NDN Blog

The Economics and Politics of Cutting Deficits

The 2011 battle over the budget brings to mind the U.S.-Soviet nuclear arms talks of the 1970s and 1980s.  The issue is not whether the antagonists can settle everything at once, but whether each will accept modest concessions and keep on talking until the next round, when more incremental compromises can be reached, and so on into subsequent rounds.   The negotiations to contain deficits in the 1980s, early-1990s and latter-1990s all proceeded in just this way, one step at a time once the two sides had found a common frame of reference.  This week shows that any meeting of partisan minds is still a long way off, since President Obama and congressional Republicans haven’t found common ground to begin the process. 

Both sides agree that whacking away at deficits running at 10 percent of GDP is an economic necessity, but they remain far apart on what those economics actually portend.  The President sees the effort as part of the larger challenge of bolstering the competitiveness of American businesses and workers.  So, his administration’s case hinges on combining targeted public investments with targeted spending cuts and tax increases for upper-income Americans.  This “cut-and-invest” approach with a side order of taxes comes directly from Bill Clinton’s 1992 campaign program, and it’s no coincidence that Obama’s top economic adviser, Gene Sperling, helped manage economic policy in that campaign.  The approach is drawn directly from mainstream economics: Invest in things that support growth across industries and regions –basic R&D, infrastructure, and education and training – while gradual deficit reduction frees up capital for private investment.  As the public investments nudge up the returns on private investment, businesses will use the freed-up capital to develop new products and services, expand operations, and hire more workers.  Finally, the deficit cuts should come gradually so they don’t squelch the natural upswing in Americans’ demand for everything businesses produce. 

The best argument for the President’s approach is that it worked last time.  When Clinton followed this script, what followed included the longest expansion on record, as well as the strongest gains in business investment, jobs and incomes in 30 years.  To be sure, Japan demonstrated in the 1990s that waves of infrastructure spending for a slow economy can be wasteful, especially when powerful interests determine where that spending goes.  And the United States isn’t immune from that dynamic – the 2009-2010 stimulus had less long-term benefits than it might have, once Congress substituted its own parochial priorities for the broad public investments that Obama had laid out in his original plan.

The Republican budget proposals are targeted very differently.  Defense and entitlement programs are still off-limits; and since those two areas account for most federal spending, the GOP cuts for everything else are much deeper and don’t distinguish between public investments and other kinds of spending.  Moreover, the GOP economic logic doesn’t accommodate either higher revenues or a gradual glide path to lower deficits.  Much like David Cameron in Britain, they believe that without draconian cuts very soon, investors will give up on the United States and America could face a Greek-style default of its public debt.  

The trouble with the conservatives’ case is that the markets don’t buy it.  If investors believed that America’s credit worthiness is at any genuine risk, we would see sharp increases in the interest rate on long-term federal bonds as those investors demanded higher returns to offset that risk.  That’s simply not happening – though not because those investors don’t take deficit projections seriously.  Rather, based on the historic record, they still trust that the two parties will find a way to contain those deficits, just as they always did in the past. 

Despite this week’s threats by both sides, the markets are probably right that the economic costs of ignoring huge, unending deficits will eventually nudge the antagonists to the negotiating table.  The calendar suggests that Democrats may well blink first: The prospect that House Republicans may really refuse to raise the debt limit will likely extract larger spending cuts from the President and congressional Democrats, if only because they know that voters would probably hold the President responsible in 2012 for any economic cataclysm that might follow.  After that, it will be the Republicans’ turn to swallow higher taxes, much as Ronald Reagan did in 1982, 1983 and again in 1984.  The base will howl, but John Boehner and Mitch McConnell know that without more revenues, they’ll be forced to embrace program cuts that would make most Americans recoil.  And broad tax reform may give them some welcome cover -- for example, to bring down the corporate rate in exchange for measures to raise more revenues from the same high-income households that will benefit most from lower corporate taxes.  

All of this would be the prelude to a later round of even more consequential discussions, when entitlement reform takes center stage.  Serious talks on Medicare and Social Security almost certainly will require a foundation of trust absent today, built on prior agreements on other spending and taxes.  But if that trust remains unattainable, there will be no deus ex machina of the sort that finally resolved the nuclear arms race – the Soviet Union’s collapse under its own economic deadweight – to bail out the American economy in the next generation. 

For more on the budget, please join us at NDN on Friday at noon for a discussion of the budget and the economy. Details available here.

The Real Economic Implications of the Uprising in Egypt

Thanks to globalization, the uprising in Egypt raises serious questions about the impact on Western economies, including America, as well as Egypt’s political and economic development.   The precipitating event for the current unrest almost certainly was a facet of globalization -- steadily rising worldwide food prices which hit record levels just before the unrest broke out.   An average household in Cairo has to spend 40 percent of its income on food, so price increases of more than 30 percent in recent months almost certainly helped fuel the volatile dissatisfaction.  Outside Egypt, the economic issue is, as usual, the price of oil.  Egypt produces little of the black stuff; but unlike Tunisia, it is an important transit country for crude.   Despite media doomsayers, however, the current unrest is very unlikely to take a serious toll on Western economies.  

A full-out civil war certainly could compromise the Suez Canal and the Sumed pipeline that links the Red Sea to the Mediterranean.   If that happens, tankers carrying more than 2 million barrels of oil a day will have to add another 6,000 miles to their journeys.   Such an interruption of shipments through the Canal and the Egyptian pipeline would shake up world oil markets and set the stage for speculators like Goldman Sachs and large hedge funds to gin up a short-term spike in prices, and profit nicely by it.   And yes, oil price increases can have huge effects on the American and world economies.  The recessions of 1974-1975, 1980, and 1990-1991 were triggered by big jumps in oil prices; and what became the Great Recession of 2007-2009 also was set off by oil price hikes. 

