by Mitt Romney
Interestingly, I think that governors understand this quite well. States actively compete with one another for businesses, and we have learned that the taxes we charge can be a major factor in company’s decision about where to locate. Soon after my friend Governor Arnold Schwarzenegger took office in California, he came to Massachusetts to see if he couldn’t poach some of our employers. He even put up a billboard of himself, inviting our companies to move to his state. So I had billboards of my own placed near California’s airports, where I knew his businesspeople would see them. The signs had me saying, Smaller muscles, but lower taxes.
Businesses often do very thorough calculations to compare the cost of doing business in one state as compared with another. While I was serving as governor, we went to work to convince Bristol Myers Squibb to locate its new biotech manufacturing facility in Massachusetts. We wanted the one billion dollars that were reportedly going to be spent to build the facility to go to our construction trades, and we wanted the permanent jobs that the facility would create. Just as important, we were anxious to make Massachusetts not just a leader in biotech research, where we were second only to California, but in biotech manufacturing as well. We figured that if we won, it could mean that other biotech manufacturers would follow suit. It could make a big difference to us in the long term.
Our team went to work to find a good building site, to accelerate the construction-permitting processes, and to demonstrate the depth of our pool of skilled labor. Those things mattered, but in my calls and meetings with their CEO, it was clear that this would come down to dollars and cents—cost of construction, property taxes, corporate taxes, and incentives. His team had built a model that boiled it all down to one number, and he told me that we were still high compared to one other state. The legislature and I went to work to put together the best tax and incentive number we could, and having done so, we won. Now several years later, the plant is about ready to open.
Now and then, companies make location decisions on a less quantitative basis—where the CEO wants to live, who knows who, or where some key skills or suppliers are located. But most of the time, I have found, it comes down to the numbers.
There’s a good deal of rhetoric today from liberal politicians who say that we need to heavily tax those corporations that send jobs overseas. I’m afraid they don’t understand that companies with subsidiaries in other countries are doing business in those countries and that they pay taxes there. Requiring them to pay still-higher U.S. taxes would make them less competitive in those markets, making it bad for their business overseas, and also for jobs here. Sales made by subsidiaries of U.S. companies are often supported by high-paying jobs in finance, accounting, research, and management here at home. And if a company’s tax burden under such legislation grew too high, it could simply move overseas to avoid it—resulting in a loss of tax revenue for the United States, not a net gain. Those of us who want to see corporate tax rates lowered to the levels of other developed countries aren’t trying to fill the pockets of executives. We’re trying to keep businesses—and jobs—here in the United States, and to expand savings and investment, personal incomes, and our entire national economy—all of which are very good things for everyone.
Savings and investment that come from abroad are a third source of national capital. In his book, The World Is Curved, economist David Smick demonstrates that Japanese families have been a major source of America’s capital. Up until 2008, interest rates had been so low in their country that Japanese households bought American treasuries to get a better return. Japan’s national savings rate was twice our own; China’s was almost four times greater. Without foreign savings and investment in America, our economy could not have continued to grow, given our own low rate of personal savings. Initiating a trade war with the rest of the world or erecting barriers to foreign investment would almost certainly result in reduced flows of foreign capital into the U.S. and would have serious unintended consequences for our pool of capital and for our economy as a whole.
The fourth source of capital is surplus government funds. Our government deficits, on the other hand, drain away capital. Michael Porter argues that controlling government deficits that are not being used to finance productivity-enhancing investments in the economy is perhaps the most direct way in which government can influence the pool of investable capital. The huge and ever-growing federal deficits shrink the amount of capital that could otherwise start and grow businesses, and when the government is forced to borrow heavily, it inexorably drives up the interest rates that individual and corporate American borrowers pay, which slows the economy at every level.
Deficits aren’t an imaginary problem that affects only imaginary dollars. They act to drain the lifeblood of the American economy. The bigger the deficit, the greater the loss of economic vitality in the private sector.
Some analysts believe that given the global flow of capital that exists today, our economy is less dependent on our own national pool of capital than it otherwise would be, and that’s undoubtedly true to some extent. But foreign investors tend to focus their investments on U.S. government debt and other securities that are rated very safe, because it’s difficult for foreign investors to know American markets, consumers, competitors, and regulations in great detail. They are thus far less likely to take risks and play a major role in financing productivity improvements in existing businesses or in providing capital for new enterprises.
In fact, risk capital tends to be invested quite locally. California’s venture capital firms invest almost 60 percent of their funds in California businesses, for example. Firms in Massachusetts, the number-two venture state after California, invest nearly 40 percent of their capital in Massachusetts; they spend more than six times as much at home as in New York, a nearby state with a much larger economy.
