Why the Value of Your House Moved Global Markets This Week

August 26th, 2010

This week’s housing news was a primer on globalization. U.S. existing home sales fell 27 percent in July, twice as sharp a drop as Wall Street analysts said to expect. (Of course, they’re the same geniuses who didn’t see their own meltdown coming; didn’t expect the long, deep recession that followed; and couldn’t figure out that the recovery would be slow and halting.) Right away, our stock markets sunk by one to two percent — no surprise there — but we weren’t alone. On Wednesday morning, the financial news led with “European Stocks Drop on Dismal U.S. Home Sales Data” and “Most (Asian) Stocks Fall Amid Speculation on U.S. Home Sales Report.”

Why does a bad report on American home sales rattle investors a half-world away? To be sure, housing is an important piece of every U.S. recovery. And the world pays close attention to ours, since we remain by far both the world’s largest market for imports and the place where most foreign multinationals maintain their subsidiaries. This time, however, there’s more at stake. Housing is both a lynchpin for a full recovery from the financial crisis that pushed most of the world to the brink of depression; and the key to something better than our current stumbling expansion.

The link to finance is straightforward. Everybody remembers how Wall Street’s largest institutions swooned or crashed when the end of the housing bubble brought down hundreds of billions of dollars in mortgage-backed securities and the credit default swaps that backed them up. But when Washington stepped in to rescue most of them, it took out its own risky bet that a housing recovery would quickly stop the bleeding. So we never seriously considered what Sweden did so successfully in the early 1990s — and what we did ourselves to resolve the S&L crisis: Take over an insolvent Bear Stearns, AIG or Merrill Lynch, pull out the weak and failed assets, and sell the still-healthy stuff to new investors who would promptly reopen the institution under a new name. And the bailouts didn’t even require that these institutions put their books back in order by getting rid of the most risky housing-based assets which they still held.

The catch is that if the housing market continued to deteriorate — as it did — more of those assets would decline in value or fail outright. Those losses, current and prospective, leave finance much less willing to lend to most other companies. And that means that strong business investment, which is a critical part of all healthy expansions, this time will follow a housing recovery, not lead it.

There’s more at stake in the current housing market than the pace of business investment. Some 70 percent of U.S. households are homeowners, which makes housing values the most important piece, by far, of most Americans’ wealth and economic security. So, the sharp drop in those values has made most of Americans poorer than they had been; and, unsurprisingly, people who feel poorer tend to spend much less. The health of the housing market, in short, now directly affects both business investment and consumer spending, and with them the outlook for the entire U.S. recovery.

It’s little wonder that world markets reacted badly to this week’s dismal U.S. housing report. Beyond the 27 percent drop in existing home sales — and one day later, sales of new homes also fell sharply — nearly one-third of the houses that did sell were “distressed” properties. That means they were either in foreclosure or sold for less than their outstanding mortgages. Average home prices did inch up a little bit, but the only reason was that the end of the temporary tax credit for first-time homebuyers led to a particularly sharp fall in their purchases, which normally involve lower-priced homes.

Nor are there signs of a real housing recovery anytime soon. Foreclosures are still running at four times their normal levels — and nothing drives down a neighborhood’s housing prices and slows down sales more than nearby homes in foreclosure. On top of that, supply continues to way outpace demand: At current rates of home sales, it would take over a year to clear all of the homes already on the market today.

If we don’t take serious steps to finally turn around these conditions, the United States and much of the rest of the world will be looking at a weak expansion, or worse, for several more years. One measure that could have a powerful effect would be steps to bring foreclosure rates down to normal levels. For example, congressional Democrats could advance a new program modeled on student loans for homeowners with mortgages in trouble. Homeowners who qualify could borrow the funds they need to stay in their homes, at a low interest rate, with no interest due the first year so long as they stay in the homes for at least two more years.

Most Republicans will denounce it as just another “big government program.” Yet, without a housing recovery, the alternative is not only smaller government but also a smaller economy, because businesses can’t find loans, people can’t find jobs, and most consumers can’t spend like they used to.