 But in order to threaten the U.S. and global recoveries, an oil price spike would have to be both very large and persistent -- for at least four-to-six months.    Before this year’s unrest gripped Tunisia and Egypt, oil prices in 2010 had risen by about 27 percent.  That cost the United States an additional $72 billion for oil imports, an extra $70 billion for the EU’s oil imports, and $27 billion more for Japan.  That’s not peanuts, but it was still just ripples for economies of their size.  Saudi Arabia is the only country with the capacity to engineer and maintain a price spike sufficient to wreck real economic havoc – as it has the capacity to prevent any other oil-producing country from trying to do the same.   

The real economic impact here threatens Egypt, not the United States; and once again, globalization is the key.   As China, Eastern Europe and parts of Latin America attest, globalization creates a new path for rapid economic development, based on vast foreign direct investments (FDI).  Over the last decade, the world’s leading multinational companies have transferred hundreds of billions of dollars in advanced technologies and business organizations directly to developing countries, including Egypt.  But FDI goes to countries whose economic and political stability those companies trust.  The political and economic conditions that emerge in Egypt once the uprising is resolved will determine whether FDI to Egypt continues, sustaining its path to modernization, or reverses itself and puts the country on a path to economic stagnation.

These FDI transfers to Egypt swamp, for example, all U.S aid.  Over the last decade, American economic assistance to the country has averaged about $500 million per-year, and total economic and military assistance has run about $1.8 billion per-year.   Over the same period, FDI into Egypt has averaged $4.8 billion per-year, nearly three times all U.S. assistance and almost 10 times our economic aid.   Moreover, these FDI transfers increased sharply in recent years, averaging $9.4 billion per year since 2006 or 6.2 percent of Egypt’s GDP.  

There’s no doubt that the chief investment officers at the world’s largest companies have put on hold new investments in Northern Africa, at least until the outcome of the uprising becomes more clear.  Many factors go into the decisions about where to set up new foreign operations by companies like Coca Cola, General Electric, and Mitsubishi – or in Egypt’s case, by energy companies such as APA and BP, and financial service giants such as Citigroup and Metropolitan life.  The size and composition of a national or regional market count, as do a developing country’s infrastructure, the skills of the local labor force, the taxes multinationals will have to pay, and the soundness of a country’s currency.

Underlying all of these conditions is a country’s basic political stability and willingness to embrace Western businesses.  Sadly, multinational have no special preference for democracies over dictatorships, so long as both can guarantee stability and the rule of law.  To be sure, democracies tend to be a little more stable and lawful than many dictatorships, and sometimes they’re more prone to undertake the large public investments that Western companies look for.  But if the Muslim Brotherhood and its allies end up on top in Egypt, the modernizing investments now planned for there and many already in place will almost certainly go to other countries – dashing many of the hopes for a better life that have fueled the uprising. 

The State of the Union and the Real Meaning of Competitiveness

Last Tuesday night, the President exhorted Americans to raise our economic game and challenged Congress to give us the means to do so.  His basic proposition, which comes from mainstream economics and more recently from Bill Clinton’s 1992 economic plan, is that expanding certain national investments can make us more competitive, especially if it’s tied to overall deficit restraint.  Moreover, Obama’s pitch for greater federal commitments to R&D, education and training and infrastructure carries greater urgency this time out, as recent sea changes in the U.S. and global economies have raised the stakes for most Americans in the new initiative’s success..   

If expanding these public investments is a radical idea, as some of the President’s opponents claim, so is the last 200 years of economic thought.  Since Adam Smith, it has been an economic commonplace that private markets and businesses will always tend to invest too little for any nation’s good in basic research and development, education and training, and infrastructure.  That’s why it has been the business of governments for nearly two centuries to mandate and pay for public education, build roads and bridges, and in many cases support basic scientific research.  

When Clinton called for the same roster of national investments, he argued from basic economics that they would make American workers more productive and American businesses more efficient.   That still holds true.  But the waves of globalization of the last 15 years provide a new framework for the operations of American businesses, based on international competitiveness.  The massive transfers of technologies and entire business organizations to developing countries by the world’s leading multinationals, especially in manufacturing, have shifted the basis of competition.  U.S., European and Japanese manufacturing operations can’t compete with the third-world dynamos on price.  Instead, our firms and workers have to compete on quality and innovation, which can depend fairly directly on the public investment priorities touted by the President last week, especially in R&D and education and training. 

The toys, cell phones, basic laptops and so on made or assembled today in China and places like it will always be cheaper than what any firm and its workers in America can produce.  That’s an inescapable advantage for Chinese companies that pay their manufacturing workers less than $50 per-week and their engineers less than $75 per-week.  That’s also why American companies and workers largely don’t produce what China exports anymore -- and why would they?   Instead, our firms and workers increasingly compete on the basis of newer, broader and higher quality goods and services.  In most cases, American companies can win this kind of competition for global market share, by coming up with more powerful and versatile laptops, cell phones and so on, often producing the technologically advanced new elements themselves.

Innovation comes in many forms, and American companies and workers operate through advanced business organizations that also can provide competitive advantages which outweigh price.  Wherever a computer, cell phone or other product is produced or put together, business customers often prefer an American or European company for the service.  When businesses wants to buy, for example, coated paper for high-end graphics, which is produced both here and in China, the vast majority still pay higher prices to buy American products, because the U.S. companies can provide better delivery times and terms, more flexible credit, and a more reliable supply of a broader range of products, all services still beyond the capacity of their developing-nation competitors.