America’s relatively plentiful venture capital resources are one reason we have become such a successful entrepreneurial nation. For the last ten years, America’s share of worldwide venture capital spending has exceeded all other nations combined. Capital does flow around the world—absolutely—but local and national boundaries still matter a great deal when it comes to the availability of the risk capital needed to launch new businesses and to increase productivity.
The tendency of foreign risk capital to stay at home may ultimately be heightened by the recent financial crisis. Of course, as long as fear of a severe disruption exists, capital will flow to the dollar as a safe haven. But as that fear continues to subside, foreign investors will reassess their willingness to invest in securities and markets that were so incorrectly rated by our agencies and poorly overseen by our regulators—and where they lost money. For us to confidently grow our economy, we must grow our own pool of capital and make it available at a reasonable cost. To do that, we must preserve the value of the dollar by defending against inflation, rein in government’s excessive deficits, simplify taxation, and reduce taxes on enterprise and investment.
Dynamic Regulation
The Republican Party has long been an opponent of overregulation, and rightly so. But I believe some people in my party are overly fond of bashing regulation as the constant enemy of growth and competition. They are certainly right about some regulations, but they are wrong when it comes to others. The rule of law and the establishment of regulations that are clear, fair, and relevant to contemporary circumstances provide the predictability and stability that is needed for investment and risk-taking.
Back when I was at Bain Capital, one of our first venture capital investments was in a technology that allowed machining companies to reuse their cutting oil—the cooling lubricants that are used in drilling, routing, and cutting metals. New government regulations had just been established to prevent companies from simply throwing used oils down the drain. The regulations ultimately led to better machining industry practices, but because they weren’t enforced for almost a decade, we lost our investment. Michael Porter is convinced that, far from being a drag on the econom
y, National advantage is enhanced by stringent standards that are rapidly, efficiently, and consistently applied. I wish more Republicans and Democrats alike understood that important truth.
Labor regulations can also help the economy or hurt it. Equal opportunity regulations increase the inclusiveness of our economy, drawing people into the workforce who might otherwise have stayed on the sidelines. Occupational safety regulations, for example, protect the individual from accidents and disability, preserving the economic benefit from workers with skill and experience. The requirement for unemployment insurance provides a benefit not only to the worker but also to the economy. This insurance helps workers who have been laid off, perhaps due to an improvement in productivity, while they find new employment that will benefit from their skills and experience. The overall impact of unemployment insurance thus can smooth the individual and national transitions that are an inevitable part of the changing global marketplace.
But much labor regulation—both in the United States and among our Western allies—actually works against workers’ best interest. In France, for example, government regulations prevent an employer from terminating an employee at will—the employer must have one of specific, legally established reasons for doing so. On its face, the measure appears to be laudable and of much benefit to workers, but what it means in practice is that French employers have an enormous incentive to delay hiring new employees as long as possible. The result has been relatively high unemployment, which is the exact opposite of what the regulation intended. The regulation also makes it far more expensive for French companies to implement productivity measures. In his best seller The World Is Flat, Thomas Friedman observes that the easier it is to fire someone in a dying industry, the easier it is to hire someone in a rising industry.
This is a great asset, Tom notes in a burst of candor that not many politicians would ever indulge; they would fear a YouTube snippet that would make them appear indifferent to the pain of unemployment. Friedman also reports that the United States has some of the most flexible labor regulations in the world. I agree with him that it’s in our best interest to keep them that way.
Regulation can have a particularly pernicious effect on the formation of new businesses, particularly in the developing world. A World Bank study found, for example, that it takes just two days to start a business in Australia, but it takes 195 days in Haiti and 149 days in the Democratic Republic of Congo. Consider what this means to new business formation in these nations. Americans have a significant advantage over many developed countries in this regard when it comes to starting a new business—it takes only six days to complete the federal paperwork required to start a company in the United States, compared with eighteen days in Germany and twenty-three in Japan. And we do a good job of keeping the federal cost down as well. Less than 1 percent of income per capita is required for new business fees and filings here, while the costs in Germany and Japan are over 5 percent and 7 percent respectively.
States and municipalities, on the other hand, can have their own dampening effect on business creation and expansion, something I personally discovered when I was governor of Massachusetts.
I had been invited to sit down with a CEO who had just opened a new facility in our state. I expected him to offer me his thanks for the role that the state and the city had played in the process. But instead, he bluntly informed me that if he had it to do over again, he wouldn’t locate in Massachusetts. It took almost ten years to get the permits and approvals from the state and the city and then finally to build, he told me. And then he rehearsed some the burdens and delays our state and city regulatory bureaucracies had placed on him, even as he was bringing us good jobs. His revelation led me to inaugurate a guaranteed 180-day approval process for any employer planning to expand or build in the state. I wanted it even faster and I wanted more of our cities to follow suit, but any step in the direction of getting businesses open in a safe, efficient fashion is a step in the right direction.
