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The President’s Budget and the Case for Moving Beyond Austerity

Wednesday, April 10th, 2013

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.

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The State of the Union and the Power of Technological Change

Wednesday, January 25th, 2012

President Obama made inequality a major theme of his State of the Union address last night, an unsurprising choice as he prepares to face Mitt Romney. Everyone now knows that just last year Mr. Romney paid a smaller share of his $21 million income in taxes than the average American paid on a $50,000 salary. But if inequality was the President’s theme, his main subject was jobs. For Obama, faster job growth depends on more government. We need Washington, for example, to retrain workers, reduce college costs, and provide special supports for manufacturers. For Romney, the answer for job creation is, what else, less government: Washington needs only to cut regulation and reduce taxes, especially for the wealthy people and corporations who, in the Romney worldview, create the jobs. But not so fast — there are other options as well. A new report from the NDN think tank suggests that certain kinds of new technologies can spur job creation more effectively than most government programs or tax cuts. The new study, conducted by Kevin Hassett of the American Enterprise Institute and myself, found that the rapid spread of new 3G wireless devices from 2007 to 2011 led directly to the creation of nearly 1.6 million new jobs. And those job gains occurred even as the overall economy was shedding 5.3 million other jobs.

Our analysis tracked shifts by consumers and businesses from 2G wireless phones to 3G smart phones and tablets, quarter by quarter and state by state, from July 2007 to December 2011. We then analyzed the links between the shift to the more powerful 3G devices and changes in employment, quarter to quarter and state by state. We did the math and found that every 10 percentage point increase in the use of those devices generated more than 231,000 new jobs within a year.

It makes clear and compelling economic sense. As a growing share of Internet use shifts to wireless devices, the people and businesses that use them become more efficient and productive. Those gains, in turn, create new value which ultimately leads to more job creation. The spread of 3G wireless devices also created a platform for new services — for example, in mobile e-commerce, mobile social networking, and location-based services. The growth of those new services also led to more job creation.

And the best news for jobs is that another technological shift is occurring right now, from 3G to 4G wireless devices. 4G wireless networks and the Internet infrastructure that supports them have the potential to drive significant new efficiencies and innovations across the economy. Jobs already are being created in 4G-dependent areas such as cloud-based services and mobile health applications. According to industry analysts, 4G wireless networks in the near future could be used to create a Smart Electricity Grid and a national public safety system.

This analysis, then, can provide a new direction for job creation efforts: Adopt spectrum and other policies that will promote the broad and rapid deployment of 4G

Still, there are also kernels of economic truth in the Romney and Obama positions. Romney is not wrong, for example, when he says that lower taxes are usually better for the economy than higher taxes. But there’s no evidence that lower taxes on wealthy people or corporations would produce many jobs. And in a period of trillion-dollar budget deficits, calls for tax cuts seem at best irrelevant, and at worst politically cynical and misleading.

The President is on firmer ground. Greater access to higher education and retraining should increase productivity and growth, at least over the long haul. Since the direct benefits from those efforts would presumably go to people from modest or middle-income households, Obama’s approach also could help address inequality. And since the President seems prepared to raise the revenues to finance his proposals, they could be more than political window dressing.

For all of these good points, these approaches are not the answer to slow job creation. For that, President Obama and Mr. Romney have to directly address the forces that actually create and destroy private-sector jobs. One such force is technology, and our new analysis shows that the 3G and 4G wireless technologies can create many more jobs than they may destroy, and do so quickly. Another approach could focus on reducing the additional costs that businesses bear directly when they create new jobs. That could mean cuts on the employer side of the payroll tax or new measures to slow increases in the health care costs that businesses bear for their employees. At a minimum, any of these approaches would produce more economic benefits for more people than all of the tax cuts promoted by Obama’s opponents.

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

Wednesday, December 14th, 2011

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

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

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

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

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

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

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

Here are three ways to begin.

