Rebuilding a National Consensus for Economic Reform

Rebuilding a National Consensus for Economic Reform

July 29, 2010

The Washington politics around America’s economic policies has become dysfunctional.  In Barack Obama’s first 18 months, the broad support for Democrats expressed in the 2006 and 2008 elections, the big congressional majorities they produced, and the public’s loud demand for change from the Bush era were enough to enact major stimulus, followed by health care and financial reforms.  The full-throated stimulus, both monetary and fiscal, halted the economy’s sickening slide towards depression, but they were not enough to ignite strong, self-sustaining growth.  So now, with the economy stuck in a holding pattern of high unemployment and slow growth, and GOP attacks dominating new-media airwaves and bandwidth, most Americans’ patience with the Democrats’ economic management has worn very thin.  The national consensus for strong action on the economy has unraveled, and the administration is unable to enact additional measures.

Last week, NDN – a prominent Washington think tank on the progressive side – sounded an alarm: If we hope to salvage the next decade, we will need a new policy and political framework. (Full disclosure: I advise NDN on globalization and economic policy.)  For the long-term, this strategy should focus on two powerful structural changes now reconfiguring the economy, globalization and the spread of information and Internet technologies.  Even more urgently, however, Congress needs to address the jobs crisis.

There’s no use in fooling ourselves that anytime soon, healthy job creation will kick in on its own.  The economic mistakes of the last administration took care of that: Financial crises always lead to recessions that are unusually deep and job-destroying; and those steep downturns typically are followed by unusually shallow and slow recoveries.  This one is no different.  Our large, financial institutions, for example, still hold tens of billions of dollars in the same financial paper that brought on the crisis, keeping business lending and investment weak.  At the same time, home values continue to sputter and foreclosures are still running several times their normal levels, eating away at the financial security and economic well-being of most Americans. So, it’s equally unsurprising that household spending also remains weak.

NDN’s new prescription calls, first, for tough love: “It’s time to describe and explain to Americans what precisely is happening with their economy” in order to “create a public logic for sustained new public and private investment in the years ahead.” Then it turns to five steps to help jump-start new job creation, now.

*          Provide more federal funds to state and localities, so American students and their parents don’t face the prospect of 300,000 fewer teachers in classrooms this fall, and comparable downsizing for police and other local and state agencies.

*          Reduce the cost for companies to create more jobs by cutting the payroll tax.  A cut on the employers’ side would directly spur job creation, while a cut on the workers’ side would do it more indirectly, by expanding demand.  These payroll tax cuts should go unfunded for one year, providing a little more stimulus, and then we should pay for them by phasing in a carbon fee.  A carbon fee would also represent the most serious step to address climate change ever undertaken here – and it would stimulate more jobs by spurring the development and adoption of low-carbon technologies.

*          Enable more Americans to gain the knowledge and skills required for most new jobs, especially the computer and Internet-related skills needed to perform well in workplaces dense with those technologies.  A big, first step: Federal grants to community colleges to keep their computer labs open and staffed on evenings and weekends, so any adult can walk in and receive free instruction.

* Help to re-stabilize house values by bringing down home foreclosure rates.   Until the housing market returns to more normal conditions, most Americans will feel less well-off, stifling normal consumer spending.  Falling home prices also make it harder for many people to move to where work is available or wages higher.  The first step here: Create a new federal loan program for lower- and middle-income people whose mortgages are in trouble.

*          Jumpstart new business formation, because so many of the economy’s new jobs are created by young businesses.  And don’t start from scratch – we can use current SBA, EDA and other agency programs to create new “acceleration centers” that could bring together entrepreneurs and venture capitalists, connect new startups with opportunities provided through the government’s new green economy and export initiatives, and then connect job seekers with those companies.

Each of these proposals has real merit; but the most important message is that we can put more Americans back to work. All that is lacking is the national will to do it.  If the President will spend August working to rebuild that will, Democrats could enact a serious jobs agenda in September and October – and do a lot better in November than anybody’s polls suggest today.

