Kevin Hassett Is a Smart Choice to Be Trump's Economic Adviser

(Bloomberg View) -- After months of uncertainty and some false starts, President Donald Trump seems to have picked someone to be the head of his Council of Economic Advisers. That someone is Kevin Hassett, an economist at the American Enterprise Institute, a center-right think tank.

This is a great move, for a number of reasons. First, along with the hiring of H.R. McMaster as national security adviser, it seems to indicate a turn toward picking responsible, mainstream conservative figures for key positions. Hassett has a lot of respect in the community of think-tank researchers and policy advisers, including from Democrats and left-leaning scholars. He has worked extensively with Glenn Hubbard, who was Mitt Romney's economic adviser. Hassett's work is broad, covering taxes, fiscal policy, finance, inequality and energy policy. It's hard to imagine Trump picking anyone better qualified.

QuickTake The U.S. Labor Force

Second, Hassett has a big innovative idea that directly address one of the most important and overlooked problems in the U.S. economy: underemployment. I've long complained that American economists and policymakers pay too much attention to economic efficiency and not enough to jobs and dignity. The downward drift in the employment rates of prime-aged Americans is a worrisome trend:

Hassett seems to agree. He's argued for a radical solution -- have the government provide jobs to the chronically unemployed.

Direct government provision of jobs is not the kind of idea one expects to hear from a Republican. But it fits with many conservative goals. Work provision keeps people's work ethic strong, preventing them from developing the habits of couch potatoes during a long spell of unemployment. As Hassett has eloquently explained, it's cheaper than either unemployment benefits or welfare, since the people getting government money are creating value. And it keeps people out of black-market activities like drug sales. It probably even makes men more attractive in marriage markets. Fortunately, there's plenty of blue-collar work to be done in the U.S. -- infrastructure repair, urban renewal, replacement of old buildings with nicer newer ones.

Hassett also supports a raft of other middle-of-the-road policies, like carbon taxes, lower corporate taxes and free trade. Though we can (and will) argue about the technocratic merits, details and optimal implementation of all of those, they're a far cry from the kind of radical changes that some of Trump's other advisers want to make. Though Trump has demoted the CEA chair from a Cabinet-level position, it's still good to have one more voice of reason in the administration.

Because this is U.S. politics, there are inevitably people complaining about Hassett's appointment. So far, the main criticism seems to concern a popular book he wrote in 1999 along with James Glassman, called “Dow 36,000.”

People in the economics and finance press like to make fun of bold asset-market predictions. When those predictions are spectacularly badly timed, the razzing is especially harsh. Hassett and Glassman's hyper-bullish book came out right before the tech-bubble collapse of 2000, earning its place alongside economist Irving Fisher's infamous declaration of a “permanently high plateau” just before the crash of 1929. Since the book was published, the U.S. stock market has had an annualized real return of less than 2.5 percent -- less than half of what would have been needed to fulfill Glassman and Hassett's prediction.

But Hassett shouldn't be dinged too hard for that blown call. The central idea of the book was that American investors underpay for stocks because they're too frightened of risk -- a fact economists refer to as the equity premium puzzle. Hassett and Glassman made the reasonable assumption that this fear was a relic of the past, and would vanish soon, resulting in higher stock prices but lower expected returns going forward.

In fact, something like that did happen. In terms of price-to-earnings ratios, stocks have remained more expensive since 2000 than in the years before, even after the bursting of the tech bubble. Currently, the expected return on stocks looks fairly low. If interest rates rise -- as it appears they're about to do -- it means that the equity premium, which equals the spread between the expected returns on stocks and bonds, is now pretty low. In other words, it looks like Hassett and Glassman's central prediction came true -- investors are willing to pay more for stocks now than in the past.

What changed was the economy itself. Growth slowed after 2000, and again after 2008. Lackluster productivity growth and a long recession mean that even with the equity premium having shrunk, stocks are lower than Hassett and Glassman predicted. Macroeconomic trends are hard to predict, so the authors shouldn't be judged too harshly.

Hassett is a reasonable, smart, forward-thinking adviser, and it's a good thing that Trump has tapped him. Now it remains to be seen whether the president will heed his advice.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

To contact the author of this story: Noah Smith at nsmith150@bloomberg.net.

To contact the editor responsible for this story: Jonathan Landman at jlandman4@bloomberg.net.

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