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Posted in Economy, Globalization, Politics, financial reform | No Comments »

How to Remain the Number One Economy as China Ascends to Number Two

August 18th, 2010

The news that China’s GDP will surpass Japan’s this year, making China the world’s number two economy, raises important issues for the United States.   There’s no prospect of China taking over the number one slot anytime soon:  Even in our present shape, the United States will produce at least $14.3 trillion in goods and services this year, compared to China’s $5.3 trillion.  But the Sino-Japanese shakeup in global economic rankings is a sign that America has to raise its game.

The real lesson here comes less from China’s ascendance than from Japan’s decline.  Twenty years ago, Japan had racked up 30 years of extraordinarily rapid growth – just as China has today – and scaremongers predicted that Japan soon would overtake us.  Yet Japan’s good times ended abruptly in 1991, ushering in two decades of economic stagnation.  And the origins of that long downward slide should seem all too familiar to Americans, since it began with the sudden collapse of a huge real estate and stock market bubble, which then triggered a banking crisis and deep recession.

Sweden had a financial meltdown the same year as Japan; yet Sweden put together a new policy consensus around economic liberalization and the economy came roaring back within three years.  On the other side of the world, Japan suffered through year-after-year of policy mistakes and paralysis by its long-ruling Liberal Democratic Party, producing two decades of economic languish.  The particulars of Japan’s decline should make our public officials squirm: Hemmed in by powerful interests and an irresponsible opposition, the LDP couldn’t bring itself to clean up the country’s banks or fix the housing market, much less undertake deeper economic reforms to prepare Japanese businesses and workers for globalization and its intense competition.  So, Japan was left instead with years of financial-sector weakness that limited business investment – sound familiar? – especially for the new enterprises that drive technological innovation and job creation.

As Japan continued to falter economically, the LDP sank trillions of yen in new public projects – and almost nothing to reform their economic policies or upgrade the skills of Japanese workers, especially millions of women consigned to positions that have no future in a modern, idea-based economy.  The result has been prolonged economic stagnation, and faltering competitiveness even for its global companies.  From 1990 to 2005, for example, Japan’s share of the world market for producing high-tech goods collapsed from 24 percent to less than 15 percent.

The question for us is whether our own political system has the capacity to address challenges here that echo Japan a generation ago.  We may not face the prospect of a national economic reversal as severe as Japan’s, and our world-class corporations should continue to prosper.  Yet, we face serious challenges of our own which, if left unaddressed by Washington, could leave a majority of ordinary Americans facing economic stagnation for a generation.

At the top of this catalog of challenges are jobs, because the storied capacity of America’s companies to create new jobs has eroded badly.  In the Bush expansion of 2002-2007, our private sector generated less than half as many net new jobs, relative to growth, as we did in the Clinton expansion of the 1990s, the Reagan expansion of the 1980s, and even the Carter expansion of the mid-to-late-1970s.  The best policy response is to reduce the cost to businesses of creating those new jobs.  We also know just how to do that – cut the employer’s payroll tax burden for net new hires, and slow future increases in the health care costs which they have to pay.

The outstanding question, however, is whether Washington can raise its game and enact these reforms. Let’s frame the political challenge in the terms that dogged economic reform in Japan for a generation.  So, can congressional Republicans accept a tax increase, even one designed to fund a corresponding payroll tax cut?  Optimally, the tax increase could contribute something on its own – for example, a carbon fee that also would help address our energy security and climate change.  For the other side of the aisle, can Democrats find a way to support a tax cut for business, even if it’s the most effective way to spur job creation?  Similarly, can Republicans swallow hard and support more regulation of our broken health care market, in order to reduce costs for business – and are Democrats prepared to trim federal outlays for powerful health-care interests if doing so will ultimately help create jobs and raise wages?