A serious public investment agenda, then, follows not only from the classic cases of private underinvestment recognized since Adam Smith, but also from the actual terms of global competitiveness which American companies and workers face today.  It’s virtually certain that greater national support for basic R&D ultimately will lead to the development and use of more advanced products, manufacturing processes, and business methods.  Similarly, greater support for education and training would ensure that more American workers are truly competitive with their foreign counterparts when it comes to operating effectively in workplaces dense with innovative technologies and operating practices.    

The third leg of the President’s public investment program focuses on traditional infrastructure.  Most infrastructure investments, to be sure, involve more traditional, price and efficiency-based competition.  But whether or not American companies are able to move people and goods from one place to another efficiently, through sound road, rail and air systems, affects their competitiveness -- if not so much with China, than with their counterparts in Europe, Japan and other advanced economies.  

The fate of these proposals will also reveal a good deal about the two parties’ real commitment to U.S. competitiveness.   With conservatives once again believing that deficits do matter – at those under Democratic presidents -- can they nevertheless distinguish between real public investments and other kinds of federal spending which many of them now consider a scourge?  And for the other side of the coin, will the President’s allies in Congress be willing to give up any other kinds of domestic spending in order to finance these new investments?   

These tradeoffs were dubbed “cut-and-invest” when Bill Clinton talked them up in 1992 and 1993 – and even he had real trouble selling the cuts to Congress.  But the truth is, it mattered less for U.S. competitiveness back then, when China and other low-wage developing nations made little that anyone else wanted to buy.  Those days are now long gone, and with them, the stakes for public investment have become much greater.

What the Obama-Hu Meetings Can Mean for the U.S. Economy

Barack Obama and China’s President Hu Jintao have genuinely important economic matters to talk about this week, even if there’s little prospect for any agreements that could materially improve our own economy anytime soon. But President Obama can –– and certainly will –– use these meetings to hammer home his long-term priorities for the U.S.-Sino relationship. And so long as Hu continues to see the United States as the “indispensable nation” for China’s economic development –– Hu’s own words –– a U.S. President’s priorities matter. And in acknowledging China’s increasing success in the global economy, the President can also remind Americans why they have to raise their own economic game –– and how his domestic policies can help them do just that.

A few of these discussions may produce quick benefits. For example, Obama will press Hu on China’s lax enforcement of the intellectual property (IP) rights of American companies in the Chinese market. A lot of Americans still see such enforcement as a parochial issue for a few big pharmaceutical and software outfits. It’s true that Chinese producers regularly try to rip off U.S. patented drugs, mainly for third-world markets; and until recently even the Beijing government used pirated versions of Windows.  But there’s much more at stake here for us. The fact is, the only promising, long-term strategy that the global economy offers the United States today depends on our outsized national capacity for developing and adopting economic innovations –– from new products and technologies, to new ways of financing, marketing and distributing goods, and new ways of organizing a business and running a workplace. IP rights in the world’s second largest market, then, affect everything from movies, machine parts and genetically-enhanced foods, to computer slates, Internet business processes, and nanomachines. 

China already is legally obliged to protect the IP rights of American companies inside China under the rules of the World Intellectual Property Organization. So, Obama will press Hu to actually meet those obligations; and since China has recently begun to build its own R&D establishment, it’s an area where China’s interests and ours are beginning to align. The truth is, this is ultimately non-negotiable for the United States. But it also should prove to be a small price for China to pay for a solid economic relationship with the country that is not only one of its largest markets, but also its leading source of foreign direct investment into China –– including new technologies and business methods that are at issue in IP enforcement. 

There is much less prospect of real progress on nudging China to revalue its currency, a recent hot-button issue for some prominent members of Congress.  A stronger renminbi certainly would appear to be in our interest, since it would cut the price of U.S. exports inside China and raise the price of their exports inside the United States.  In practice, it probably would make little difference to our economy. A stronger renminbi mainly would help companies in places which produce the same things as domestic Chinese companies –– places like Bangladesh and Thailand, not Michigan or Alabama. Yes, it would shave the price of U.S. products inside China –– but it would do the same for the products of our Japanese and European competitors.

Anyway, Hu has no intention of taking major steps in this area. Chinese leaders have always approached the value of their country’s currency as a matter of national sovereignty.  The truth is, we don’t react very well either when China or the governments of other countries criticize U.S. monetary policies, such as the recent blasts from Germany and China about the Fed’s second round of quantitative easing.  And even if Hu approached this matter less dogmatically, it wouldn’t change that fact that the cheap renminbi is a critical part of the country’s basic strategy for strong, export-led growth; or that Hu and his fellow leaders see the success of that strategy as a lynchpin of their own political legitimacy.  And while it won’t be mentioned this week, China’s long-term goal in this area is to claim for the renminbi part of the U.S. dollar’s role as the world’s reserve currency, which would come at our expense and help insulate the renimbi from future pressures to revalue. 

Obama may get a more receptive hearing when he presses Hu to engage with the United States –– and the rest of the world –– on climate change. Both men know very well that China is now the world’s largest greenhouse gas emitter.  That’s mainly because China has the world’s most ambitious program for building new electricity-generating plants; and since its only significant domestic energy source is coal, that’s what those plants run on.  Hu also knows that the world will address this threat sooner or later –– and when they do, China cannot afford to sit on its hands.  Obama’s challenge is the same one he faces with many Americans –– come up with a strategy that will raise the price of fossil fuels without imposing serious costs on the economy.  Here at home, the answer to that riddle is a carbon-based tax with the revenues recycled for tax cuts in other areas.  For China, Obama’s approach will have to be more subtle –– for example, intimations about a future agreement to promote joint ventures by U.S. and Chinese companies to develop and sell new alternative fuels and climate-friendly technologies. 

