The economic news and data have turned distinctly upbeat. With unemployment down, consumer confidence up, and personal debt back to normal levels, it was no surprise when last week’s revised report on first quarter GDP showed consumer spending rising at twice the rate of the preceding three quarters. Housing investment is now increasing at a 14 percent rate, following a 25 percent drop in home foreclosures compared to the first quarter of 2012 and many months of rising housing prices. Business investment is still sluggish, but corporate profits are strong, and the stock market is setting new records. These positive reports also explain why markets barely moved when Federal Reserve chairman Ben Bernanke noted recently that the Fed’s aggressive program to keep interest rates low might wind down sooner than expected.
The biggest drag on the economy, as usual, is government. If not for Washington’s misguided sequester cuts, tax increases and continuing layoffs by state and local governments, GDP would be growing at a healthy three to five percent annual rate. Even so, conditions are improving enough to sharply drive down the deficits projected for the next two years. With Europe stuck in a double-dip recession, the United States once again finds itself a prime engine of global growth.
Credit for much of this turnaround goes to the Fed, and some of it is luck. But business attitudes and orientation count here, too. In particular, American policymakers and businesses have been committed to globalization for the last two decades, especially compared to their European counterparts. And this deep engagement in global markets is a critical factor in the economy’s renewed strength. Not only are exports one of the brighter points in the current recovery. In addition, years of sustained competition in global markets have made many U.S. industries markedly more efficient and innovative than their rivals in other advanced economies.
Bill Clinton deserves some thanks for all this. He not only articulated the need for Americans to actively engage in world markets, clearly and convincingly. He also made that attitude concrete by corralling bipartisan majorities to enact NAFTA, create the World Trade Organization, and draw China and other large developing nations into a global trading system. American multinational companies may be best known today for their byzantine strategies to minimize their U.S. taxes. But their many years of investing in foreign markets at higher levels and rates than firms from other major economies count for a lot more. Once there, they have had to compete with lower-cost producers in markets those producers know better than they do. This intense competition has forced U.S. multinationals to come up with new efficiencies and innovations, which they also have applied to their U.S. operations and markets.
The falling U.S. trade deficit provides clear evidence that all of this matters. In the first quarter of this year, for example, our trade imbalance was $22 billion less than it was a year earlier. This may seem remarkable, since stronger growth here than in Europe and Japan would suggest a rising U.S. trade deficit as imports rise and exports fall. It’s true that some imports are up — but so are most exports, including high tech goods that account for 19 percent of all U.S. exports. The main reason, though, is globalization as U.S. companies that have spent years setting up shop around the world now tap into fast-growing markets across the developing world.
Consider whom we now trade with. Our traditional major markets of Europe and Japan now account for just 25 percent of U.S. exports. They’re overshadowed today by the 32 percent share of our exports which go to our NAFTA partners, Canada (19 percent) and Mexico (13 percent). Another 12 percent of U.S. exports go to the rest of Latin America, seven percent to China, and 13 percent to the rest of non-Japan Asia. In fact, American firms export nearly half as much to Africa and the Middle East as they do to Europe.
President Obama is now doubling-down on the commitment to globalization. Last term, he got Congress to approve new free trade pacts with South Korea, Colombia and Panama. This term, he’s pressing for a major new trade deal with Pacific Rim countries and another with the European Union. The negotiations for the first deal, the Trans-Pacific Partnership Agreement (TPP) began in 2010. Now, the President is pressing all interested parties — Australia, Brunei, Chile, Canada, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam, along with the United States — to complete the deal within one year. That’s an ambitious deadline, since TPP would lower or end many thorny domestic barriers to open trade. Among these are regulations and other impediments to competing in service-sector businesses, with state-owned enterprises, and in areas of government procurement, as well as health and safety regulations targeted at foreign competitors. And if we and the ten other Pacific Rim countries can strike the deal on TPP, Japan and South Korea would probably join too, and further expand its impact.
Completing a new free trade pact between the U.S. and the EU within the President’s two-year deadline will be equally daunting. Here, too, the issues include many of the toughest for trade in the 21st century, encompassing barriers rooted in the domestic regulation of services as well as health and safety, labor and environmental rules, agricultural subsidies, data privacy, and anti-trust policy. These are very difficult matters not only for the regulation-prone countries of continental Europe, but for the United States as well. Nevertheless, German Prime Minister Angela Merkel and the UK’s David Cameron are both on board with Mr. Obama. Alas, France’s President Francois Hollande is less enthusiastic, and the president of the European parliament, Martin Schulz, has warned that any deal must “put the European model at its core,” especially with regard to “labor unions and social rights.”
Both sets of negotiations will test everyone’s patience and political limits. But the process will recommit the United States to the path of liberal internationalism that has helped drive American prosperity for more than 65 years. And if they succeed, the result will not only reassert America’s global economic leadership. The new agreements should also permanently raise the incomes of tens of millions of people here and abroad, along with the sales and profits of tens of thousands of U.S. and foreign companies.