Here’s another challenge we will have to meet to avoid a version of the Japanese disease: Restore higher levels of domestic savings to support and promote higher levels of both private investment and public investments, especially in education and training, and in 21st century infrastructure including universal broadband and a modern electricity grid.  We now know, after two generations of trying, that tax breaks aren’t enough to convince most Americans to save more.  Since the 1990s, we’ve provided generous tax breaks in various forms that cover 80 percent of all personal saving, all to no avail.  The only certain way to raise national savings, it appears, is to reduce public dissaving, through lower budget deficits.

Facing an economic slowdown that could go on for a long time, can Republicans accept cuts in defense spending – even with Secretary Robert Gates’ blessing – and measures to expand revenues?  Ronald Reagan, of course, did take the same two difficult steps; but he was more willing to compromise, it seems, than some of his current-day followers.  Across the aisle, will Democrats vote for measures that expand revenues from those they don’t call “rich,” even gradually, along with measures to trim future Medicare and Medicaid costs, even if it requires trimming benefits?

Stating the challenges so concretely exposes the political difficulties.  But we also know what can happen eventually when a wealthy country – one like Japan – loses the political will to raise its’ game.

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Who’s Really to Blame for High Unemployment, and What to Do About it

August 10th, 2010

An economic slowdown is now here – one we repeatedly cautioned would come – so even the Federal Reserve is downgrading its forecast.   Alas, the United States isn’t alone.  The prospects for Europe look even worse, especially with their largest banks so heavily invested in the bonds of EU member countries still skirting the edge of sovereign debt defaults.  And now China faces the cross pressures of trying to boost their weakening exports while letting some of the air out of their own housing and financial bubbles.  That will spell serious problems for China’s four state megabanks, whose loans keep much of Chinese industry afloat.   We’ll be lucky to come out of this dismal environment with just another year of slow growth and high unemployment.

So, with the midterm elections coming on, most Americans have one question for their elected officials and those hoping to replace them:  What decisive steps are they prepared to take to rescue this economy?   Remarkably, the answer from much of the GOP opposition seems to be, repeal part of the 14th Amendment and stop Muslims from building a mosque in downtown Manhattan.    Of course, there’s also lots of finger-pointing about the economy, including the audacious claim that the fault for the high unemployment lies in the Administration’s economic policies, especially the stimulus.

Since that claim has some popular traction, and even support from a handful of muddled conservative economists, let’s test it with the hard data from the Bureau of Labor Statistics.

From December 2007 to July 2009 – the last year of the Bush second term and the first six months of the Obama presidency, before his policies could affect the economy –  private sector employment crashed from 115,574,000 jobs to 107,778,000 jobs.  Employment continued to fall, however, for the next six months, reaching a low of 107,107,000 jobs in December of 2009.  So, out of 8,467,000 private sector jobs lost in this dismal cycle, 7,796,000 of those jobs or 92 percent were lost on the Republicans’ watch or under the sway of their policies.  Some 671,000 additional jobs were lost as the stimulus and other moves by the administration kicked in, but 630,000 jobs then came back in the following six months.  The tally, to date:  Mr. Obama can be held accountable for the net loss of 41,000 jobs  (671,000 – 630,000), while the Republicans should be held responsible for the net losses of 7,796,000 jobs.

So, when some of those GOP candidates change the subject from unemployment to treacherous immigrants, they actually may know precisely what they’re doing.

Some Democrats may take satisfaction from these data; but that won’t be enough for most voters, not while Democrats still control the White House and Congress.   The opposition may get away with silence about what they would do to bring down unemployment – apart, of course, from the traditional GOP catechism of tax cuts.  But Democrats will have to lay out a more serious program if they hope to convince America to keep them in power.