These issues also give Obama the opportunity to drive home his case for new public investments at home –– in education and training, for example –– to expand America’s modest comparative advantage in fielding a workforce that can adapt easily to new technologies and business methods. This week’s meetings also could provide a platform to highlight his tax incentives for businesses, so they can make the investments required to better compete with Japanese and European companies in the Chinese market.  And any meaningful U.S.-Sino discussions on climate change will dovetail nicely with the administration’s calls to expand R&D in this area, and so establish a more commanding position for the United States –– with or without China –– in global markets for green fuels and technologies.

Why It Doesn’t Matter Much that Obama’s Jobs Record is Better than Bush’s


The great partisan squabble of 2011 over the economy begins this week with the new Congress.  Even if some of the rhetoric seems fresh, the core issues likely to become the stuff of real political fights – the terms of entitlement spending, the shape of the tax code, and the value of public investment -- are all familiar from battles during the previous two administrations.  There is one important difference, however, which will startle both sides.  When we probe the economics and politics, it appears that the real issue for most Americans isn’t jobs and unemployment, but incomes and wealth. 

The first clue lies in public data which have been almost universally ignored:  George W. Bush’s record on jobs was much worse than Barack Obama’s.  Both men took office during recessions which had taken shape under their predecessors, but with quite different effects.  So far, we have 21 months of jobs data under Obama, from February 2009 to November 2010:  Over that period, as the administration took numerous steps to support the economy, American businesses shed a net of 1,975,000 jobs.  George W. Bush’s approach was much simpler, relying almost entirely on large tax cuts.  Yet, even though the 2001 downturn was barely a blip compared to what Obama would face eight years later, Bush saw 2,852,000 private-sector jobs disappear in his first 21 months.  The job losses in Bush’s first two years, then, were nearly 1 million larger than during Obama’s first two years.  Set aside the first six months of each president’s term, before their policies could take effect, and the comparison grows even starker.  In those subsequent 15-month periods, American business under Bush shed 1,772,000 jobs, compared to job gains of 715,000 under Obama’s program. That doesn’t include the most recent developments, including a report today from ADP Employer Services estimating that private employment jumped by 297,000 in December.  By any economic measure, then, the Obama approach has been much more successful with regard to jobs than the Bush program which congressional Republicans now want to repeat.  

But the Bush program was much more successful politically, judging by the 2002 and 2010 midterm elections.  To be sure, the Bush White House managed to change the subject from its dismal jobs record to terrorism and Saddam Hussein, which helped a lot.  But the huge Democratic losses last November, despite Obama’s much better record on jobs, tell us that the main issue for most voters – at least those with jobs -- probably wasn’t unemployment at all, but rather their overall economic condition.  In this regard, Bush was as lucky as a Rockefeller:  He inherited an economy which under Clinton had produced large income and wealth gains for most Americans, giving them a critical cushion to muddle through the 2001 recession without having to cut back much.  Obama, on the other hand, had the misfortune of inheriting a much weaker economy from Bush, one which had left most Americans treading water even before the financial crisis and Great Recession of 2007-2009 eroded their assets.   

Let’s retrace the real conditions.  Throughout the Bush expansion, most Americans experienced no income gains, although their wealth appeared to increase.  Here, the stock market isn’t very important.  The Federal Reserve reports that the top 20 percent of Americans control 93 percent of the value of all financial assets, including pension and retirement accounts.  With 80 percent of the country holding only 7 percent of the nation’s financial assets, the falling stock markets of 2000-2001 and 2007-2009 had little direct effect on most people economic condition.  But one asset is widely held by Americans: Nearly 70 percent of the country owns their own homes.  Bush’s legacy to Obama, then, included not only a half decade of stagnating incomes, but also wealth losses for most people amounting to between 25 and 30 percent of the value of their homes.  Layer a deep recession on top of all that, and voters grow very cranky.

The truth is, most people are prepared to live with large job losses that affect others, so long as their own economic conditions remain decent.  But wipe out a good slice of their assets, so that most of them have to cut back, and whoever is in office will pay a big political price.

Where does Washington go from here?  The GOP wants to replay the Bush program, which is no more likely today to lead to sustained income progress and wealth gains than it was in the last decade.  This time around, they also want to layer on deep cuts in public spending, an approach likely to cut the legs off of the fragile expansion which just now is beginning to take hold.

The administration’s alternative looks a lot like Bill Clinton’s program, which did help promote broad income gains.  In his State of the Union address and budget proposal, President Obama will likely call for targeted, new public investments in infrastructure, R&D and education, additional steps to expand foreign markets starting with the free trade agreement with Korea, and measures to bring down the deficit very gradually by restraining defense, Medicare and overall discretionary spending.   This agenda may not usher in another historic boom, but it would provide a more solid foundation for long-term income progress.

It’s also time to help Americans rebuild their assets through new public steps to finally stabilize housing values.  The best way to do that is to provide direct loan assistance to those facing home foreclosures, since high foreclosures are the most powerful force still driving down housing prices in most places.  Otherwise, the voters may prove to be quite cranky again in 2012, endangering second terms for scores of congressional Republicans and perhaps even President Obama.