American exceptionalism has become a theme of our immigration debate. From both sides, we hear that America is a uniquely desirable place that, for good or ill, draws an outsized share of the world’s immigrants. The truth of this matter is that large-scale immigration is a worldwide phenomenon tied to contemporary globalization. Porous borders and rising education levels have allowed tens of millions of people in developing societies to become more mobile, and new communications and transportation technologies give everyone access to information about other countries and ways to get there. Perhaps most important, rising global demand has created vast new opportunities for foreign labor — whether it’s to bolster the shrinking labor pools across much of Europe, provide services in thinly-populated, oil-rich countries in the Middle East, or cater to wealthy global elites in dozens of tax havens.
So, despite dire warnings that U.S. immigration reform will set off another invasion of America by new immigrants, the data show that many other countries are stronger magnets for foreign workers than the United States. In fact, when it comes to foreign-born residents, America looks fairly average.
It is true that more foreign-born people live in America today than anywhere else. But that’s mainly because we are a very large country, with more native-born people as well than anywhere except China and India. And most of our immigrants came here with our permission: Two-thirds of all foreign-born people living in the United States are naturalized citizens or legal permanent resident aliens, and another 4 percent have legal status as temporary migrants. That leaves about 30 percent who are undocumented.
Consider the percentages of foreign-born residents living today in various nations: America with just under 13 percent of its population foreign-born, according to U.N. data, ranks 40th in the world for immigrants as a share of the population. By contrast, across the 10 most immigrant-intensive countries, foreign-born people account for between 77 percent and 42 percent of their total populations.
These unusually high proportions of immigrants appear to be generally linked to global trade and finance. In the top 10, for example, we first set aside the special cases of Macau and Hong Kong, whose Chinese populations are counted as foreign-born, and Vatican City. Of the remaining seven nations, four are in the Middle-East — Qatar, the United Arab Emirates, Kuwait, and Bahrain — where tens of thousands of foreign workers are needed to help meet global demand for oil and provide services for native populations grown wealthy off of their oil. The other three countries in the top 10 are global tax havens and financial centers — Andorra, Monaco, and Singapore — that draw thousands of global elites followed by foreign workers to provide their services.
The next 10 most immigrant-heavy countries, where foreign-born persons comprise between 42 percent and 22 percent of their populations, include five more tax havens (Nauru in Micronesia, Luxembourg, Lichtenstein, San Marino, and Switzerland) and three more oil rich, Middle Eastern countries (Saudi Arabia, Oman, and Brunei). The two others in this group are the special cases of Israel, where Jewish national identity is the draw, and Jordan, home to tens of thousands of people displaced by the Iraqi and Israel-Arab conflicts.
Beyond the top 20 countries for foreign-born residents, numerous other nations that closely resemble the United States, in economic opportunities and social benefits, also draw immigrants in greater relative numbers than America. For example, some 19 percent to 20 percent of the populations of Australia and Canada are foreign-born, compared to our 13 percent. Austria, Ireland, New Zealand and Norway also lead the United States in immigrants as a share of their populations, as do the smaller and less-advanced nations of Estonia, Latvia, Belize, Ukraine, Croatia, and Cyprus. A similar pattern emerges from OECD data covering 25 industrialized countries from 2001 to 2010. Over that decade, the share of the American population born somewhere else has averaged 12.1 percent. By this measure, the United States trails not only such countries as Australia, Austria, Canada, Luxembourg, Switzerland and Israel, as noted above, but also Sweden, Germany, and Belgium.
This pattern also does not change much when we look at the most recent, annual “net migration rates” of various countries (2012). That’s a standard demographic measure calculated by taking the number of people coming into a country, less the number of people who leave, and divide by 1,000. Using that measure, the United States ranked 26th in the world. At 3.6 net immigrants per-1,000 in 2012, we trail far behind three oil-rich countries averaging 24.1 net immigrants per-1,000 (Qatar, UAE, and Bahrain), 13 tax havens averaging 10.8 per-1,000 (from the British Virgin Islands and the Isle of Man, to the Cayman Islands and Luxembourg), and two countries that have become sanctuaries for refugees (Botswana and Djibouti at 14.9 per 1,000). In addition, at least four other advanced countries also had much higher net migration rates last year –Australia, Canada, Spain and Italy, averaging 5.3 net immigrants per-1,000 or a rate nearly 50 percent higher than for the United States.
Given the role of labor demand in migration flows and the particular demand in the United States for skilled workers, it is also unsurprising that, according to the Census Bureau, almost 70 percent of foreign-born people residing here, by age 25 or older, are high school graduates. In fact, nearly 30 percent hold college degrees, the same share as native-born Americans. On the less-skilled part of the distribution, of course, we find many undocumented male immigrants. But as we showed in a 2011 analysis for NDN and the New Politics Institute, undocumented male immigrants also have the highest labor participation rates in the country: Among men age 18 to 64 years, 94 percent of undocumented immigrants work or actively seek work, compared to 83 percent of native-born Americans, and 85 percent of immigrants with legal status.