So, here’s a four-part program for Democrats to take to the voters.  First, create jobs by expanding an Administration initiative already in place:  Deep cuts in the payroll tax for employers who expand their workforce.   Second, shore-up the weak housing market and stabilize falling home prices with a long-overdue, new initiative:  A loan program for homeowners with mortgages in trouble, modeled on federal student loans, to bring down foreclosure rates.  Third, prepare tens of millions of Americans for the jobs the economy will begin to create once it’s back on track:  Provide grants to community colleges to fund free computer training for any American adult who walks in and asks for it.  And fourth, put in place some long-term deficit reduction to head off higher interest rates when the economy does begin to expand again.  Rolling back the Bush tax cuts for higher-income folks is a beginning, but it should be paired up with serious spending restraints.  The best place to start is health care:  Slow down Medicare and Medicaid cost increases with much stricter and more comprehensive versions of the cost-containment measures already enacted in the President’s health care reforms.

That would be a real program that the parties could debate in the fall campaigns – and if the Democrats prevail, they could run on its results in 2012.

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Rebuilding a National Consensus for Economic Reform

July 29th, 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.

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Jobless Benefits, Deficits, and the Art of Washington Compromise

July 22nd, 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.

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

July 15th, 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.

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In Promoting Universal Broadband, Less Truly Is More

June 23rd, 2010

The right federal policy isn’t always hard to figure out. Take broadband. As broadband becomes an increasingly important factor in securing access to economic opportunities and public information, it’s obvious that the right public policy is to promote universal broadband service. Not only are most job openings today posted only online, so is most information about health care, government services, education, and most personal services. Perhaps more important, the ability to do most jobs depends increasingly on a person’s knowledge and capacity to perform well in workplaces dense with broadband and information technologies, which in turn people can greatly facilitate by using broadband as part of their daily lives.

So, it matters that last year, for example, only 46 percent of African-American and 48 percent of Hispanic households had broadband service, compared to two-thirds of white households.

It’s also not hard to figure out how to actually achieve universal broadband service by the end of the decade, the reasonable goal of President Obama and nearly everyone else. Start with what we know about how personal computers and dial-up Internet became so ubiquitous. The key lay in two singular forces: Scientific advances increased the usefulness of these technologies, and those advances and market competition helped drive down their prices. These same forces already have driven the spread of broadband, in less than a decade, from essentially zero to over 60 percent of all American households.

There’s always a hitch, of course, and this time it comes from recent technological advances which could sharply drive up broadband prices, especially the wild popularity of video applications which gobble up bandwidth at 100 to 1,000 times the rate of text applications such as email. Facing a quantum jump in demand for bandwidth, the Internet Service Providers (ISPs) find themselves with two choices: Increase their long-term investments in broadband infrastructure by huge amounts, which someone will have to pay for — $300 billion to $350 billion, by the FCC’s reckoning — or let Internet congestion slow down everything in their customers’ online lives. Since the second option isn’t acceptable to almost anyone, the new public policy question at the heart of the drive to achieve universal broadband has become; how do the ISPs pay for the additional investments without hiking broadband prices so much that digital divides becomes permanent?

This problem has been further complicated by outside efforts to convince the FCC and the Congress to set new rules directing how the ISPs charge for broadband. Such rules could effectively require that the additional costs be added to the flat monthly fees everyone now pays for broadband service. But a new study out this week shows that the outcome of the fight over such rules will likely determine whether we achieve universal broadband anytime soon or, in the alternative, find ourselves stuck with digital divides that leave millions of lower-income Americans offline for a long time. The study, issued Monday by the Georgetown University Center for Public Policy and Business — and written by Kevin Hassett and myself — simulates a number of ways to pay for the additional investments and measured the impact of each on the path to universal broadband.

First, we asked what happens if the additional costs are passed through in the monthly flat-fees that everyone currently pays. Since broadband is already a nearly “mature market,” with new users joining at a relatively slow pace, this approach would translate into monthly fees in the range of $70 per-month. While a number of factors affect whether people adopt broadband service, cost is the largest factor — and especially for lower-income people, who unsurprisingly are most sensitive to cost increases. So, we can expect that a pricing system which forces ISPs to pass along their additional investment costs in higher fees for everyone would push universal broadband far into the future — and that’s just what our simulations found. By 2020, 18 percent of African —American households, and 17 percent of Hispanic households would still be without broadband service. In fact, broadband fees would likely be so high that 15 percent of white households also would be offline at the end of the decade.