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

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

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

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

Posted in Economic Strategy, Economy, Jobs | Comments Off

The Truth about Job Creation under Obama and Bush

Wednesday, November 16th, 2011

Everyone knows that unemployment is high today and unlikely to fall by much soon. Yet, a longer view of the official jobs data would startle most people, including virtually everyone in the media. Nearly three years into Barack Obama’s presidency, his record on private job creation has actually been much stronger than George W. Bush’s at the same point in his first term. Whatever the public perception, the real record provides strong evidence for both the relative success of Obama’s economic program and how hard it now is for American businesses to create large numbers of new jobs — as they did once so effortlessly, and without political prodding.

Let’s go to the numbers reported by the Bureau of Labor Statistics (BLS). In the first 33 months of George W. Bush’s presidency, from February 2001 to October 2003, the number of Americans with private jobs fell by 3,054,000 or 2.74 percent. Perhaps Americans were too distracted by Osama bin Laden to pay attention, or everyone was lulled by the dependably strong job creation of the 1980s and 1990s.  Whatever the reason back then, Americans are certainly paying attention to jobs now. Yet, few seem to have noticed that Barack Obama’s jobs record has unquestionably been much better. In the first 33 months of his presidency, from February 2009 to October 2011, private sector employment fell by 723,000 jobs or 0.66 percent. That means that over the first 33 months of the two presidents’ terms, jobs were lost at more than four times the rate under Bush as under Obama. 

To be fair, new presidents shouldn’t be held responsible for job losses or job gains in the first five or six months of their administrations.  Bush’s signature tax cuts, for example, weren’t enacted until June 2001; and while Congress passed Obama’s signature stimulus program earlier in his term, it didn’t take effect for several more months. But the story is the same when we start counting up jobs without the first five months of each president’s term. The BLS reports that from July 2001 to October 2003 under Bush’s program, U.S. businesses shed 2,167,000 jobs, or about 2 percent of the workforce. Over the comparable period under Obama’s policies, from July 2009 to October 2011, American businesses added 1,890,000 jobs, expanding the workforce by 1.75 percent. In fact, private employment in Bush’s first term didn’t begin to turn around in a sustained way until March 2004, 38 months into his term. By contrast, private employment under Obama started to score gains by April and May of 2010, 14 to 15 months into his term.

The same dynamics have played out with manufacturing workers. While they have taken a beating under both presidents, they suffered much harder blows under Bush than Obama. Setting aside, once again, the first five months of each president’s term, the data show that under Bush, 2,141,000 Americans employed in producing goods lost their jobs by October 2003, a 9 percent decline. Under Obama, job losses in goods production totaled 183,000 over the comparable period, a 1.0 percent decline.

Public perceptions, especially of Obama’s record, may be skewed by the collapse of the jobs market in the months before he took office. In the final, dismal year of Bush’s second term, from February 2008 through January 2009, American businesses laid off an astonishing 5,220,000 workers, 4.5 percent of the entire private-sector workforce. Obama and the Fed managed to staunch the hemorrhaging. But the huge job losses in the year before he took office have become a political hurdle which Obama must overcome before he can take credit for putting Americans back to work.

Apart from the obvious disconnect between conventional wisdom and what actually has happened with jobs, the data also speak to certain features of the labor market and the policies we use to affect it. For example, both presidents began their terms with large fiscal stimulus programs, backed up by more stimulus from the Federal Reserve. So, the record now shows clearly that when the economy is depressed, spending stimulus has a more powerful effect on jobs than personal tax cuts.

Beyond that, why couldn’t either president restore the much stronger job creation rates of the 1990s and 1980s? Obama’s economic team can point to the long-term effects of the 2008 housing collapse and financial crisis, especially the impact of four years of falling home values on middle-class consumption. But another factor also has been at work here, one which contributed mightily to the slow job creation under both presidents, and will similarly affect the next president.

The tectonic change from strong job creation of the 1980s and 1990s to the current times is, in a word, globalization. From 1990 to 2008, the share of worldwide GDP traded across national borders jumped from 18 percent to more than 30 percent, the highest level ever recorded. Intense, new competition from all of that additional trade has made it harder for American businesses to raise their prices, as competition usually does. That’s why inflation has remained tame for more than decade, here and nearly everywhere else in the world. The problem that American employers have faced — and still do — is that certain costs have risen sharply over the same years, especially health care and energy costs. Businesses that cannot pass along higher costs in higher prices have to cut back elsewhere, and they started with jobs and wages.