On balance, the data show that the United States is not home to an unusually large share of immigrants, legal or otherwise. As globalization has increased the demand for labor in dozens of countries while lowering the barriers to people moving to other places for work, America has become fairly average as a worldwide destination.
By Paul Stockton
As you read this, U.S. adversaries are scouring our financial system, electric power grid, and other parts of our critical infrastructure for vulnerabilities to cyber sabotage. President Obama’s Deputy National Security Advisor for Homeland Security and Counterterrorism, Lisa Monaco, says that prosecutions of cyberterrorists “will be critical tools for deterrence and disruption” of their attacks. Before we can bring cyberterrorists to justice, however, we have to fill a major gap in our legal framework to prosecute them. Michele Golabek-Goldman and I have a new article in the Stanford Law and Policy Review that examines that gap and how to fill it. (Intrepid readers can access the analysis, “Prosecuting Cyberterrorists: Applying Traditional Jurisdictional Frameworks to a Modern Threat,” through the Social Science Research Network.)
The stakes in the cyber realm could not be higher. Former Defense Secretary Leon Panetta framed this challenge in his customary, direct terms. A few months before leaving office, he warned that the United States is in a “pre-911 moment” in which “attackers are plotting” to attack U.S. infrastructure with potentially devastating effects. Moreover, he warned us all that “a destructive cyberterrorist attack could virtually paralyze the nation.” (Full disclosure: I was Assistant Secretary of Defense for Homeland Defense under Secretary Panetta, and more than once got the benefit of his salty assessments of the threat — and sometimes of my own performance.)
We need to solve two big problems before we can have a strong, effective system to prosecute cyberterrorists who attack us from abroad. The first challenge lies in strengthening our technical means to accurately and convincingly attribute attacks to their perpetrators. Attribution is especially difficult when attackers hijack thousands of computers across the globe without their owners’ knowledge or consent, and commandeer those computers to conduct a destructive, coordinated “botnet” operation (as in the massive 2007 attack on Estonia). Nevertheless, federal agencies and private companies are making major progress towards solving the attribution problem.
The second problem is just as important but has received far less attention: that is, building the legal framework to prosecute cyberterrorists. The few experts who have examined this problem, such as Oona Hathaway at Yale Law School, generally argue that the United States should extend the reach of our domestic criminal laws to cyberterrorists who attack us from other nations. The problem remains, what is the basis in international law for such an extension of extraterritoriality? The solution should not only advance U.S. national security interests, but also support our broader effort to build an international consensus and agreements to fight cyberterrorism.
The answer lies in what international law experts call “prescriptive jurisdiction” based on “the protective principle.” The protective principle says that a nation can exercise jurisdiction over conduct outside its borders when the conduct directly threatens its security or critical government functions. Historically, this principle has extended a country’s jurisdiction in cases involving terrorism, counterfeiting, drug trafficking, and immigration. Courts here and in other countries have agreed that those crimes sufficiently threaten their national security to warrant jurisdiction. On this basis, a foreign-based cyberterrorist attack that could incapacitate our power grid, compromise broad public safety, and jeopardize the economy should also fall under our legal jurisdiction.
The benefits of establishing such a basis for prosecution would be far-reaching. Being able to prosecute would-be attackers before they strike their targets would be especially important for protecting the power grid and other critical infrastructure, given their importance to our economy and national security. After a few successful prosecutions, the policy might well discourage others from undertaking such attacks. Moreover, as part of a broader global effort to create new international norms and agreements for the cyber realm, a new legal framework for prosecuting these cyberterrorists would rest on tenets of international law.
For the detailed legal and policy analysis of this approach, and how it would help the United States and the international community build a broader framework to prosecute, deter, and foil cyberterrorist attacks, read our article — and send along your comments!
Your views on the larger challenge that cyberattackers pose to America’s critical infrastructure owners and operators are also welcome. Colleagues and I at George Washington University’s Homeland Security Policy Institute are looking at new approaches to establishing market-based incentives for investments that address emerging threats to the electric grid and other critical infrastructure. I would welcome your thoughts as we move forward.
America’s Gross Domestic Product — GDP — is a very powerful statistic. Markets and politicians zealously track the quarterly numbers looking for a bottom line on how investors and the rest of us feel about our conditions and prospects. Compiled by some 2,000 economists and statisticians at the Bureau of Economic Analysis (BEA), GDP pulls together everything they can measure concerning how much America’s households and various industries earn, consume and invest, and for what purposes. Over the last two weeks, however, two new developments should have reminded us that we know less about GDP than we usually believe.
Early this week, the BEA itself tacitly acknowledged that the GDP measure lags behind the actual economy. The Bureau released a set of changes in how it calculates GDP, designed to take better account of the economic value of ideas and intangible assets. Today, few among us would question the notion that new ideas can have great economic value. But some 15 years ago, long before smart phones, tablets and protein-based medications, the BEA started to study how to revise the GDP measure to take better economic account of innovations. This week, the Bureau announced that when a company undertakes research and development or creates a new book, music, or movie, those costs will be counted as investments that add to GDP, rather than ordinary business expenses, which do not.