What was an irritant to big business is often an insurmountable obstacle for small business. Labor regulations, tax filings, permits, approvals, and delays can be financed and navigated by a major corporation. But to the people who just want to open a store or a garage or a restaurant, that kind of hassle and time costs money they may not have. Taking a weed-wacker to small-business regulation should be a regular agenda item for every growth-oriented state, city, or nation.
Excessive regulation that slows the creation of new businesses and the expansion of existing businesses, as Friedman notes, tends to hurt most the very people it is supposed to protect. At the same time, in order to provide the structure and predictability that business needs and to protect against abuses, we need dynamic regulations, which are up-to-date, forward-looking, consistently applied, and free of unnecessary burden.
We certainly suffered from the absence of dynamic regulation in the 2008 economic collapse, particularly in the area of housing finance. While some outdated regulations had been eliminated, modern replacements had not been put in place. Mortgage banks had become loan-origination offices rather than true banks and were allowed to churn out mortgages without any meaningful regulatory oversight. Commercial banks bought new asset classes—derivatives and mortgage-backed securities—that likewise were not regulated to reflect either their risk or their lack of transparency. The wholesale failure at the federal level to revise and refine outmoded regulatory structures even as the ever-aggressive private sector sought out new profit centers allowed the risks in the system to overwhelm the collective good. We know the bill we have all paid as a result. What is odd is that some are looking to the same people in Congress as a source of wisdom on how to avoid a repeat of the fiasco—one about which they had received many warnings, failed to act, and actually abetted with the worst sort of populist boosterism that facilitated adding even more risk into an already overlever-aged sector. We have to fully understand what happened in order to protect against its recurrence, and we need a sober and balanced assessment, not political rhetoric and posturing.
What Went Wrong and What to Do Now
For the fifty years from 1950 to 2000, average U.S. housing prices, after inflation is removed, rose by less than one half percent a year (see graph on following page). The growth was remarkably steady over five decades. If the index for a home price in 1950 was 105, it had risen to about 120 by 2000—again, taking out inflation. So, 15 points of growth in fifty years. Then suddenly, beginning near the year 2000, real home prices took off like a rocket. By 2006, the home price index was almost 200! That means about 80 points in six years—five times more price growth in six years than had occurred in the previous fifty years. No bubble like that has ever endured; it simply had to pop.
What created a bubble like this in the first place? The true answer is a lot of things. Politicians wanted low-income families to be able to buy homes, so they pushed the federal government’s mortgage guarantors, Freddie Mac and Fannie Mae, to ease up on their loan requirements. As far back as 1999, The New York Times reported that Fannie Mae has been under increasing pressure from the Clinton administration to expand mortgage loans among low and moderate income people. The Times went on to accurately predict the peril: Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush times. But the government-subsidized corporation may run into trouble in an economic downturn.
Mortgage banks and other originators generally didn’t care whether the loan could be repaid or not because once a loan was closed, the originator sent it off to Wall Street, which sliced it into parts to resell to investors. At most stops along the way, commissions were paid. To help home buyers get a mortgage, originators made loans with no or very low down payments—the average down payment on a home in 2007 was 2 percent! (By contrast, in 1971, the bank in my town required that I put 20 percent down on my house.) Some buyers were not asked about their earnings or their ability to repay the loan. By 2006, over half of all mortgages originated in the Un
ited States were subprime, jumbo, seconds, or other nonconforming loans—in other words, more risky than normal loans.
U.S. Housing Average Price 1950 – 2000
(Excluding Inflation)
Source: Robert J. Shiller, Irrational Exuberance, Princeton University Press 2000, Broadway Books 2001, 2nd edition, 2005, also Subprime Solution, 2008, as updated at http://www.econ.yale.edu/~shiller/data.htm
U.S. Housing Average Price 1950 – 2009
(Excluding Inflation)
Source: Robert J. Shiller, Irrational Exuberance, Princeton University Press 2000, Broadway Books 2001, 2nd edition, 2005, also Subprime Solution, 2008, as updated at http://www.econ.yale.edu/~shiller/data.htm
Wall Street was happy to take the mortgages from the originators because they made enormous amounts of money by bundling them up, reslicing them in new and complicated ways, and selling those slices off to others—a technique that most believed spread the risk while in fact it was spreading the disease. And to boost their returns even higher, Wall Street leveraged itself far beyond historic and prudent levels. When mortgages turned sour, this leverage meant there was virtually no ability to absorb the losses.