One irony here is that the Obama health care reform should relieve some of the pressure on jobs, by slowing medical cost increases. The administration’s energy program, still stalled in Congress, also might slow fuel cost increases, at least over time. So, if he does win reelection in the face of high unemployment, there is a reasonable prospect of stronger job creation in his second term than in his first one — or in either of George W. Bush’s terms.

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Posted in Globalization, Jobs, Politics | 2 Comments »

Grading Obama and the GOP Hopefuls on their Plans for Jobs and the Economy

Monday, September 12th, 2011

Last week’s GOP debate at the Reagan Library, followed the next night by the President’s address to Congress, threw into stark relief the strengths and weaknesses of each side’s understanding of jobs and the economy. The Republican hopefuls get a gentleman’s C on the impact of regulation on economic activity. But their approaches to the overall economy and job creation ranged from silly to dangerous, and earn them all F’s. The President has to produce results, and his ideas aren’t constrained by primary challengers. This may help explain why his approaches are broader and more thoughtful, earning him a solid B on the overall economy and an A-minus on job creation.

All of the Republican hopefuls — the two leaders Rick Perry and Mitt Romney, the so-serious minded Jon Huntsman and Ron Paul, and the media-infatuated Michelle Bachmann and the rest — agreed on one economic prescription: Apply deep and immediate budget cuts to an economy generating little growth and no jobs. This common position not only defies the basic dynamics of supply and demand in a slow economy. It also rejects the policies of the last five GOP presidents. After all, it was true-blue conservatives Ronald Reagan and George W. Bush who justified big spending increases for defense and big tax cuts to boost the flagging economies of their own times.   

Nor are the Republican wanna-be’s chastened by the current examples of Germany, France and Britain, which all embarked on austerity programs this year while the European Central Bank (ECB) raised EU interest rates. The results have been even more anemic growth than our own. In fact, the two GOP frontrunners along with the inimitable Mr. Paul not only demanded deep spending cuts, but also sided with the ECB by denouncing Fed chairman Ben Bernanke as an inveterate inflationist. The markets they all claim to worship don’t see it that way, since our long-term interest rates remain near record lows. For their determined contempt of introductory macroeconomics, all of the GOP putative presidents flunk.

The current President at least appreciates that this economy needs a boost, not more headwinds. His package adds $450 billion over 12 months, in theory adding new demand equal to 3 percentage points of GDP. In practice, it would work out to be less than that, since people will save some of the money they gain from lower payroll taxes, and some of the tax cuts for businesses won’t be taken up. The administration also gets credit for recognizing that the sick housing market is a critical piece of the puzzle behind the slow economy. Their answer, however, misses the most basic point: Mr. Obama called for expediting Fannie Mae refinancings to put more money in the pockets of some homeowners. But that won’t affect the more economically consequential, high foreclosure rates that have been pushing down housing values, and so dampening people’s willingness to spend. On balance, give the President’s economic team a solid B on the overall economy.

Both sides also call for tax cuts to spur job creation. All of the GOP candidates, however, would focus on cutting corporate taxes. Now, most economists agree that the corporate tax cries out for reforms, especially a lower marginal rate tied to ending distorting tax breaks for favored industries.  But no reputable economist who doesn’t aspire to a top position in the next GOP administration has found that those reforms would have noticeable effects on jobs in any short or medium-term. With large U.S. businesses already holding some $1 trillion in banked profits, by what economic logic would additional tax cuts move them to create jobs?

The only route from this GOP position to new jobs depends on lower corporate taxes translating into higher dividends, mainly for the very affluent, which they would then spend, boosting demand. Even so, much of those additional dividends probably would be saved, which wouldn’t create any jobs under today’s conditions. Moreover, the GOP hopefuls also insist on spending cuts to offset any lower corporate tax revenues — and that would mean job losses. For their resolute ignorance of labor economics and public finance, these hopefuls score another F.

President Obama’s tax plan is both more detailed and better targeted to creating jobs — which should be unsurprising, given how much he has riding on near-term results. He would reduce the cost to businesses of creating new jobs and maintaining their current workers. To do this, he would temporarily suspend the employer side of the payroll tax for new hires by firms with about 1,000 employees or less, and temporarily cut by half all employer-side payroll taxes for firms with about 100 workers or less. This strategy is eminently sensible — and downright brilliant compared to the broad corporate tax cut championed by the Republican hopefuls. Full disclosure: I’ve urged the administration to propose cutting the employer side of the payroll tax since December 2009, including eleven times in these blog essays.