In an instant, the official accounting of the economy’s total current product increased some $400 billion. Business profits also have been larger than we thought, because ordinary business expenses reduce reported profits, while investments do not. Most important, the revisions told us that American businesses and government, together, now invest just 2.1 percent of GDP in R&D — less investment than in the 1990s here, especially by businesses, and less than much of Europe.
While this week’s BEA changes bring us closer to an accurate picture of GDP, last week we learned how naïve we can be about blatant misuses and distortions of GDP. This story began four years ago, when two well-respected economists, Carmen Reinhardt and Kenneth Rogoff, published an economic history of financial crises. R&R’s timing (2009) was impeccable, and their book was a bestseller for an academic treatise. More important, it gave its authors wide public credibility when they issued a paper the following year, “Growth in a Time of Debt,” that claimed to have found a deep and strong connection between high levels of government debt and a country’s economic growth. The data, they reported, showed that when a country’s government debt reaches and exceeds the equivalent of 90 percent of GDP, its growth slumps very sharply.
With the big run-up in government debt spurred by the financial crisis and subsequent deep recession, conservatives who had waited a long time for a plausible economic reason to slash government found it in the new R&R analysis. And based on its authors’ newly-elevated reputations, conventional wisdom-mongers from think tanks to editorial boards echoed the new line on austerity. Even the most liberal administration since LBJ couldn’t resist the new meme. Despite a palpably weak economy, the President and congressional Democrats grudgingly accepted large budget cuts, and then pumped the economy’s brakes some more by insisting on higher taxes. And we were not the only ones so economically addled. As government debt in Germany, France, Britain and most other advanced countries rose sharply, conservatives there argued that less government was a necessity for average Europeans as well.
Just last week, we learned that the R&R 2010 analysis was so riddled with technical mistakes that its “findings” about what moves GDP are meaningless. When three young economists from the University of Massachusetts found they couldn’t replicate the results – the standard test for scientific findings — they took R&R’s model apart, piece by piece, to figure out why. It turns out that R&R – or more likely, their graduate assistants – left out several years of data for some countries, miscoded other data, and then applied the wrong statistical technique to aggregate their flawed data. And as bad luck would have it, all of their disparate mistakes biased their results in the same direction, amplifying the errors. In the end, instead of advanced countries experiencing recessionary slumps averaging – 0.1 percent growth once their government debt exceeded 90 percent of their GDP, the correct result was average growth of 2.2 percent carrying that debt burden.
Utterly wrong as R&R’s analysis was, the austerity advocates proceeded to badly misuse it. The authors had merely reported a correlation between high debt and negative growth – or, as we now know, between high debt and moderate growth – without saying what that correlation might mean. Hard line conservatives and their think tank supporters, here and abroad, quickly insisted it could only mean that high debt drives down growth. That can happen, but only rarely — when high inflationary expectations drive up interest rates, which at once slows growth and increases government interest payments. In the much more common case, Keynes still rules: Slow or negative growth leads to higher debt, not the other way around. In those more typical instances, cutting government only depresses growth more, further expanding government debt. Occasionally, the correlation of negative growth and high government debt reflects some independent third cause. The tsunami and nuclear meltdown that struck Japan in 2012, for example, simultaneously drove down growth and drove up government debt. And sometimes, there is no correlation: Britain carried government debt burdens of 100 percent to 250 percent of GDP from the early-to-mid-19th century, while it was giving birth to the Industrial Revolution.
The R&R analysis did not distinguish between these various scenarios. Yet, the conservative interpretation became the received public wisdom. The IMF, the World Bank and most politically-unaffiliated economists insisted that slashing government on top of weak business and household spending would only make matters worse. No matter. The inevitable result was not the stronger growth as promised, but persistently high unemployment and slow growth here, and double-dip recessions for much for Europe and Japan. In the end, R&R deserve less criticism for their mistakes than for their failure to correct the damaging distortions of their deeply flawed work.
The President released his FY 2014 budget today, and right off, it makes more economic sense than most of what passes for serious fiscal discussion in DC. In particular, it offers up new public investments, uses revenues and entitlement changes to restore long-term fiscal sanity, and phases in those changes down the road when the economy (hopefully) is stronger. Apart from Fed policy, the budget is government’s most powerful tool for affecting economic growth. So, the critical economic question is what budget approach would most effectively boost U.S. growth, for both the near-term and longer. The best answer for now is a plan built around an ambitious public investment agenda, serious measures to broaden the tax base and pare entitlement benefits for well-to-do retirees, and reform that finally resolve the festering issues left over from the 2008-2009 financial meltdown.
To appreciate why continued austerity would be economically reckless, just review the economic data from 2012. Yes, the United States grew faster than almost any other advanced economy. But that’s only because the Eurozone has been back in recession, France and Britain treaded water at 0.1 percent and 0.2 percent growth, and Germany grew less than 1 percent. Even in Northern Europe, Denmark contracted and Sweden expanded just 1.2 percent. So, the United States looked good with 2.2 percent growth — although only 0.4 percent in the final quarter of 2012 — in-between Canada’s 1.9 percent rate and Australia with 3.3 percent growth.