Employment increased by 297,000, exceeding the highest projection in a Bloomberg News survey, after a revised 92,000 rise in November, according to figures from ADP Employer Services. The median estimate in the Bloomberg survey called for a 100,000 gain last month.


The Pitfalls of Economic Nostalgia

The United States faces economic problems as daunting as any seen since the 1930s. GDP growth and job creation remain slow in the early stages of the current recovery, when both should be strong.  Moreover, the pressures of globalization, along with technological advances, have reduced the capacity of American businesses to create new jobs even when demand is strong.  These changes have boosted productivity, but most people’s wages and incomes remain stalled.  And in the most dynamic sectors of our economy, those technological advances increasingly demand skills beyond those of most working Americans.  These developments also have produced rapidly widening gaps in incomes and wealth, so that 20 percent of Americans now own 93 percent of the nation’s financial assets.  And the one asset that most families can claim, their homes, has lost an average of 30 percent of its value in the last three years.

Yet, Washington continues to respond to these challenges through an economics of nostalgia.  The economic agenda of most conservatives today consists mainly of tax cuts for those at the top who earn, save and invest the most, resting on an unflagging faith that markets are self-correcting and invariably produce the best possible outcome.   After all, this approach seemed to work in the 1980s -- even if its reprise under George W. Bush led to nearly a decade of historically anemic job creation and stagnating incomes, and culminated in a disastrous financial meltdown and long deep recession of 2007-2009.   The progressive response amounts mainly to a series of stimulative spending and tax measures bolstered by virtually unlimited and free loans for large financial institutions to stimulate their own lending.   And while similar approaches worked in the 1960s and 1990s, the current iteration has produced the weakest recovery in decades. 

The progressives are closer to the mark than the conservatives, because when the private sector underperforms as badly as ours has over the last 18 months, it needs stimulus of the sort currently promoted by the President and likely to pass the Senate this week.   But in an economy hampered by serious structural problems, stimulus alone cannot ignite strong and self-sustaining gains in growth, jobs and incomes.  To accomplish that, both sides need to put aside their traditional responses and consider new approaches that can directly address the structural problems holding back real prosperity.  Ironically, the most significant initiative to do so is the one program that the Administration gets the least credit for – the health care reforms or at last those parts which over time should slow the rate of increase in medical and insurance costs, and thereby help provide a foundation for faster job creation and wage gains.

These nostalgic economic nostrums seem to blind most of Washington to the necessity for a new economic strategy.  For example, it should be evident to all but the most ideologically-blinkered free marketers that the housing market has been dysfunctional for nearly a decade.  Moreover, the sustained decline in housing values has produced a “negative wealth effect” which continue to dampen consumer demand when the various stimulus measures run out.  Conservatives argue for letting those markets work their will, which would amount to another two years of slow demand and declining assets for most Americans.  A better strategy begins by acknowledging that declining housing values are a real problem, now driven by high levels of home foreclosures.  We can try to fix that with a new loan program to help families facing foreclosure keep their homes.  And if that strengthens consumer demand, it should also trigger significant increases in business investment – and together, both should generate real job gains.

The problem of slow job creation isn’t limited to our current circumstances – in the expansion of 2002-2007, American businesses created jobs at less than half the rate, relative to GDP growth, seen in the expansions of the 1980s and 1990s.  Much of this problem comes from the intense competitive pressures unleashed by globalization, which limit the ability of businesses to pass along higher costs by raising their prices, and therefore forces them to cut costs when, for example, their energy, health care or pension bills go up.  A reasonable response to this problem would be measures to lower the cost to businesses of creating new jobs.  For the short term, for example, we can give U.S. multinationals 18 months to bring back their foreign profits at a lower tax rate, but only if they already expand their U.S. workforces by 5 percent to 10 percent.  That would produce an estimated 750,000 to 1.3 million additional jobs.  For the longer term, we should consider cutting the payroll tax for employers on a permanent basis and using a carbon fee to restore the revenues for Social Security.  

Similarly, neither stimulus nor the market alone can affect the growing mismatch between the IT skills required to excel at most well-paying jobs today and the training of most American workers over age 30 or 35 years.  For $300 million to $400 million a year – a fraction of the smallest bank bailout of 2008 or 2009 – Washington could provide grants to community colleges to keep their computer labs open and staffed in the evenings and on weekends so any adult could walk in and receive free computer training.  It’s also time to join the rest of the advanced world in recognizing that higher education has become as much a public good as elementary and secondary education.  Our idea-based economy now requires that government also ensure genuine low-cost access for both undergraduate and graduate training for anyone attending public colleges and universities, tied perhaps to a requirement for a year or two of public service.

This leaves us a major structural problem that at least Washington acknowledges – the prospect of damaging long-term deficits once the economy recovers, tied to fast-rising entitlement spending for retiring boomers.  The economics of nostalgia will be of little use here as well, but a view of a more effective strategy will require a separate discussion. 

Taxes and the Art of the Possible

Barack Obama exhibited this week what Machiavelli called the essential quality of a successful statesman, “virtu,” or the capacity to advance a society’s vital interests while respecting the constraints of conditions beyond his control.   The vital interest at stake here is a decent economic expansion that improves the circumstances of the vast majority of Americans, and the critical condition beyond the President’s control was the Republicans’ ability to block any tax increase for a very small minority of high-income households.  While this week’s tax deal isn’t nearly enough to drive a robust recovery, it should be good economic news for most Americans. 