The alternative approach comes from another striking phenomenon seen here and around the world: A relatively small share of all Internet users — 10 to 20 percent, tops — account for the vast majority of the new pressures on bandwidth. These are people who watch scores of videos online every day, spend hours in multi-player online game worlds, or use broadband to watch HD television shows and movies. This fact can give shape to a new pricing strategy: Pass along most of the additional costs to those who consume vast amounts of bandwidth or the content providers transmitting extremely high bandwidth offerings. There is no reason why broadband should remain an “all-you-can-eat for one price” facility, especially if it means raising prices so much that millions of people have to give it up.

So, we simulated what would happen if broadband providers passed along 80 percent of their additional investment costs in higher prices to the 20 percent high-bandwidth users and their content providers, with only the remaining 20 percent of those costs to be borne by the rest of us. This approach puts the United States back on a rapid path to universal broadband: By 2019, all racial, ethnic and income groups should find themselves within one or two percentage points of universal adoption.

A word to the wise at the FCC: Do not consider any rules which, however inadvertently, might force the nation’s broadband providers to stick to their current, “one-price (or two) fits-all” pricing approach. When it comes to promoting universal broadband, it turns out that less truly is more.

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The Importance of Blaming the Right People for the Wall Street and Gulf Disasters

June 16th, 2010

This year’s notorious Supreme Court decision on campaign finance found that corporations have the full rights of individuals, at least in the area of campaign finance. While that ruling may have serious consequences for how we conduct elections, most of us already approach big companies as if they were people — and then, when those companies wreak havoc on the economy, no one can be found to hold accountable. Congress may pass new regulations, but that’s little consolation to the victims. Anyway, both the Wall Street meltdown and the Gulf spill unfolded not only because regulation was weak or lacking, but because enforcement was lax where regulations did exist. In both cases, then, we see signs of “regulatory capture,” with the SEC and the Minerals Management Service applying their existing regulations in ways which, at a minimum, permitted the persistent risks that eventually led to disaster. In the quest for accountability, there also will inevitably be lawsuits. But the companies may not survive to pay any judgments; and when they do, the costs fall to shareholders. The executives whose decisions brought on the crisis are left unaccountable — a moral hazard of the first degree — and the rest of us are left unsatisfied. In fact, very similar dynamics are at the heart of the Tea Party movement, only with unaccountable public officials in the place of unaccountable CEOs.

Some of the public’s outrage about both crises probably stems from people’s assumption that large companies do operate like people, at least in respecting broad social norms. So, we expect our bank to be concerned about our personal finances, a view implicitly encouraged by the sketchy form of the neoclassical economics that dominates public discourse. In an abstract world of the perfectly efficient market, that market constrains banks to offer us goods and services that serve our interest; in the real world, our banker’s retail job is simply to sell us his bank’s products based on how profitable they are to that bank. And even when we recognize the difference, we assume our bank won’t abuse our trust, because the law will prevent it and, anyway, educated people just don’t act that way.

Similarly, whether or not Gulf residents expected oil companies to share their concerns about their regional environment — and many certainly did have those expectations — the market was supposed to ensure that the risk of incurring $20 billion or more in liability costs would prevent reckless operations of deep-water rigs. For how this works in the real world, think of Toyota: Like Toyota, BP adopted a calculus in which cost-saving measures outweighed those risks; and in deep-water drilling, that often involves less stringent safety systems and standards. So, even as BP was fined much more often than its rivals for deep-water rig safety violations, BP shareholders enjoyed years of higher returns.