With such dismal growth, here and across the developed world, the budget’s first mission should be to strengthen it. There is no economic basis for any short-term spending cuts or tax increases, especially on top of the continuing, mindless sequester. To be sure, under very special conditions, austerity can stimulate economic activity in a weak economy — namely, when high inflationary expectations drive up interest rates, constraining investment and consumption. But those conditions have nothing to do with our current economy since interest rates here and across the advanced world are at or near record lows. The case for austerity, then, is simply politics, and the continuing calls from conservatives to slash federal programs merely mask their fervid preference for a small, weak government.
Economics matters more in this debate, and progressives should use our slow growth to promote an expanded agenda for public investment. They could call on Congress to dedicate an additional one percent of GDP to investments that will strengthen the factors that drive growth. That could mean, for example, more support for reforms to improve secondary education, reduce financial barriers to higher education, and provide retraining for any adult worker who wants it. It also could mean renewed public support to develop light rail systems across metropolitan areas and improve roads, ports and airports. This is also the right time economically for Washington to more actively promote the frontiers of technological innovation by expanding support for basic research. Finally, let’s review federal regulation with the aim of lowering barriers to new business formation. New and young businesses are reliable sources of new jobs and greater competition. Those elements, in turn, stimulate higher business investment, particularly in new technologies.
Progressives also would be well advised to accept long-term entitlement reforms that could accompany the new public investments. Since Social Security provides at least 90 percent of the income of more than one-third of retirees, pension reforms should focus on some form of means-testing. The best template to contain healthcare spending is more elusive. The Affordable Care Act includes a half-dozen measures calculated to slow rates of health spending. So, a bipartisan effort to strengthen those measures, perhaps with malpractice reforms to entice conservatives, would be a good place to start.
These initiatives, by themselves, still won’t be enough. Economic history teaches us — if only we’d listen — that the recovery that follows a financial crisis is always slow and bumpy, unless policymakers directly resolve the distortions that brought about the crisis. Many of those distortions in finance and housing linger on. In finance, the challenge is to get financial institutions to divest themselves of their remaining toxic assets and, equally important, further limit the impulse of these institutions to speculate in exotic financial instruments that remain only lightly regulated, like a hedge fund. The political resistance will be daunting, of course. But the economics is clear: Until such changes occur, Wall Street will not focus sufficient resources towards supporting home-grown business investment.
The challenge in housing is as difficult politically, though technically less complicated. Across the nation’s five largest mortgage holders, almost 12 percent of all mortgages were in serious trouble at the close of last year. Some 6.5 percent of all mortgages were delinquent, another 1.6 percent of them were in bankruptcy proceedings, and 3.6 percent were in foreclosure. So long as these rates are abnormally high, especially foreclosures, housing values will be weak — and the primary asset of most U.S. households will languish. Even worse, a weak housing market consigns most homeowners to stagnate economically or even grow steadily poorer; and that means they will consume less and the recovery will continue to be stunted. One sensible approach would be a new federal program to help people avoid home foreclosures through government bridge loans — like student loans — made available until the job market recovers.
This year’s budget debate will probably follow a now-familiar and sterile course, in which the President offers his plan, which is promptly met with partisan invective, followed by personal attacks from all sides. For average Americans to see their economic prospects really improve, progressives will have to forgo the partisan fights and instead use the Obama proposal to start a new public conversation, one focused on the challenges and changes necessary to get this economy back on track.
With Europe’s brazen mismanagement this week of the banking collapse in Cyprus, the Euro crisis moved closer to farce and, potentially, closer to a serious problem for the rest of us. Over the past three years, as global investors have periodically fled the government bond markets of Greece, Portugal, Ireland, Spain and Italy, Eurozone leaders have grudgingly spent $650 billion bailing those countries out. The whole point of these bailouts has been to protect the solvency of the European banks that hold most of the bonds of those countries, including any of the leading banks in Germany and France. Yet, last week, when the two major banks in tiny Cyprus needed a modest bailout of $13 billion to hold the Eurozone together, European leaders proposed that all of the banks’ depositors help pay the bill. In short, they were prepared to tear up the EU pledge of deposit insurance, the last defense against nationwide bank runs.
Luckily, the people of Cyprus said no. Yet, this Tuesday, Eurozone finance ministers came up with a new way of restructuring the ailing Cypriot banks that will still mean large losses for their large depositors, as a condition of the latest bailout. So now, the next time global investors lose confidence in the bonds of, say, Italy or Spain, the banks across Europe that hold those bonds may face waves of withdrawals by their largest depositors. That could bring on the kind of far-reaching financial crisis which the bailouts were designed to head off.