Yes, the President agreed to two more years of the Bush tax cuts for very well-to-do people, covering their overall incomes, dividends and capital gains, and sheltering all but the very richest estates from inheritance taxes for two years.  But those were concessions to conditions beyond his control, since without them, there would have no action at all. Moreover, in return the President won the GOP leaders’ acquiescence to some significant help for nearly everyone else.  Beyond two more years of lower tax rates for average Americans, he secured expanded tax credits for parents putting their children through college, a one-year payroll tax reduction for working people, an expanded Earned income Tax Credit for working poor families, and an additional year of unemployment benefits for millions of out-of-work Americans.  

To be sure, that won’t be enough to drive a strong expansion.  That still requires difficult measures to correct the distortions that brought on the original financial crisis and still continue to dampen the expansion.  A strong revival of consumer spending, of the sort that powers most early expansions, still depends on steps to stabilize housing prices.  And while this week’s deal includes another dose of tax breaks for business investment, a surge in business spending will have to wait for consumers to begin spending freely again and for lenders to clear their books of billions of dollars in real estate-related investments that continue to deteriorate.  Nevertheless, the deal passes the basic test of sound economic policy by moving the economy in the right direction, and should help nudge the jobless rate down a bit.  

The temporary nature of these measures also provides intriguing opportunities for Democrats.  The payroll tax reduction would expire one year from now, just as the 2012 campaigns get going.  Ultimately, neither party would let that happen, but the President could use its prospect to drive progressive social security reforms.  For example, the 2 percent cut in the payroll tax rate for employees could be phased out very gradually, and the lost revenues could be offset by raising the cap on the wages subject to the tax.  The 1983 social security reforms set the cap to cover 90 percent of all wages, rising each year at the same rate as average wages.  But since the wages of those at the top have grown much faster than the average, today the cap covers only 85 percent of wages.  Push it back to 90 percent, as the Bowles-Simpson Commission has proposed, and we could phase out the “temporary” tax rate reduction over a decade’s time and take a big step towards guaranteeing the system’s long-term solvency.

Moreover, the tax cuts for high-income Americans could be more vulnerable politically two years from than they are today.  It’s safe to say that the deficit will be a hot-button issue in 2012, and with the Bush tax cuts now set to expire in January 2013, the election-year deficit debate will include heated arguments over who should have to pay higher taxes.  According to current polls, at least, the public’s answer is those high-income folks.  

While the loudest complaints about the deal have come from progressive Democrats, the real question is why the Republicans agreed to it.  For all of the GOP’s talk about jobs and deficits, the deal exposes their real bottom line: Preserve at almost any cost lower taxes on the incomes of the top 2 percent of Americans and on the estates of the top 0.5 percent.  The deal equally highlights the President’s priorities – tax relief for the middle class, and help for the unemployed and the poor.  And if the economy finally begins to gather steam by 2012, the contrast embedded in this week’s deal might well boost the President’s prospects.

The Quiet Role of Class in the Coming Budget Battle

The political struggle over how the federal budget will shape American government is now in full swing and likely to dominate Washington for the next two years.  This week, the President joined the battle by proposing a two-year freeze on federal pay, his symbolic version of Bill Clinton’s maxim that “the era of big government is over.”  In doing so, he aligns himself with growing public skepticism about the value of much of what Washington does.  Yet, the anger driving the public debate isn’t really about federal spending much less federal pay.  It’s about continuing high unemployment and stagnating incomes, because if Washington can’t get that right, what credibility does it have to manage everything else the public pays for?  

There’s another, more subliminal factor feeding the public’s anger about taxes and spending, and the only accurate term for it is economic class.  Most Americans are fine with rich people getting richer, even when they get richer faster than everyone else -- so long as the rest of us make progress too.  But that’s clearly and painfully not the case today – the stock market and corporate profits are way up and multi-million-dollar Wall Street bonuses are back, while high unemployment won’t budge, wages are down, and the value of most people’s homes keep falling.  On top of that, it was middle-class Americans who financed a recovery, through taxpayer bailouts and emergency spending, which so far seems to benefit only the wealthy.  These factors alone should give Republicans pause as they prepare to block the extension of unemployment benefits and hold tax cuts for the middle-class hostage to preserving the tax cuts for the well-to-do. 

The bigger political question is how most Americans would feel about the GOP’s hard-line positions, if they realized how much the economy in recent years has tilted to favor the wealthy.  Recent data from the Federal Reserve document this tilt.  In 2007, for example, the top one percent of Americans owned about 35 percent of all of this country’s assets or wealth – including houses, stocks, bonds, businesses, and so on – and the top 10 percent owned 70 percent of those assets.  The distribution of financial assets is even more skewed:  In 2007, the top one percent owned 43 percent of the total value of all bank accounts, stocks and bonds, business equity, mutual funds, pensions, and retirement savings; and the top 20 percent of Americans owned an astonishing 93 percent.  Ownership of only one type of asset is still spread around fairly broadly: With 70 percent of Americans being homeowners, the bottom 90 percent owned 40 percent of the total value of all residential real estate in 2007.  But that fact is no longer evidence for the conservative trope that good times for the wealthy presage good news for everyone else:  Since 2007, the housing bust has destroyed about 30 percent of the value of American homes, and it was triggered by Wall Street geniuses who took the taxpayer bailouts and now are pocketing multi-million dollar bonuses.  

The tilt towards the wealthy is also much less steep in most other societies.  While the top 10 percent of Americans own 70 percent of this country’s wealth and assets, the top 10 percent of Britons own only 56 percent of the wealth of their nation, the top 10 percent of Canadians own just 53 percent of their country’s assets, and the top 10 percent of Germans hold but 44 percent of the assets of their nation.   

