Obama Channels Clinton on the Economy, But Will it Work the Second Time?

Obama Channels Clinton on the Economy, But Will it Work the Second Time?

December 14, 2011

In Kansas last week, President Obama laid out the economic brief for his reelection. Its substance plainly recalls the program Bill Clinton offered in 1992. Both plans are built around new public commitments to education, R&D and infrastructure, some fiscal restraint to finance the public investments and unleash more private investment, plus some modest redistribution of the tax burden from working families to the wealthy. This formula still strikes the right notes politically, at least for those who aren’t diehard, pre-New Deal conservatives. But economically, this mainstream approach will face much greater hurdles today.

Most of the President’s conservative critics have focused on his call for more revenues from affluent Americans, starting with a surtax on millionaires. In fact, congressional Republicans not only have rejected the surtax; they’ve also suggested that they might hold payroll tax relief hostage until Obama agrees to make the Bush upper-end tax cuts permanent. It’s a bluff, and not a very good one: The GOP will stop the surtax on the rich, but they cannot be seen at the same time as raising taxes on everyone else. Whether or not Bush’s largesse for upper-income Americans survives will turn on who is inaugurated in January 2013.

This tax debate may pack a good political punch for Obama; but in the end, it doesn’t have much economic significance. Yes, a higher marginal rate, in itself, would have negative effects. But in the real world, a higher rate never operates by itself. The additional revenues may help bring down interest rates by reducing deficits and so spur business investment, as they did under Clinton. Or the same revenues could help finance public investments that make businesses more efficient and productive. And the truth is, the adverse effects of a higher tax rate on the wealthy, by itself, fall somewhere between quite weak and very weak. What else can an economist infer from strong growth in the 1950s when the top rate exceeded 90 percent, quickening growth in the 1990s after Clinton hiked the top rate, and more tepid growth after Bush cut the top rate?

The harder and more important issue is whether the combination of more public investment and smaller deficits, which worked so well for Clinton, will make much difference today. Like Clinton in 1992, Obama last week called for more federal dollars in the three specific areas that can boost productivity and growth in every industry, and which businesses tend to shortchange. This covers worker education and training, basic research and development, and transportation infrastructure. The theory, confirmed by the boom of the latter 1990s, is that these factors help make businesses more efficient and their workers more productive. Together, those gains translate into higher incomes and stronger business investment, especially if businesses don’t have to compete with Washington for capital to invest. And all of that should produce stronger growth, more jobs, and a much-sought-for virtuous circle.

The catch lies in jobs and wages. If the public investments allow businesses to become more efficient and productive, but those investments do not lead to higher incomes and more jobs, the only result will be higher profit margins. The whole virtuous circle will slow down or even stall out, much like what happened once the 2009 stimulus ran its course. In the 1990s, the strategy worked like a charm, because U.S. companies still responded to higher growth and productivity with strong job creation and wage increases. But those connections have weakened badly since then.

Consider the following. The Bush expansion from 2002 to 2007 saw GDP grow by an average of 2.7 percent a year, 30 percent slower than the 3.5 percent annual gains for a comparable period in the 1990s, say 1993 to 1998. But while the number of private sector jobs grew by more than 18 percent from 1993 to 1998, this rate fell to less than 6 percent from 2002 to 2007, a two-thirds decline from the earlier period . Even worse, the connection between productivity and wage gains broke down even more. In the 1990s, productivity grew 2.5 percent per-year, and average wages increased nearly in lock-step, by 2.2 percent a year. In grim contrast, productivity grew 3 percent a year from 2002 to 2007 while the average wage didn’t go up at all.

Clinton’s program could take strong job creation and wage gains virtually for granted. President Obama’s program will have to address these issues head on, and in ways that might attract some bipartisan support. Obama will also have to contend with additional hurdles, including the persistent economic drag from the financial crisis and, perhaps, from another round triggered by Europe’s faltering sovereign debt.

Here are three ways to begin.

First, while the President’s temporary payroll tax cut for workers provides some welcome stimulus, reducing the tax burden that falls directly on job creation on a permanent basis — the employer side of the payroll tax — would be more powerful economically.  We could cut employer payroll taxes in half, for example, and replace the revenues with a new carbon fee on greenhouse gases. In the bargain, the United States also would become the world’s leading nation in fighting climate change.

To address stagnating wages as well as slow job growth, the President should recast his training agenda as a new right. Most jobs today — and virtually all positions very soon — require some real skills with computers and other information technologies. All working Americans should have the opportunity to upgrade their IT skills, year after year. They could have that, and at modest cost to taxpayers, if Washington will give community colleges new grants to keep their computer labs open and staffed at night and on weekends, so any American can walk in and receive additional IT training for free.

Finally, U.S. multinationals have lobbied furiously, without success, for a temporary tax cut on profits they bring back from abroad. Give them what they want, if they will give the economy what it needs. We could let U.S. multinationals bring back, say, 50 percent of their foreign profits at a lower tax rate if, and only if, they expand their U.S. work forces by 5 percent. A 6 percent increase in a company’s U.S. workers would entitle them to bring back 60 percent of those profits at a lower tax rate, and on up to a 10 percent job increase and 100 percent of foreign profits.