From the vantage of Berlin or Paris, the new deal is certainly appealing in broad, if crude, political terms. European voters get the satisfaction of forcing the well-heeled depositors of the failing banks to pay a price, along with those banks’ investors. And many of those depositors aren’t even Eurozone citizens: Instead, they’re hyper-rich Russians, including at least 80 oligarchs who looted much of their country’s economy and then shifted their proceeds to foreign accounts. They didn’t choose Cypriot banks for their investment expertise, since the bankers sunk much of the deposits in Greek sovereign bonds, the world’s worst investment. They chose Cyprus because it’s a traditional tax haven with very low taxes and strict bank secrecy laws. Old times may also have played a role with many of the oligarchs, since Cyprus was once the KGB’s favorite listening post on the Middle East.
The global economics of the deal, however, are simply terrible. Large depositors account for a tiny fraction of all Cypriot bank accounts, but more than half of all Cypriot bank deposits. It’s a pattern seen almost everywhere, including the United States. Here, bank accounts of $250,000 or more account for less than one-half of one percent of all bank accounts, but nearly one-quarter of total bank deposits. In normal times, our own deposit insurance limits the amount subject to its guarantee at $250,000. But when confidence in banks is fragile or failing, the government always steps in to guarantee all deposits. That’s just what the Treasury and FDIC did in September 2008, to prevent a run on American banks by large depositors that would have spread the crisis across the U.S. banking system. That unlimited guarantee remained in place until our financial system was stable and healthy again, ending only at the end of last year.
Eurozone leaders have ignored these basic tenets of deposit insurance. Instead, they have sent a troubling message to large European depositors: Even in a financial crisis, large accounts are no longer safe. So, the next time that global investors begin selling off Italian or Spanish government bonds, threatening the solvency of the banks holding those bonds, we could see a run by large depositors not only in Italy and Spain, but also across Germany and France. And that would set off a new financial crisis that could trigger a downward spiral across much of world – including here in America.
Moreover, it seems that unnecessary economic mistakes have become the new norm. Austerity programs for economies struggling with weak recoveries, both here and across much of Europe, are the most common example. That’s why the Eurozone, taken together, has been in a recession for nine months; why Britain’s GDP has declined in four of the last five quarters; and why even the German economy has been contracting since at least last October. And an extended downturn in Europe only increases the likelihood of renewed government bond problems in Italy or Spain which, given this mismanagement of deposit insurance in Cyprus, could spiral out of control.
These are not the only examples of inane economic policy thinking these days.
Paul Krugman this week, for example, offered a defense of capital controls, citing how the movement of funds in and out of national markets can destabilize economies. But the issue is not the unfettered movement of funds across global markets. In fact, those capital flows have been a key factor in the strong performance of many developing economies, as well as our own economic stability. Rather, the problem lies in what financial institutions do with those funds and the willingness of governments to enforce sensible limits on what they do. In the end, the spectacular stupidity of Eurozone leaders this week may be just the most recent and dangerous example of how politicians manage to miss the most obvious and important economic point.
Paul Ryan’s new budget blueprint released this week — details to follow, as usual — will only intensify the partisan warfare over the deficit. In truth, the deficit is just a cover story here, since the real debate is over the scope and role of government itself. Ryan at least is more upfront about it than most – he includes large new tax cuts as well as draconian spending reductions in what is ostensibly a plan to “balance the budget.” In his fervor to miniaturize Washington’s domestic role, however, he cannot provide the resources to maintain the core commitments of Social Security and Medicare.
The ideological core of this debate also explains why most of the proposals and agreements of the past year have paid so little heed to the needs of the economy. There is no doubt that the spending cuts and tax hikes of the last six months have weakened economic growth — and as a result, deficits actually could be larger over the longer-term than they otherwise would have been. The additional spending cuts contemplated for the next six months under the sequester — and under most of the grand bargains being floated to supersede the sequester — would inflict more damage. In this regard, Ryan stands at the extreme with a plan that would drive us back into recession.
Nonetheless, a major deal that includes entitlement reforms and tax-loophole closings remains possible. In the politics that could determine the relative weights of those two factors, Republicans will have less maneuvering room on taxes than Democrats will enjoy on entitlements. That’s because primary challengers from the far right already have taken down a number of conventional Republicans, heightening the GOP’s resistance to more revenues. By contrast, there have been no successful attacks so far on centrist Democrats for supporting the cutbacks in federal programs now in place. This political difference suggests that more of the burden in any grand bargain will likely fall on entitlements than on revenues. The next question is, what entitlement changes could Democrats accept and still preserve the essential missions of those programs.
Let’s consider Social Security and its core guarantee of basic economic security for more than 40 million retirees (plus nearly 9 million people with disabilities). Unfortunately for Ryan and his fellow supporters of austerity for the elderly and disabled, no change that would trim the benefits of all Social Security recipients is compatible with the program’s central mission. To begin, while countries such as Germany, France and Italy provide monthly pension checks equal on average to 75 percent or more of a person’s average monthly wages over a lifetime, this “replacement rate” for Social Security is only about 40 percent. That translates into an average monthly benefit of $1,230, or less than $15,000 per-year. Moreover, these bare benefits comprise at least 90 percent of the total income for more than one-third of all current Social Security recipients.