Jobless Benefits, Deficits, and the Art of Washington Compromise

July 22, 2010

The President will sign another $34 billion extension of unemployment benefits this week, and this is only the beginning of a debate almost certain to produce uncomfortable moments for both parties. For now, the Republicans have embraced the more shameless position. Their new talking points tell us that the economy cannot afford any new measures that would increase the deficit – a very long way from Reaganomics, indeed. But all this comes on top of the previous GOP story line that the slow economy and high jobless rate prove that the President’s economic program has failed. With no evidence that global investors have any qualms at all about U.S Government debt – if they did, the market yield on Treasury bills wouldn’t hover around one-third of one percent – the slow economy they use to blame Obama should be entirely able to absorb more deficit spending without problems. It’s true, of course, that consumer spending and business investment remain weak, and American companies aren’t creating many new jobs. But even most GOP economists concede that the combination of the 2009 stimulus package and two years of near-zero interest rates from the Fed explain why we moved from monthly job losses of a half million or more to small monthly gains, and from output contracting at a 4 to 5 percent rate to output growing again moderately.

But it’s not enough to produce a healthy recovery, because economies hit by financial meltdowns need stronger medicine than easy fiscal and monetary policies. So, while Democrats are right that an economy as weak as this one won’t be harmed by another small dose of deficit spending, it also won’t help the overall economy much. That’s because it doesn’t touch the underlying forces holding down growth and jobs, which are actually the same forces that drove the crisis. To begin, high unemployment isn’t the only or the most powerful force holding down consumer spending. Americans aren’t spending like they used to, mainly because the sharp fall in housing markets has left most of us a lot poorer than a few years earlier. And there’s no relief in sight while home foreclosures continue to run at several times their normal rates, further depressing housing prices.

There’s a similar story behind business investment, which still lags because nearly two years after the crisis peaked, the financial institutions that dominate business lending remain weak. The Paulson and Geithner Treasuries both rejected not only the original TARP plan to buy up the sick assets held by those institutions – which admittedly would have been hard to carry off successfully – but also calls to take over failing banks, remove those assets from their balance sheets, and sell off new, healthy entities. Since they also didn’t come up with anything else to sequester the junk from the rest of the system, financial institutions are still saddled with hundreds of billions of dollars in bad assets and derivatives. And with the housing market (or change ‘with’ to ‘while’) still driving down the value of many of the mortgage -backed assets that remain on the books of the big banks – and sovereign debt markets in Europe also looking perilous – financial institutions are still writing down losses and hoarding capital for the next storm. Again, monetary and fiscal stimulus – or austerity for that matter – can’t solve the problem.

In the face of these daunting problems, much of Washington has decided once again to yell about deficits. Even so, they can’t quite get their stories straight. Republicans unwilling to let the deficit rise by $34 billion for one year to give jobless Americans a little more assistance, insist nevertheless that Congress reenact the Bush 2001 and 2003 tax cuts for high-income Americans, set to sunset this year, at a cost to the deficit of $750 billion over 10 years. And quite a few Democrats who point out that abrupt austerity measures can easily hurt a slow economy, still won’t consider extending those tax cuts for even a year or two. Neither side can have it both ways.

If Republican really believed that temporary increases in the deficit were dangerous, they would be leading the fight to roll back those tax cuts. And if Democrats really believed that cutting the deficit in a slow economy is dangerous, they would be calling on the President to preserve the same tax cuts. However, inside the contradictions on both sides may well lie the seeds for a sensible, Washington compromise.

While economists may argue about the effects on a slow economy of temporary increases in spending or tax incentives, they generally still agree that once the economy is healthy, the large deficits now forecast for years to come will begin to displace private investment and drive up interest rates. At a minimum, that should mean no new, permanent tax cuts or spending programs. So, here’s the compromise: Extend the Bush tax cuts for high-income Americans for two years, at a cost of $75 billion, and match it with $75 billion over two years in additional assistance to the states, now facing the prospect of laying off tens of thousands more police, teachers, and other public servants. And if that’s too brazen for those screaming about deficits, add a measure or two that would raise $150 billion over the following three to five years. In a spirit of shared pain, Republicans could begin by agreeing to a small fee on financial transactions that normally would make them blanch. In return, the Democrats could pledge to limit increases in non-defense discretionary spending to inflation minus one percent, for five years. All it really requires is a burning desire by Republicans to hold on to the Bush tax cuts, matched by a heartfelt yearning by Democrats to preserve as many public employee positions as possible. And who knows: If it works, it could be a first step towards a much broader agreement on serious, long-term deficit reduction.