The decision to limit these new tax incentives to small and medium-size companies is less than ideal, since big businesses employ nearly half of all workers. On the other hand, big businesses are sitting on hundreds of billions of dollars in banked profits, so they clearly have the means to hire more workers. On balance, these proposals deserve an A-minus.

The same score goes to the President’s call for more direct, job-related spending. This includes new funds for the states to prevent more layoffs of teachers, police and firefighters; new support for school construction; and additional investments in infrastructure (through a National Infrastructure Bank). More problematic are the jobs benefits from other parts of the plan, including support for expanded access to high-speed wireless and public-private partnerships to rehab homes and businesses. There’s also little direct jobs benefit in the administration’s otherwise-laudable plans to reform the unemployment insurance system and bar employers from discriminating in hiring against long-term jobless people. All told, another A-minus.

The Republican hopefuls have time to develop better strategies for growth and jobs, especially compared to their current dismal positions. They’ll have to play catch-up, however, because President Obama has proposed a sound new jobs agenda. And if congressional Republicans refuse to work with him on it, the public will know whom to blame.

 

Posted in Economic Strategy, Economy, Jobs, Political Strategy, Politics | Comments Off

For a Strong Economy, Keep Europe Afloat and Keep Americans in Their Homes

Monday, August 29th, 2011

The persistent sluggishness of the recovery here in the United States and in most of the world’s advanced economies should underscore a stark lesson from economic history: Systemic financial crises are the products of deep economic problems, and they can’t be solved by simply treating the after-effects of slow growth. It’s long overdue that the United States and Europe directly address the deep market distortions that brought about the crisis of 2008 and 2009.

So far, all we’ve done is substitute large doses of fiscal and monetary stimulus for the hard work.  That pulled us back from the brink of a Depression. We also shouldn’t have been surprised that once the stimulus played out, the same distortions reasserted themselves. We may technically be experiencing a recovery. But unless we’re more forthright in our interventions into both the housing and financial markets — on both the international and domestic stage — we’ll remain exposed to the possibility of a renewed crisis, one even more severe than the one that began three years ago.

These considerations don’t drive policy, in part because so many economists still see the crisis as an anomaly, one that will be followed in due course by markets reasserting their natural optimality. This view, of course, ignores or slights the overwhelming evidence of how inefficiently and “sub-optimally” the financial and housing markets have performed for years. U.S. and European financial markets have systematically failed to reasonably price the risks of trillions of dollars of derivative securities; housing markets here and across much of Europe have sustained a classic speculative bubble and equally classic crash.  

Our current predicament has as much to do with our own lame responses to the consequent crisis, as it does with the original crisis itself. Washington provided bailouts and virtually-free credit for financial institutions without applying requirements as to how that new-found money ought to be used. There also were new housing initiatives, but based on a fanciful view that a little federal money would be enough to convince bankers to extend new credit to people already on the brink of default. Finally, there was a substantial fiscal stimulus — a good and necessary move — but one cobbled together from the wish lists of hundreds of members of Congress.

The results are now clear in the data. Financial institutions amassed trillions of dollars without expanding business lending, mainly because the financial-market distortions that brought on the crisis are still with us. These institutions are still holding trillions of dollars in wobbly asset-based securities, whose risks even now they cannot reasonably price. So they sit on most of their new capital (after paying out their bonuses), in hopes of avoiding another bout of bankruptcy from those assets, should another crisis erupt. Yet, the prospect of new legislation to sustainably resolve those weak assets by pulling them off the books — as Sweden did in its early-1990s banking crisis, and we did in the S&L crisis of 1989-1990 — is nonexistent.