Let’s do the math. The terms just described translate into an annual income of less than $16,300, which amounts to a very bare minimum. After all, the average cost today of a small apartment (rent and utilities) is over $7,000 per-year. Even if elderly people pay 20 percent less than the average, their rent and utilities still claim an average of $5,600 per-year or nearly 40 percent of all their income. Add to that at least $335 per-month for food at a poverty level ($4,000 annually) and another $310 per-month for Medicare Part B and Part D premiums and other out-of-pocket medical expenses ($3,700 annually). That leaves tens of millions of elderly and disabled Americans with about $130 per-month ($1,600 per-year) to cover all other expenses such as clothes, transportation, recreation, state and local taxes, and any unexpected expenditures.
These data suggest that any across-the-board benefit cut today is incompatible with Social Security’s essential mission. That takes off-the-table changes in the annual inflation adjustment or the retirement age. Given current benefits, the only reforms consistent with the program’s central commitment are ones based on means-testing. For example, Congress could apply a smaller annual cost-of-living adjustment to the benefits of the top tier of retirees. And if Congress is set on guaranteeing the system’s solvency for the next 75 years, in the same spirit they should think about applying the payroll tax to the capital income of the top tier of workers. Not that there is an enormous rush, given the actuaries estimate that the system’s solvency is secure for at least another quarter-century.
Much like George W. Bush’s proposal to privatize part of Social Security, the 2013 Ryan budget is simply uninterested in the missions that animate federal entitlement programs. Democrats would commit a grave mistake, as a matter of both social policy and politics, if they also sacrificed those commitments in search of Republican acquiescence to more revenues.
This week’s bout over federal spending pits Tea Party militants, conservative pundits and most Republican office holders against the President, his congressional allies and most economists who pay attention. But behind the politics, there is simply no economic basis for the immediate spending cuts that would follow the sequester — or immediate tax increases for that matter. The economy is still fragile enough that GDP went negative in the last quarter, when inventory purchases and federal spending both slowed more than usual. And just last weekend, Moody’s credit rating agency stripped the United Kingdom of its AAA rating — not because UK deficits are too high, but because Britain’s premature austerity policies are leaching away the growth required to make its deficits manageable. Moody’s decision only echoed recent warnings from the IMF and World Bank against just such precipitous moves to bring down cyclical deficits.
Back home, President Obama’s odds of prevailing on the sequester would be greater, if those who have made careers out of fetishizing a balanced budget were not receiving quiet support from much of Washington’s split-the-difference political pros, including a clutch of Democrats. Looking out a few weeks, a chorus of self-described centrists and a few liberals could nudge the President into accepting a “compromise package” of substantial, immediate spending cuts and what Ronald Reagan used to call “revenue enhancers.” If it stops there, the economic damage will be contained. But the scenario could turn worse if, as seems likely, such a compromise also becomes embedded in a Continuing Resolution that will cover the rest of the fiscal year and create a new, lower baseline for 2014.
This premature austerity inescapably will weaken the economy, raising deficits even more down the line. Worse, such a bipartisan agreement could reinforce both parties’ natural resistance to contain Medicare spending and build up the tax base, especially over the long-term. And that could finally convince global financial markets that the United States has lost its way economically. The result would be higher interest rates, which in turn would mean even slower growth and higher deficits. What the markets want and have long expected from us is just fiscal common sense. That means, first, sidestep the sequester trap and instead increase federal investments in infrastructure, basic R&D along our technological frontiers, and access for all adults to upgrade their skills. Then follow it up with serious steps to contain long-term Medicare spending and expand the national tax base.
The American Dream is a precious and curious thing. According to the basic narrative, if you work hard, opportunities will present themselves – which, to be sure, usually involve working even harder. And if you do this long enough, you’ll be able to raise a family in conditions that prepare your children, like you, to work hard for the opportunities to work harder. It should be said that the aspirations of most modern societies do not revolve around a lifetime of work. What makes the American dream something precious is the freedom to choose the work you do, especially if you’ve worked hard, and the prospect that your hard work will lead to a better life. Americans believe in this dream, because it generally has delivered as promised — at least until the last decade.
The next four years will test whether Mr. Obama can do anything meaningful about the economic forces which have recently blocked access to that dream for most Americans. In fact, a vivid statement of this problem hung in the Chicago campaign office of David Simas, who headed up polling operations for the President’s reelection. As it happened, the chart came from research and analysis which I did for NDN. That research showed how productivity and per-capita GDP grew fairly steadily from 1992 to 2009, while average incomes grew at nearly the same rates only until 2000, and then flat-lined for the past decade. Simas and David Axelrod, the president’s chief strategist, dubbed the chart the “North Star” of the campaign, while Time Magazine simply called it, “The Most Important Chart in American Politics.”
The chart was meant to remind the campaign staff that the rewards (income gains) of working hard (productivity and per capita GDP gains) had largely stopped for most Americans. From this came the campaign’s central theme of growth based on progress by the middle class, in contrast to Mr. Romney’s shopworn Republican faith in growth spurred by tax breaks for the wealthy. The theme has even gone trans-Atlantic: NDN’s Simon Rosenberg and I have made the same case to leaders of Britain’s Labour Party, and last week the Guardian reported that the analysis was reshaping that party’s agenda.
