It's the Business Climate, Stupid

President Obama said in his State of the Union Address that he wants to bolster job growth. Well, there's no mystery about how to accomplish that.

Crack open the recently released 2010 Index of Economic Freedom, note the strong link between economic freedom and prosperity and read about the examples of Hong Kong, Singapore, Australia, New Zealand and Ireland, which were ranked as the world's most attractive places to do business. Note other examples such as Turkey, Montenegro, Poland, Croatia and Qatar -- nations credited with significantly reducing home-grown, man-made barriers to business investment and economic growth -- and how they've prospered.

Specifically, these countries get credit for giving their citizens more freedom to work, produce, consume and invest, "with that freedom more protected and less restricted by the government."

In the meantime, the U.S., which got dropped from the rankings of the world's freest countries, got dinged for:

1. Burdensome top tax rates, exceeding international averages
2. Excessive government spending -- spending that's directly and indirectly displacing private-sector activity and growth
3. The 2002 Sarbanes–Oxley Act, which significantly increased disclosure and accounting requirements for small firms and reduced IPO activity
4. Government interventions in financial markets and the automotive sector and speculation about more change (the wrong kind) in the future -- changes that have increased price distortions, reduced market efficiency and raised concerns about the security of private property and the integrity of business contracts.
5. Uncertainties created by changes to regulation and policy that have discouraged entrepreneurship and job creation.

"The U.S. government’s interventionist responses to the financial and economic crisis that began in 2008 have significantly undermined economic freedom and long-term prospects for economic growth," the report concludes.

Here's what should be done:

1. Prioritize (for once) what the federal government does and slash government spending accordingly (easily done, right?)
2. Simplify the tax code and reduce taxes in a broad-based, even handed fashion that leaves it to the market to most efficiently pick winners and losers.
3. Stop scaring the banking system. One reason so many banks are restricting credit and holding so much in reserves is their uncertainty about what will happen to the economy and financial industry regulation.
4. Stop scaring small businesses: Suspend the most burdensome and time consuming provisions of the Sarbanes-Oxley Act when it comes to small business.
5. Make the temporary 2001 and 2003 income tax cuts permanent. The prospect of an automatic tax increase out there does not help business decisionmakers on the margins.
6. Increase human capital. When it comes to job growth, it takes two to tango -- a job opening and somebody qualified to fill it. Too many Americans are unqualified to fill 21st century jobs. Encourage (or rather, stop discouraging) states and cities that are trying to make the public K-12 system perform better, like the private sector, and compete for its clients (students, in theory). Read: more charter schools, more school choice. This costs nothing, on net, except some well spent political capital. The potential gain to the economy would be enormous. According to McKinsey and Company, the ongoing dysfunction of our public K-12 system costs our economy $2.3 trillion a year in lost human potential, and that's likely an underestimate. Granted, that's more of a long-term benefit, but necessary if we're to restore this economy's vitality in the long-run.
7. Reduce uncertainty. Stop scaring the markets with frequent, ever-changing policy prescriptions and announcements. Give businesses a more stable playing field. They need to be more confident about taking risky long-term decisions to expand their operations.

For each of these prescriptions, the president will find plenty of support from Republicans and moderate Democrats who understand how an economy works and, more importantly (for them), how much their political careers and legacies depend on getting it right.

While I've been skeptical about this "recovery" and its direction, recent events, including the President's change of focus, make me more optimistic about the U.S. economy's long-term prospects. What makes me most optimistic is that America's politicians and policymakers are losing their margin for policy error and folly.

We're facing sky-high deficits and debt, a refreshed and lengthening track record of bad policy and its consequences, a rising pile of economic casualties from those bad decisions and a growing litany of U.S. multinationals reporting intentions to scale down operations here and expand them abroad.

The financial crisis is just the latest in a 20-year string of bubbles whose implosions have exposed a long-running rot or hollowing out of the U.S. economy -- a development that preceded the crisis itself.

Generating economic growth the old fashioned way -- by earning it and improving the business climate -- is becoming one of the few options left as financial markets grow nervous about public sector debt in the U.S. and worldwide.

Mario Gabelli of GAMCO Investors puts it well:

To create the next Google, the next YouTube, the next great startup, you have to give entrepreneurs the clarity and conviction that they can make money.

Listen carefully, and you'll find -- reading between the lines -- that this is being acknowledged more widely by the political class in both parties, including President Obama. The only question is, how long will it be before this option -- inconvenient and painful for many politicians -- becomes the only viable one left to them.