The prospect of another imminent crisis on the horizon ought to put the necessary policies into relief. One initiative that cannot wait: President Obama should call an emergency G-8 meeting to help head off a new financial meltdown in Europe. The sobering fact is that many of Europe’s largest banks are nearly insolvent. It’s a legacy from not only the 2008 – 2009 meltdown, but also the EU’s decision in 2007 to reduce bank capital requirements under the level set by the “Basel 2” accords. Americans benefited from the fact that our own banking regulators dawdled in making similar changes desired by the Bush administration, by which time even the Bush Treasury had doubts about cutting capital requirements. The result today is that the German and French banking systems in particular are in much worse shape than Wall Street.

Now these weak banks face additional, large-scale losses from the falling values of Italian and Spanish government bonds, a contagion from the now-anticipated defaults of Greek and Portuguese public sovereign debt.  If this turmoil intensifies, it will probably pull down some of Europe’s largest banks. And if institutions such as BNP Paribas and Deutsche Bank (the world’s two largest banks) fail, the U.S. and global economies would probably follow. Moreover, this time, the consequences would be even more dire than in 2008 – 2009, since governments have already exhausted their fiscal and monetary policy options.

We can still head off a 1931 scenario if Germany and France will accept the inevitable and obvious: A common Euro currency requires that every member pledge its full faith and credit for Eurobonds to support the full faith and credit of everybody else. Otherwise, the failure of a small member (today, Greece and/or Portugal) can destroy confidence in the economic sustainability of much larger members (Italy and Spain). And then, everybody’s goose is cooked.

The political catch is that the solution puts French and German taxpayers on the hook to bail out fiscally-inept Greece and Portugal. Chancellor Merkel and President Sarkozy have tried to avoid the political blowback from introducing Eurobonds by trotting out smaller options. It is a decision that hearkens to the Bush administration’s misguided attempts to avoid bailing out Lehman Brothers. Investors aren’t buying it. So if Greece goes down now, Sarkozy and Merkel will be forced to rescue Italy and Spain — and perhaps France itself — at incalculably greater cost to everyone.

President Obama should not delay to call for a G8 meeting: Europe needs to hear that the United States considers its current course unacceptable, and that Washington would be ready to help fund IMF support for a broader solution that can head off another full-blown crisis.

If we intervene to put Europe back on course and avoid a replay of 1931, we still will be facing the prospect of a persistently slow economy. Preventing that kind of long-term stagnation would require that we finally address the distortions in the housing market by stabilizing housing prices. Policymakers’ most promising avenue to that end would be to focus on bringing down foreclosure rates and keeping American families in their homes.

There is no doubt that housing prices are central to our current growth dilemma. People spend freely when their incomes are rising or their wealth is increasing. During the last expansion and leading up to the current crisis, the incomes of most Americans stagnated. Instead, growth and business investment were driven mainly by the “wealth effect” created by fast-rising housing values. Now, the economy is caught in the flip-side, as four years of sliding housing prices drive a powerful negative wealth effect that continues to hold down consumption.

The broad reach of these effects reflects how wealth is now distributed in the United States: According to Fed data for 2007, the bottom 80 percent of American households held 40 percent of the value of all real estate assets, compared to a miserable seven percent of the total value of all financial assets (and yes, that includes pensions). Home equity, in short, is very nearly the only real asset for more than half of all Americans. The decision to allow housing values to fall for four straight years—in contrast to the equity and bonds of large financial institutions—leaves the majority of American consumers growing poorer month after month. Just as people who grow richer spend more, people who find themselves poorer spend less. So, consumer demand and with it business investment will not recover until housing values stabilize.

To help make that happen, policymakers could establish a temporary loan program for homeowners whose mortgages are in trouble, to help bring down foreclosure rates and so begin to stabilize housing prices and stem the negative wealth effect. The program should not be a giveaway; if it were, it would create enormous moral hazard and enrage everyone who works hard to keep up their own mortgages. So, the loans would carry an interest rate above current 30-year mortgage rates, and those who take advantage of them would have to turn back to taxpayers a share of any capital gains earned later from selling their homes.

It’s very important that we get this right. Unfortunately, the signs from Washington right now aren’t promising. The Obama administration reportedly is considering a program to promote large-scale mortgage refinancings at the current, low fixed rates. If it worked, lower mortgage payments could free up an estimated $85 billion for consumers. But since those whose mortgages are in trouble probably wouldn’t qualify, the refinancing program would inject a little stimulus without affecting housing values. That means it would leave intact the current, negative wealth effect.

