caused Treasuries to rally. But, you know, also that series of events created the Boll-Simpson Commission, which seemed to be simulating some public dialogue about fiscal policy and budget reform, but didn't seem to really go anywhere until, you know, 12 years later. In fact, things maybe have gotten worse in recent years. I want to just finish on talking to you about these new endeavors that you have started. You recently have founded the Global Liberty Institute and your sub-stack, Liberty Lens. What are they about?”
Josh: “We started this. So, the Global Liberty Institute is a joint effort between myself and Scott Atlas, somebody who's well-known from his work during 2020 and during COVID to try to shed some actual rational light on the health policy responses. And we started this organization, I think, for two purposes. First is that it's an international organization, sort of in the spirit of the World Economic Forum. And the World Economic Forum and a lot of the other international organizations have been doing, pushing really, really hard on the research front on a lot of what I think of as being sort of, kind of big government, sort of rationales for big government, combined with, you know, combined with sort of a cooperation between corporations and government, which is going to kind of feed even bigger government. And, you know, some of these topics are things like, you know, addressing inequality. We were talking about this before. If you listen to these international organizations, you know, you would think that we're having this explosion in inequality that requires some kind of new massive redistribution of money. But when you look at the actual statistics that a lot of this stuff is based on, a lot of their claims are based on, they're very, very flimsy. They don't actually hold up. And really, these organizations are feeding the public a line, a narrative that makes them want to believe, that makes them believe that we need all this additional redistribution. And so, one of the sets of things we're trying to do is just kind of have an organization that brings together researchers across different countries to try to provide some, put some of the stuff in a more rational lens, things like inequality or climate. You know, what's the rational response to climate change? You know, the idea that we're going to go to net zero and that we have, you know, it's going to cost over $100 trillion to do that. You know, this is something that's being pushed very, very hard by a sort of cooperation between large companies that are going to profit from it and governments that enjoy increasing their power. And I think the evidence of that is that, you know, one of the last COP meetings, I think the COP meeting in Glasgow, Scotland, you know.”
Jon: “That's a big environmental conference.”
Josh: “Big environmental conference, yeah.”
Jon: “Copenhagen, I think.”
Josh: “Right. You know, the financial institutions, the banks were lining up to provide this $130 trillion of financing. Well, of course they were. I mean, you know, if you tell everybody, hey, okay, we need to destroy all of this capital that we have, this dirty, you know, this dirty energy producing capital. We need to replace it with this green capital. And we're going to have to finance it somehow. So, the companies, they're going to build that new stuff. They're going to have to borrow or raise, you know, $130 trillion. Well, you know, who benefits and who loses from that? I mean, clearly the financiers who are going to get to be the intermediaries and loan the money or provide the equity capital, they're huge beneficiaries of that. I like to compare that to the sort of broken window fallacy. You know, the broken window fallacy of Bastiat, which is this idea that, you know, there's this fallacy that, hey, maybe, you know, we should go around breaking windows and hiring repair people to repair them because we can generate all this economic activity. Well, you know, the person who would benefit from that would be the glass repairman. And in this case, you know, the entities are going to benefit from it are, you know, the companies are going to build all this new green energy and the financiers are going to finance it. So, I'm getting off topic, but you asked about GLI. So GLI is trying to, you know, be a voice of reason on those topics. Second role of GLI is that organizations like the World Economic Forum have done really well at organizing young people on their economic policy objectives and young people who then end up going into public policy. So, the chairman of the World Economic Forum, Klaus Schwab, is fond of actually boasting that graduates of his program include people like Justin Trudeau. I mean, he's proud of that fact, but I don't think necessarily you should be proud of it, but he is. And, you know, the government of Argentina, you know, which is the economic basket case, what you have to hand to them, though, is that they have been incredibly effective at mentoring these people. And so, what we are doing with the Global Liberty Institute, and I know you were able to attend our first Rising Leaders’ Summit in Palm Beach in February, is to try to do a better job of organizing and mentoring rising policy leaders who are going to be facing the economic problems of the day, the critical and pressing and really dramatic economic problems of the day, using the rational principles of economics. And I hope that we're going to be able to do that.”
Jon: “Fantastic. And your new Liberty Lens sub-stack?”
Josh: “Yeah, so the Liberalness sub-stack is an attempt to write some pieces, get some pieces out there that in a sort of short-to-medium form that's a little longer than an op-ed, has some little more facts and figures you can put into an op-ed in the Wall Street Journal, addresses some of these topics, the ones that I've been mentioning. So, our first post-up is about inequality, and I've been saying in this podcast a few times why it is I think that the inequality statistics are misstated, that there hasn't been an explosion in inequality the way that a lot of these news reports would have you believe. Go check out Liberty Lens, libertylensecon.substack.com if you want to see more, and we'll be taking on a bunch of the other topics as we go forward. So, we just launched it last week, and that's our first post, and looking forward to more.”
Jon: “Well, this has all been fantastic, Josh, talking about everything in your career, starting from learning German as an undergrad at Yale and going to work in Germany and working in finance. I think you're one of the few undergrads I know that has really sort of applied and maintained their language skills in another language. And your distinguished career as a public economist and career as a professor here at Stanford and at the Hoover Institution and your time in government at such a historic time when really these issues around spending and debt I think really became pivotal. And of course, there's I think great arguments as well that there was a great need for a response then as well. And really wonderful to hear about these new initiatives, the Global Liberty Institute and Liberty Lens, fantastic that there's more public engagement going on and that you're working with young individuals, and fantastic that you're also engaging in longer-form data journalism as well. Really, really wonderful to hear. Thank you so much, Josh, for joining us.”
Josh: “Thank you, Jon.”
Jon: “Today, my guest was Josh Rau, who is the Orman Family Professor of Finance at the Stanford Graduate School of Business and is a senior fellow at the Hoover Institution. He is also the co-founder of the Global Liberty Institute in the Liberty Lens sub-stack. This is DE capitalism and Freedom in the 21st Century podcast where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Thanks so much for joining us.