The realization that the long-time link between incomes and productivity gains and the link between job creation and growth had both weakened, actually came from research I had done for Futurecast, a book I published in 2008. Rosenberg and I had sounded the first alarm even earlier in an NDN report in 2005. By June 2007, NDN issued a long essay I did on how certain elements of globalization could hold down income progress and job creation even as productivity and GDP increase. And from that point on, we returned again and again to this new challenge to the American Dream. It was the subject of five of these blog essays in 2012, for example, as well as a Washington Post op-ed published just last week.
Now, we are developing additional analysis to gauge just how broad and deep the problem has become. Using new Census Bureau data, I recently tracked the income progress of every age group – those born, for example, in 1950, 1951, 1955, and so on — as it aged through recent expansions and recessions. Looking across all of the age cohorts, I found that people’s incomes grew an average of 1.5 percent per-year in the 1983-1989 expansion, followed by income losses of 2.6 percent per-year in the 1990-1991 recession. So, the entire 1983-1991 business cycle produced average, net income gains of 5.3 percent. Things got even better in the 1990s: Across all age groups, the incomes of Americans grew an average of 1.6 percent per-year from 1992 to 2000, followed by the brief and modest recession of 2011 which brought income losses averaging just 0.2 percent. Across all ages, then, the 1992-2001 business cycle produced average net income gains of 14.2 percent. That’s the American Dream truly paying off.
From that point on, all of the data point to the grim conclusions of the “most important chart in American politics.” Tracking all age groups as they aged through the 2002-2007 expansion, we find that people’s income grew an average of zero percent per-year over those six years, followed by income losses averaging 1.7 percent per-year in the 2008-2009 recession. So, the 2002-2009 business cycle produced net income losses averaging 3.4 percent across all age groups. For the first time in America’s postwar history, most people lost ground over the course of an entire business cycle. And the early signs for the current expansion are even more discouraging: In its first two years, 2010-2011, incomes across all age groups continued to fall at an average rate of 1.0 percent per-year.
In his response to the President’s State of the Union address, Marco Rubio gave the GOP’s current prescription for the American Dream: Cut federal spending now, because incomes and jobs can come back only if Washington will do less of everything. It’s the Romney platform without the tax cuts. It’s also the game plan which conservative governments in Britain and Germany followed faithfully, until it produced double-dip recessions in both countries.
Mr. Obama’s program, at least, starts in a reasonable place economically. For example, it focuses on research and development by promoting “advanced manufacturing,” and on a variety of efforts to upgrade people’s skills. The Census data do show that since 2000, people with graduate degrees have seen their incomes rise pretty steadily, though more slowly than in the 1980s and 1990s. However, recent evidence also suggests that a college degree no longer guarantees healthy income progress. A more comprehensive response also would involve, for example, steps to reduce certain business costs that come out of people’s wages and salaries, such as employer-provided medical coverage.
The President’s approach, by itself, won’t restore the American Dream. Like his senior campaign staff, however, he clearly recognizes the challenge we all face and its pivotal role in American life.
This morning’s disappointing report that GDP actually declined by 0.1 percent in the fourth quarter of last year is a lesson in how government and serendipity can shape our economic path, especially in the short-term. The basic elements of economic prosperity are in place. To begin, Americans are spending again: Personal consumption accelerated from a 1.6 percent increase in the July-August-September quarter to 2.2 percent in October-November-December. Even better, spending on durable goods — autos, appliances, and so forth — increased at nearly a 14 percent rate. That should be no surprise, since disposable personal income rose at a strong and healthy 8.1 percent rate in the fourth quarter. Firms looking to the future are spending, too: Business investment expanded more than 8 percent, and investments in equipment and software were up more than 12 percent, a rate reminiscent of near-boom times. Housing is back as well, with residential investments growing at a rate of more than 15 percent.
How does all this good news translate into a flat quarter? For one thing, our exports fell faster than our imports. One reason for that was the economic slowdown in the huge European and Japanese markets. The other was Hurricane Sandy, which disrupted shipments in and out of the huge, New York and New Jersey ports. The hurricane also disrupted inventory purchases, which slowed by two-thirds compared to the preceding quarter. But the biggest single drag on the economy was Washington: Federal spending fell 15 percent, led by defense which declined at the fastest quarterly rate, 22 percent, in 40 years. Those declines were fueled entirely by politics, especially planning for the spending sequesters threatened for January 1.
We cannot influence the weather, but we can control the impact of government on the economy. This report should remind us that the economy remains vulnerable to precipitous, additional budgetary austerity. And given the progress we’ve already made on deficits — $1.2 trillion in cuts over 10 years enacted in 2011 and $700 billion in new revenues enacted late last year — we can now proceed in a very measured way with the final stage of long-term entitlement reforms and additional revenues. And to assure everyone that grown-ups who understand the economy are in charge again in Washington, Congress should cancel the sequesters and enact a clean, long-term increase in the debt limit.