The gap in incomes also has grown substantially over the last generation, and that suggests that the wealth disparities will only continue to increase.  From 1982 to 2006, for example, the share of all annual income claimed by the top one percent of Americans increased from 13 percent to more than 21 percent; and the top 20 percent of us took home more than 61 percent of all the income earned here in 2006.  Put another way, 80 percent of Americans have to divvy up about 38 percent of all the income generated in our economy.  To be sure, a modestly progressive tax system ensures that the top one percent and the top 20 percent both contribute slightly larger shares of all federal revenues than they collect as income.  But their share of federal revenues is also much smaller than their fast-growing share of the nation’s wealth.  

 These disparities have grown not from our politics, but from the way the economy is evolving.  For example, our economy is increasingly capital-intensive – just consider, for example, how much more technology-dense most offices and workplaces are today, compared to just 20 years ago.  Since capital is the source of more wealth creation than before, the wealth of those who own most of it has been growing faster.  Incomes also are linked closely to the ability to work with all of that capital, increasing the income share of the top 20 percent of Americans with the most advanced skills and education.  It is certainly not the burden or responsibility of government to alter the economy’s natural course.  But when that course precludes meaningful economic progress for most people and creates profoundly undemocratic disparities in wealth and incomes, it surely becomes the government’s responsibility to ensure that the majority can genuinely thrive in that economy. 

That’s a budget battle that President Obama could champion with confidence.  For example, a good handful of subsidies for various industries would pay for low-cost access to college and graduate training for any young American with the drive and ability to see it through – as Britain, Germany and other countries, all with much smaller disparities of wealth and incomes, do.  A small tax on financial transactions could float a new program of low-cost loans for homeowners with troubled mortgages, and so help stabilize the housing values that comprise the only asset of most Americans.  Even a modest reform of the “carried interest” tax preference for hedge funds and private equity funds could more than pay for grants to community colleges to provide free computer training for any working person who wants it.  And surely it’s time for the new realities of wealth and incomes in the United States to provide part of the framework for reforming our taxes and entitlements.  

While Obama Promotes US Interests Abroad, His Opponents Deny Reality At Home

Most of Washington is stuck "in what we call the reality-based community … people who believe that solutions emerge from your judicious study of discernible reality. That's not the way the world really works anymore. … When we act, we create our own reality.”  Karl Rove, 2004.

Rove’s famous comments came to mind this week as President Obama and his political rivals launched new policy offensives.  Hop-scotching across Asia, the President nudged the center of U.S. foreign policy towards international economic interests and concerns.   From Delhi and Jakarta to Seoul and Tokyo, he has focused on the predominant economic realities that inform the decision-making of our major allies and competitors.  In the process, he has begun to recast our critical relationships around issues that allow the United States to draw on its greatest advantages, a market four times larger than China’s, and our capacity to develop the advanced technologies and business methods driving modernization across the world. 

Back in Washington, congressional Republicans launched their own offensive, trumpeting their plans to use their majority in the House of Representatives and expanded numbers in the Senate.  But their agenda seems to draw less on the hard realities that drove most of those who went to the polls two weeks ago -- jobs and incomes – than on the full-throated ranting of the more extreme elements in their political base.  As if saying so will make it so, they are uniting around non-negotiable demands to repeal health care reform, cut taxes for high-income people, and slash domestic spending in unspecified ways.

These dueling offensives recall the 1990s even more than the Bush era.   Bill Clinton came to office on the heels of the collapse of global communism, and so happily refocused American foreign policy on international economic matters.  Barack Obama was less fortunate, with two wars and worldwide economic turmoil dominating his early foreign policies.  But less than two years later, the Iraq conflict is winding down, the Afghan war has a new course, and global markets are more stable.  So for now, he can concentrate on the economic concerns -- currency values, trade barriers, debt, and worldwide demand – that once again are central factors in our real relations with other nations.  And as in the 1990s, real movement on these international issues can help build a foundation for the progress on jobs and incomes at home that dominates the President’s domestic agenda.  

Appropriately, the President chose the world’s most economically-consequential region, Asia, to quietly launch his new foreign-policy offensive.  His agenda began with new commercial openings and investment arrangements with India and with Indonesia, two of the world’s fastest-growing and most protected large markets.  Next, he turned to the G-20 summit in Seoul, where he fended off Chinese criticism of our monetary stimulus and called for measures to address the global imbalances that set the stage for the 2008 global meltdown.   He will wind it up in Japan, the world’s third largest economy, where he will lead discussions on currency, trade and economic growth at the Asia Pacific Economic Cooperation forum.   Whatever the outcomes of all of these meetings and agreements, the President is subtly shifting the focus of American influence to the real matters that drive our relationships with most other countries. 

Back home, economic reality for many of the President’s opponents – John Boehner is a lonely exception – is being redefined by the likes of Glenn Beck and Rush Limbaugh.   Somehow, hundreds of billions of dollars will be cut from the budget without touching the defense programs and entitlement benefits which account for most spending.  Next, all of the Bush tax cuts must be extended forever, even in the face of the GOP’s sky-is-falling rhetoric on the deficits.   And any compromise on the tax cuts in the lame duck session, before they expire on December 31st, is off-the-table – despite GOP attacks on the President for allegedly fostering “economic uncertainty.”  Prominent Republicans this week also attacked the Federal Reserve’s “quantitative easing” program to support growth, as if the prescription for jobs and incomes in a weak economy is to end monetary as well as fiscal stimulus.   Ironically, this last offensive echoes China’s position that the new Fed policy will make U.S. exports “unfairly competitive.” 