That’s what it will take, just to begin, for an economically-powerful program of public investment and fiscal restraint to work its magic this time.



Will Europe Step Back from the Brink this Week?

December 6, 2011

On the edge and the eve of a financial market meltdown, Germany seems to now accept that the Eurozone sovereign debt crisis poses the greatest danger to the European, American and global economies since the early 1930s. Yet, the world still is far from out of the Euro-woods. Yes, Angela Merkel’s Chancellery has finally signaled that she and her government will permit the European Central Bank (ECB) to stabilize the value of Italy’s public debt. But first, Italy, France and 14 other Eurozone nations have to prove themselves worthy by accepting German rules for fiscal policy. The clock is ticking: If they don’t agree to those conditions at the European summit later this week, Merkel will nix ECB intervention, and the meltdown will begin.

The gravity of this crisis is genuinely unique. When the U.S. financial market seized up in 2008, the systemic dangers were largely limited to institutions which had used reckless leverage to invest in securities or credit default swaps based on a housing bubble, like Lehman Brothers and AIG. This time, the systemic threat extends to everyone who has trusted in what has long been considered one of the safest assets in the world, the governments bonds of large, advanced European nations. That covers almost all large European banks and companies.

Furthermore, in the 2008 – 2009 crisis, governments had powerful tools — bailouts, new guarantees, stimulus, and interest rates cuts — to contain the worst of the crisis to those reckless financial institutions. For this second round, coming out of the first meltdown, governments everywhere have very few tools left to prevent the crisis from badly damaging entire economies.

So, if the ECB and Eurozone governments fail to act in the next few days and weeks, the results will be devastating. Most of the huge sovereign debt of Italy, the epicenter of the systemic threat, is held by German, French, Italian, and Spanish banks. The value of Italian bonds already has fallen sharply, eating away at the capital of those banks. That’s why lending by large Eurozone banks has virtually stopped, pushing most of Europe back into recession. That’s also why “interbank loans” in Europe — the billions of Euros or dollars in overnight loans that keep the banking system there liquid from day to day — also dried up.

To ease these liquidity pressures, the Federal Reserve and the ECB, along with the central banks of England, Japan, Switzerland and Canada, joined hands and stepped in last week. They cut by half the price they charge banks in their own countries to borrow dollars from their central banks, which the Fed has agreed to supply as required. Stock markets everywhere rallied, hoping this move would buy the Eurozone enough time to put in place a real solution. But the new loans cannot do more than that. The liquidity squeeze they address is only a symptom of the real problem, which is that the holdings of Italian government bonds by Europe’s big banks could bankrupt them. If those bonds fall in value much more, it will wipe out their capital.

If that weren’t bad enough, European governments may find themselves unable to contain the meltdown to banks with large holdings of Italian bonds. In 2008, the U.S. and European governments averted bank runs by quickly guaranteeing the money market accounts where most corporations keep their operating funds. But when the problem is the credit of governments themselves, who will believe them if they pledge to guarantee money market or other accounts — and where would they find the funds to do so if investors won’t buy their debt?

The good news for the United States is that American banks and companies got rid of most of their investments in Italian and other Eurozone government bonds over the last year. The bad news is that no one knows how many credit default swaps they hold against the default of those Italian bonds, or against the default of the corporate bonds of the Eurozone banks that actually hold most of Italy’s debt, or the corporate bonds of Eurozone companies that depend on those banks.

Europe sidestepped the danger of the credit default swaps against Greek debt by convincing the large institutions that held most of Greece’s bonds to voluntarily accept a 50 percent write-down. This 50 percent “haircut” is comparable to what usually happens when a government formally defaults. But because the write down of Greek bonds was technically voluntary, it didn’t trigger the credit default swaps.

The same approach won’t work for Italy, because its outstanding debts are just too large: Eurozone banks could not accept a 50 percent write-down on Italian bonds without becoming insolvent. And if the big financial institutions outside Europe — Goldman Sachs, Bank of America, Barclays and Bank of Tokyo-Mitsubishi, for example — have substantial European based credit default swaps, the fallout will threaten the global financial system. The sudden insolvency of European banks could damage the American economy in other ways as well. For instance, American banks and corporations are engaged in hundreds and perhaps thousands of deals today with large European banks. If those banks go down, all of the existing deals will be thrown into doubt.

If the crisis does hit the Eurozone and then spreads to the United States, most of the steps that policymakers took to contain the damage in 2008 – 2009 will not be available. Voters are very unlikely to tolerate another big bank bailout or large stimulus. And with interest rates already near zero, the Fed won’t be able to cut those rates enough to meaningfully support a sinking economy. The only move left will be to print money. To be sure, that’s what Europe faces today in an ECB intervention. Yes, it may lead to a steep devaluation of the Euro, which ultimately could unravel the currency union.

In a world in which better options are no longer available, the only course left is to address crises, one at a time.