The Feds in Business: An Exit Strategy

Get in, get out should be the rule. What Obama needs to do first: protect workers

By Chris Farrell

The federal government appears to be everywhere when it comes to the economy. It's actively shoring up the banking system, weighing in on executive pay, negotiating with the medical-industrial complex, offering bailout money to insurance companies, even playing hardball with financiers who balked at the Chrysler bankruptcy.

This historic expansion of Washington's role has upended many traditional relationships. The Federal Reserve Board has greatly expanded its reach into the private sector, too, and it has abandoned its independence to work hand-in-glove with Treasury Secretaries Henry Paulson and Timothy Geithner. "There is no debating that the government is grabbing more power from the private sector," says Edward Yardeni, economist, investment strategist, and head of Yardeni Research.

He's right. But there's little debate left that radical efforts by fiscal and monetary leaders are making it increasingly likely that the economic abyss has been averted. And Fed Chairman Ben Bernanke has argued in recent speeches that he and the rest of the Fed's policy-setting members are well aware of the risks they've taken on with their extraordinary initiatives and that the central bank has an exit strategy designed to reduce its impact on private market decision-making and maintain the central bank's vaunted independence. We'll see if Bernanke can pull it off.

What about the Obama Administration? At the moment it has so many initiatives in the works—and the economy remains fragile enough—that its lack of focus on a clearly articulated exit strategy from its involvement in the operations and finances of a big chunk of American business is understandable. Still, it leaves the Administration vulnerable to charges of creeping socialism, fiscal imperialism, and other equally incendiary terms.

Even More Power to Business Lobbyists

Yet even many people who don't believe the Administration harbors any desire to run large parts of private industry share a nagging worry that the more taxpayer money is on the hook, the greater the pressure on Washington to intervene in the economy. Perhaps most worrisome, the longer Washington closely oversees key segments of the economy, the greater the ability of lobbyists to influence the rules written by legislators to benefit well-heeled clients.

Here's a potential standard for defining an exit strategy. It isn't really a reach, since the idea runs through many talks given by Administration officials: Let's focus on saving capitalism from the capitalists—and then get out of the way.

The phrase "saving capitalism from the capitalists" comes from a 2003 public policy book co-authored by Raghuram Rajan and Luigi Zingales, economists at the University of Chicago Booth School of Business. Their argument was that government support for free markets around the world shouldn't mean backing policies that largely favor the rich—far from it. Yet that's what public policy—especially deregulation in financial services—had degenerated into in the U.S. and elsewhere in the global economy.

In the current environment, achieving that egalitarian goal requires a two-step standard. First, set the rules of the game, build in incentives that encourage competition, embrace transparency and openness, and then let the free market work its magic. It's an approach the Administration is already taking in its discussions on regulatory reform in the financial-services industry—just ask Geithner and Larry Summers. The same holds for the push behind creating a cap-and-trade system to deal with global climate change.

But the standard would call for a hands-off approach regarding certain matters, even hotly contested things such as CEO compensation. Don't like gargantuan CEO pay packages? Hike taxes, but don't try to dictate private pay. The same goes for energy. Put the carbon cap-and-trade system in place, and then let the market figure out the best alternative fuels. In essence, it's a get-in-and-get-out move.

A Safety Net for Workers, not Bankers

The second step entails the Administration moving away from bailing out capitalists and focusing instead on workers. Even when the economy resumes climbing at a rapid pace and the unemployment rate drops, dislocations will continue. Millions more workers will lose their jobs or be forced to find new ones. Many Americans will have to change careers or look to bolster their education or work skills. This isn't easy in good times, let alone in bad ones like now.

"Ordinary people increasingly feel they do not have the access to education and health care they need to get good jobs," said Rajan in a talk in South Korea on May 11. "The crisis only brings this issue to a boil as people feel there are two sets of rules—one for ordinary citizens whose house is foreclosed and another for the banker who gets an enormous bonus even while his bank is bailed out by taxpayers."

Rajan notes that the Administration is focusing on policies to bolster opportunities for those who have been left behind. When it comes to saving capitalism from the capitalists, the construction of a better safety net is paramount. And here the operating principle should be to protect the interests of employees, not companies.

The most important goal should be a universal health-care system where everyone is covered whether they are employed, between jobs, or embarking on an entrepreneurial venture. The federal government could also allow companies to fail or go into bankruptcy while subsidizing laid-off workers with vouchers. This would allow the worker to decide which human capital investment makes the most sense for his or her circumstances.

These two steps would accomplish two things: They would unleash the benefits of competition and protect workers from the downside of creative destruction. Balancing these forces will be a tricky task, to be sure, but if the efforts succeed, the economy will heal and ultimately prosper in the years ahead.

Farrell is contributing economics editor for BusinessWeek. You can also hear him on American Public Media's nationally syndicated finance program, Marketplace Money, as well as on public radio's business program Marketplace. His Sound Money column appears on BusinessWeek.com.