These implacable opponents’ latest gambit involves the debt ceiling, which will come up in the early months of next year.  Some Republicans in both the House and Senate now threaten to block this normal procedure on the principal that’s already too high for their comfort, while others propose to let it go through only if the President agrees to $300 billion in budget savings – again without specifying any real cuts they would support.  This one is dangerous even as just a threat, since any serious suggestion that the United States might find itself legally unable to pay the interest on its’ Treasury notes and bonds would sharply drive up interest rates.  In the real world, that would cut off the fragile recovery and possibly send the entire world economy into a tailspin. 

Politics always involves a good deal of posturing and shenanigans.  But these escapades, at this moment, have real consequences, not least of all for millions of struggling Americans who apparently hope that divided government will restore their jobs.  By definition, divided government can produce the results that voters want only through reasonable compromise.  And much as when Newt Gingrich and his fantasy-fueled followers took power, if the radicals leading the offensive this time continue to deny that fact, they too will find themselves bested by a reality-based president. 

The Mid-Term Elections and the Failure, Yet Again, of Trickle Down Economics

This week's seismic shift in the Congress will not change the problems facing its members and the President. This is the third consecutive election to bring large losses for the party in power, all for the same reason.  For a decade, neither party has been able to deliver the rising incomes and economic security that matter most for average Americans.  For all of the stark differences between the Bush and Obama presidencies, these economic results and the political outcomes that have followed are less surprising than one might think.   That's because the Obama administration, despite its rhetoric and efforts, finds itself backed into a version of the same, failed trickle-down economic model that its predecessor embraced openly.

Yes, the last two years of Democratic dominance produced small gains in jobs, especially compared to the massive job losses at the close of Bush's term, and modest gains in incomes compared to stagnating wages under the Republicans.  Like his predecessor, however, Obama now presides over an economy that continues to produce much greater gains for those at the top.   While most Americans are struggling, corporate profits are up sharply, and the stock market has recovered all of the ground it lost in the financial crisis and its aftermath.  Perhaps most galling, Wall Street is preparing to hand out another round of mega-bonuses, dismissing the fact that they were the ones who brought down the economy for everyone else, and that the average people who bailed them out aren't sharing in their private boom. 

Most Americans accept, at least intuitively, that the financial bailout ultimately saved everyone from a much worse economic fate.  But the public's anger tells us that voters also sense that Wall Street's rapid return to good times wasn't accidental.  They're right: Once again, Washington made the restoration of big profits for Wall Street the lynchpin for a broader recovery.   The key was the administration's decision, once further stimulus to directly support average people seemed to be off-limits, to embrace the indirect approach of massive, on-going monetary stimulus.  Its principal element was open access at the Fed for big finance to borrow funds at near-zero interest rates, which the administration's economic team hoped would jumpstart business investment and large consumer loans.  In practice, Wall Street didn't use much of more than $1 trillion in nearly-free money to expand business lending.  With consumer spending sidelined by high unemployment and the still-falling housing market, demand for business loans remained slow.  Moreover, once the big financial institutions were safely bailed out, they used their unlimited and nearly-free funds from the Fed to buy U.S. and foreign government securities and other safe instruments, generating the large profits that now fund their bonuses.

This trickle-down approach has been further amplified by the Fed's "quantitative easing" program.  That's their latest effort - the second time in two years -- to get the trickle going by buying up to $1 trillion in nearly any long-term assets that Wall Street wants to unload. It hasn't worked yet:  Last week, the report on third quarter GDP showed that most of the tepid, 2.0 percent growth came from inventory buildup, while final sales slumped.   So long as the trickle doesn't reach most Americans, the Fed's efforts won't work politically either.

In fact, there were alternatives-and there still are.  A more effective approach, for both the short and long terms, would link immediate new spending and tax reductions for most Americans with long-term entitlement changes to control deficits down the line.  Given the scale of the economy's current troubles, this is an opportunity for the administration to think big - for example, a multi-year payroll tax holiday and new light rail systems for the nation's 30 largest metropolitan areas; new research initiatives on the scale of the moon shot for green fuels and technologies and medical breakthroughs; or free tuition at public colleges for students from families earning less than $120,000, an approach now in place at Harvard and other elite universities.

Perhaps most important, the economy needs a federal loan program for families with mortgages in trouble to help stabilize housing prices by keeping foreclosures rates in check.  Such a measure could short-circuit much of the "negative wealth effect" from falling housing prices which continues to hold down consumer spending and, with it, business investment.  Yet, when one loudmouth on cable TV ignited a rightwing cry against direct federal assistance to keep people in their homes, who among the Democrats had the gumption to refute him?

What approaches can we expect from the Republicans who will run the House of Representatives?  Their leading proposition is to extend the Bush tax cuts, on the view that you don't raise taxes in a weak economy-- and they're basically right.   Of course, they also want to cut current spending, which would slow the economy more than restoring the Clinton-era tax rates for high-income people.  The truth is, most Republicans are all talk on the deficit.  Apart from Paul Ryan and his handful of true-believers, the GOP is probably no more willing today to pull back current spending for any sizable group or interest than they were under George W. Bush, when federal spending grew at the fastest rate since LBJ.    

Yet, there may be opportunities to agree on something beyond the expected, temporary extension of the Bush tax cuts.  President Obama can begin by going beyond trickle-down and pressing for major initiatives to directly help average Americans, including payroll tax relief and mortgage loans, linked to long-term spending reforms for the entitlement programs.  If the Republicans refuse, that's a debate the President should welcome as he prepares his run for reelection.

Syndicate content