If we can’t depend on regulation or potential liability to stop reckless corporate decisions, it’s time to focus less on the corporate “person” and more on the actual people who make those reckless decisions. The laws of corporations have long shielded a company’s decision makers from personal liability for corporate decisions, based once again on the idealized view that market competition will reliably drive executives to make decisions based on their shareholders’ best interest. But economists have long recognized — it’s called the “agent-principal problem” — that the interests of executive decision makers (the agents) can diverge sharply from those of the shareholders (the principals). And how those executives are rewarded for their decisions can make that divergence very wide and deep if, as with both Wall Street and BP, they can earn huge bonuses for steps that boost short-term earnings even when the decisions that generate those earnings eventually bring down the company. While Paul Volcker and a few others have called for a ban on such compensation schemes, Congress has bowed to Wall Street protests, in a form of “legislative capture” as dangerous as its regulatory counterpart.

The result are nearly perfect conditions of moral hazard for America’s top executives, especially in critical areas like finance and energy, where their moral hazard can be most dangerous to the rest of us. Since moral hazard affects the top decision makers, perhaps more than their institutions more generally, the Wall Street and Gulf disasters suggest that it’s time to revise the limited personal liability provisions of the corporate form: The government should be able to sue executives personally for decisions that turn very bad for the rest of us — involving costs of, say, at least $25 billion — when those decisions entail risks that rise to a standard of negligence. This change could even be part of broader tort liability reform. But whether it is or not, it’s time to pierce the veil of the corporate “person” and get to the real people whose personal interests repeatedly lead them to embrace risks that end up harming tens of millions of others.

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Memo to the President and other World Leaders: Resist a Simpleminded Push to Cut Budget Deficits Now

June 9th, 2010

A dangerous and infectious economic idea is spreading around the world. Last week, the liberal majority in the House of Representatives rejected efforts to inject a little more stimulus into the economy; and across much of Europe and Asia, presidents, prime ministers, parliaments and congresses are calling for tighter budgets. Many economies face some genuine threats these days; and suddenly, one of the more prominent among them is the simplistic view of many public officials that their still weak economies now need a strong dose of fiscal discipline. What they ought to worry about are the odds of another economic downturn and a chance that we all may face a second financial crisis.

Here at home, we know from the most recent data that American businesses aren’t hiring new workers in any real numbers, nor are banks lending most classes of businesses much new capital. All this tells us that the 2009 stimulus, which has just about run its course, was not enough to restore healthy, self-sustaining growth. Yet, most politicians still don’t appreciate how damaging fiscal stringency can be for an economy that remains too weak to generate decent job creation or business investment. They may have to rediscover the lesson that FDR and his top advisers learned back in 1937, when federal belt tightening sent the barely-recovering U.S. economy back into deep recession.

In a strong economy, a big dose of additional deficit spending may well crowd out private investment, push the Fed to raise interest rates, and create significant long-term costs for taxpayers who will have to finance the additional debt forever. But it’s obvious that this economy is still very far from being strong. The Fed, for example, will never raise rates under current conditions — a mistake which, as Fed Chairman Bernanke has noted, was the lesson of 1930-1932. Under these conditions, additional spending for initiatives which also make sense in themselves can actually increase private investment and long-term growth, which in turn would substantially reduce the long-term financing costs of the additional debt.

The current political passion for tight budgets, already in full play in Germany and Britain, may have been triggered by the sovereign debt crisis unfolding in Greece and, perhaps soon, across much of southern Europe. Yet, the ultimate sources of most sovereign debt crises are weak productivity and flagging competitiveness. Add an irresponsible government willing to run unsupportable deficits and loose monetary policies, instead of taking the difficult steps required to address the underlying economic problems, and a sovereign debt default becomes a real possibility.

But the United States isn’t facing Greece’s dilemma, and neither are Germany or Britain. And the best policies to maintain the confidence of international investors even as our own national debt rises rapidly would be measures to further bolster our underlying productivity and competitiveness. That will be especially true if the European Union’s plan to address Greece’s sovereign debt problem fails — as it almost certainly will — and the ensuing chaos triggers new worldwide financial meltdown. At a minimum, the falling value of Greek bonds, along with those of Portugal, Spain, Hungary and Italy, will further slow our own recovery and growth, making premature deficit reduction even more damaging.