The Economy is Slowing Down – Alas, Much as We Expected

July 15, 2010

Recent polls have left most Democrats discouraged, even if the loss of public confidence reflects economic weaknesses largely beyond their control. Americans these days seem to both blame President Obama for economic developments that were not his doing and discount his real accomplishments in other areas. It’s hardly a surprise that life in politics is unfair. The real misstep here has been the President’s persistent optimism about the economy, since the basic shape and force of the current economic undertow were entirely predictable — and actually predicted by a number of us.

This is not a case of the hooey bandied about by know-nothing partisans that the President’s stimulus “failed.” Regardless of what he might have done in early 2009, the U.S. economy could not have avoided a long, bad recession — nor, without heroic action could we have escaped the slow recovery now disappointing many Americans. What we got is the basic shape of recessions that are triggered by financial meltdowns and the recoveries that eventually follow them. Yes, the crisis grew out of years of regulatory and economic-policy negligence, mainly by the Bush crew. But once it arrived, there was never a realistic prospect that $800 billion of new spending and tax cuts over two years would produce a big, V-shaped bounce back, as it might have if this were just part of a normal business cycle. In fact, all of that fiscal stimulus, on top of even more powerful easy Fed policies, did stop the slide into a Depression and finally pushed us into a slow recovery.

We also know why the stimulus couldn’t do more than that — or, more precisely, why it’s in the nature of a financial crisis to take years for an economy to recover fully. To begin, financial meltdowns leave most households markedly poorer in ways that ordinary business cycles don’t — what’s your house worth today? — and that makes most people a lot less eager to spend. So, as the stimulus has wound down, retail sales have stumbled for both of the last two months — in fact, the only people spending like most Americans used to, are the very wealthy, who still have more money than they know what to do with. And most others, even if they’re inclined to spend, have a hard time getting credit because a financial meltdown also leaves lenders much weaker. It also shouldn’t have surprised anyone that this reluctance to lend has extended to most businesses, keeping investment weak.

Moreover, these developments unfold in an economy that had serious problems before the meltdown and everything that has followed. The recession has drawn people’s attention to a decade-long problem: American business’ capacity to create new jobs, even when growth is strong, has weakened markedly. In the Bush expansion of 2001-2007, we produced less than half as many new jobs as we did during comparable periods of the 1982-1989 expansion and the 1992-2000 expansion. And when the economy turns down these days, it also sheds jobs at extraordinary rates. More than 3 million jobs were lost in the 2001 recession and its aftermath, which was six times the job losses, relative to the decline in the GDP, seen in previous recessions. Much of the same happened this time, as the recent recession cost nearly 8 million jobs. In fact, the jobs losses have been so large and so persistent that they’re putting independent downward pressure on the economy, eating away further at investment and consumer spending.

On top of all this, the potential for a second financial crisis, or a second round, is out there. The problem this time begins in Europe, where governments struggling with unproductive economies and large and fast-mounting deficits are having trouble finding global investors to finance their new bonds. It started in Greece and is spreading to Portugal, Spain and perhaps beyond; and while the EU says it will bail them out if the worst comes, the markets continue to bid down the value of their debt. The rub here is that nearly all of that debt is held by financial institutions still weakened from the last crisis, especially French and German banks which, for example, hold $630 billion just in Spanish government bonds. Even if those bonds, along with Greece’s and Portugal’s, skirt a formal default, their declining value is driving some major European banks to the edge — much as the plummeting value of mortgage-backed securities two years ago destroyed Lehman Brothers, Bear Stearns, Merrill Lynch and AIG. And if large European institutions fall, their counterparties on Wall Street will be left holding tens of billions of dollars in obligations no longer worth much. This scenario is still far from likely, but it remains quite possible that we could find ourselves back where we were in late 2008.

The good news is that if another crisis comes, the administration will have more tools to deal with it, as Congress is on the verge of passing some decent financial reforms. They might need those new powers, because congressional Republicans seem committed to blocking anything the President proposes, whatever the cost to the American economy. And whether or not the administration finds itself facing another economic crisis, or merely has to deal with a stagnant job market and meager wage gains, the luxury of large Democratic margins will soon be gone. In either case, President Obama will have to reclaim center stage and mobilize American opinion in ways that force his opponents to concede to sensible measures — much as Bill Clinton did after the Democrats’ 1994 setback and Ronald Reagan did after the big GOP losses in 1982. If the President can pull that off, he can still build a serious and successful economic legacy.