Still, while the stimulus helped temper the 2008-2009 recession and hastened its end, it was never enough to restore healthy growth to an economy twisted out of shape by a historic housing bubble and then cracked open by a systemic financial meltdown. So, the administration and Congress need to do now what should have been done in 2009 to address the forces that drove the crisis. For example, Americans won’t start consuming again at the levels needed to drive jobs and investment until they stop feeling poorer, and that will still require measures to bring housing foreclosures back to normal levels and stabilize housing prices. Moreover, so long as foreclosures remain abnormally high, our banking system’s holdings of mortgage-backed securities and their derivatives will continue to deteriorate — and the continuing losses will keep banks from restoring normal business lending. The administration’s program of subsidies for banks to refinance troubled mortgages didn’t work, so we need stronger medicine. Here’s one approach: Since the government now owns Fannie Mae and Freddie Mac, which continue to hold a decent share of the nation’s mortgages, Congress can direct them to help bring down foreclosures by renegotiating and refinancing the troubled ones in their portfolios.

Deficit anxieties also shouldn’t stop us from taking serious steps to help reboot job creation. The best course would be measures that can reduce the cost to businesses of creating those new jobs, so let’s cut in half the payroll taxes that employers pay on new employees. And since slow job creation was a serious problem for several years before the financial meltdown, there are good grounds for making this change permanent. But since the long-term trajectory of our deficits and national debt do matter, we should also take steps to pay for this change once the economy really recovers. And here’s the best way to do it: Offset the costs of lower payroll taxes for employers, two or three years from now, by phasing in a new carbon-based energy fee, which also happens to be the most effective way to reduce the greenhouse gas emissions driving climate change.

In the meantime, the administration also can lay the groundwork to restore long-term fiscal sanity by addressing the two big forces that created large U.S. deficits even before the world’s current problems. And there’s no mystery about what those forces are — sharply-rising health care costs and substantial cuts in the tax base. Their big political challenge is to leave the deficit alone until the economy regains its strength, while building some form of national consensus for both greater revenues and much stronger steps to contain health care costs.

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Some Hard Truths about Globalization and Jobs

June 3rd, 2010

I find myself in Stockholm, an old capital city of a small economy animated by the drive of ingenious entrepreneurs and the extraordinary global success of more native companies than any other nation its size, from Ikea and Erikson to the Tetra Laval packaging giant and the Axel-Johnson conglomerate. Sweden’s economic drive and success are predicated on an acute understanding of the particular demands that globalization imposes on most business enterprises. So, Sweden seems an appropriate place to think about the special difficulties that American economic policymakers face. The United States has been economically dominant for so long that we too easily overlook how unforgiving global competitors and investors can be when our parochial politics produce simplistic fixes for complicated challenges.

Exhibit One is one of the final actions by the House of Representatives before its Memorial Day recess. The majority, convinced that they’ve found a new, economic wedge issue, passed legislation to strip our most successful global companies of a “tax break” which allegedly encourages them to “ship jobs overseas.” The provision in question lets U.S. multinationals defer paying the U.S. corporate tax on the profits of their foreign subsidiaries until those profits are formally transferred back to the U.S. parent company. The claim that this provision leads Microsoft, Google, Amgen or General Electric to ship jobs abroad is an appealing slogan, but it’s one with no real economic foundation in a global economy.

The slogan and the policy behind it depend on what is, at best, a nostalgic view of how companies actually operate in global markets. In the 1970s and 1980s, U.S. companies that went global did so by setting up production facilities in places with lower costs — wages, real estate, construction and so on — and then shipping the products produced there back home or to their major markets in Europe. That shift in production was a big factor in the hemorrhage of manufacturing jobs back in the 1970s and early 1980s. But the truth is, the globalization of the last 20 years has changed most of that.

First, our international advantages now come not from producing standard goods more cheaply in other places, but from developing and applying new ideas to the creation and production of countless goods and services. That’s why our globally competitive industries today are no longer automobiles and steel, but the companies that create and provide goods and services based on new intellectual property — from Internet content and infrastructure, and software and advanced IT hardware, to pharmaceuticals and biotech, business services and entertainment. Moreover, the critical, idea-based services that these industries rely on, along with the idea-based headquarter services that all global companies depend upon, remain firmly entrenched in the United States. That tells us what the rest of world knows all too well: In a global economy, America’s core economic advantage is simply that we perform these idea-based operations better than anyone else.

The result confounds the basic proposition that “tax deferral” costs American jobs. As a stream of recent research has demonstrated, increases in investment and jobs by the foreign subsidiaries of U.S. global companies no longer come out of investment and jobs at home. Instead, as those foreign subsidiaries expand, mainly to serve foreign markets, their demand for and use of those idea-based, headquarter services expands too. So, the data and the operations behind them now show that increases in jobs and investment by foreign subsidiaries are now accompanied by increases in investments and jobs by the parent companies back home. For all of these reasons, raising the tax burden on American companies with foreign operations would reduce investment and job creation not only in abroad, but here at home as well.

It’s true, of course, that American multinationals, especially in manufacturing, hemorrhaged jobs again over the last decade, in the face of globalization. But most of those jobs have been lost to domestic outsourcing, as companies increasingly turn to other U.S. firms for services such as maintenance, legal and accounting advice, and so on. The culprit here is the fast-rising financial burden of providing health care and pension benefits, especially in a competitive global economy that makes it much harder to pass along those costs in higher prices. Raising the tax burden on the foreign earnings of U.S. multinationals won’t begin to touch this daunting challenge.

The recent House action actually could be even more damaging than these developments suggest. The reason that our tax system has provided this tax “deferral,” for nearly as long as we’ve had a corporate income tax, is that America is nearly the only major country that taxes its businesses on their worldwide income, regardless of where it’s earned. Britain, Germany, Japan, China and nearly everyone else of economic consequence have “territorial” tax systems that tax international companies only on the profits they earn within each nation’s own borders. On top of our distinctive “worldwide” tax system, we also now find ourselves with nearly the highest corporate tax rate of any major economy. So, without deferral, America’s globally successful industries would face a much higher tax burden than their European or Asian rivals. And that would mean lower rates of return for U.S. companies, which in turn would lead to less investment, less innovation, and ultimately fewer U.S. jobs.

Ending deferral could not only cost tens of thousands of American jobs. It also could create an illusion that Congress has already done what it has to, in order to create more jobs. The slowdown in U.S. job creation has emerged as a very serious, new challenge over the last decade. But the way to address it has to begin with recognizing the real sources of the pressures on jobs in a global economy. The problem is not efforts by businesses to build a global presence, which after all is a fundamental part of global success. Rather, part of the real issue here lies in the American economy’s increasing and distinctive reliance on ideas rather than physical assets to create value. This historic development puts a big economic premium on people’s ability to operate effectively in workplaces and factories dense with the information technologies that create and manage ideas and information. The reasonable response to that, again, is not higher taxes on foreign-source earnings, but a new domestic program of grants to community colleges to provide free computer and Internet training to any adult who walks in and asks for it. The pressures on jobs and wages also now come, as suggested earlier, from the fast-rising costs for business of providing health care coverage. The answers to that lie in serious measures to contain the pace of medical cost increases. The President’s recent health care reforms contain a number of modest steps in this area, and the Congress would do American workers a genuine service by strengthening and expanding them.

After all that the American people have endured in the last two years, surely it’s time to resist the siren call of facile slogans and easy answers, and become truly serious about both jobs and globalization.

Posted in Economic Strategy, Economy, Globalization, Jobs | No Comments »

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