We don’t have time to wait for the markets to begin operating rationally again. The economy will only right itself when housing values stabilize and distortions in Wall Street’s and Europe’s financial systems have been addressed. We will need to intervene on both domestic and international fronts, to restore consumer demand and business investment — and with them, President Obama’s prospects for reelection.

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The Best Advice for the President: Think Big and Move On

Wednesday, August 10th, 2011

In good times, a President without clear economic policies may not suffer for it. But in shaky and uncertain times like today, failing to advance a coherent strategy to ease people’s genuine economic troubles can be fatal politically, for a president or his opponent. Yet, it happens with some regularity, often because the candidate simply prefers to talk about foreign policy or other things. Consider the first George Bush in 1992, dismissing people’s economic worries to return again and again to his Gulf War success. Think of John McCain in 2008, with no plan to stem the financial meltdown but eager to talk about his opponent’s character failings. And reaching further back, there was George McGovern decrying the Viet Nam War, but with little to say about the inflation and slow growth.

Both parties will certainly have economic programs for 2012. Yet, both parties are in danger of passing lightly over the core issues of jobs, housing values, and incomes. The problem for the Republican nominee is the Tea Party, which may well force him or her to embrace its radical bromides. That assumes, of course, that the GOP doesn’t nominate Rick Perry or Michelle Bachman, who won’t need to be convinced. Whoever the nominee is, he or she will have to stand for abolishing the minimum wage. On the budget, the nominee will have to support moving Medicare towards vouchers with spending caps that don’t take account of health care costs, and a balanced budget amendment that won’t take account of recessions. The nominee also will have to stand for the repeal of Wall Street regulation and more tax cuts to frost the cake of the rich.

This prospect presents President Obama with two choices. He can run against the Tea Party platform and insist that a minimalist approach is preferable to the other side’s eccentric agenda. One catch is that the GOP nominee almost certainly will have a “Sister Souljah” moment when he ostentatiously distances himself from some loony piece of the Tea Party platform. (My personal favorite is the call to abolish our “fiat” currency and revive the long, well-buried gold standard.)  And if the GOP nominee can weave a story about how a balanced budget and less government will help create jobs and restore housing values, and repeat that story often enough, it could be sufficient to trump Democratic minimalism.

But the President has another choice. He can offer up a new program of “Big Ideas” that directly takes on jobs, stagnating incomes, housing values, and the nation’s debt. The conventional wisdom is that this is too risky, because it would tacitly acknowledge that his first-term program didn’t deliver the prosperity his economic team promised. But since everyone in the country is already aware that it didn’t deliver as promised, acknowledging it would be a small concession.

To be sure, the Tea Party-dominated House probably wouldn’t pass anything that Obama proposes before the election. The economy will get a little more support from the Fed, but essentially will be on its own. Nevertheless, the President can lay a foundation for stronger job and income gains in a second term — if he’s reelected — by campaigning for a new economic program.

With persistent, high unemployment, Obama needs to show that he knows how to reduce the costs for businesses to create new jobs and preserve old ones. One direct way to do that would be to cut the employer side of the payroll tax by half, and then he could propose to pay for it through tax reforms that include a carbon-based tax to help address climate change. He also can show that he knows how to help create new, small businesses which, in turn, will create new jobs. Since our major financial institutions have largely stopped providing credit to small entrepreneurs, he could propose a new government-sponsored enterprise that could float bonds for community banks to finance those business loans.

The biggest obstacle to a stronger recovery remains the sick housing market. Nearly two-thirds of American households, in effect, grow poorer every month as the values of their homes decline and, with it, any equity they built up. And people who feel they’re becoming poorer don’t spend, which in turn keeps this recovery anemic. The best leverage we have to stop the decline in housing prices is to bring down home foreclosure rates. The President can show he knows how to do that too, by proposing a new temporary loan program for homeowners with mortgages in trouble. To be sure, this is treacherous territory, politically and economically, since it could enrage homeowners who don’t qualify and induce moral hazard for those who do. But the President can address both problems with some tough love. Homeowners who receive the loans would be on the hook not only to pay them back. On top of that, 10 percent of any capital gains from an eventual home sale could go back to the taxpayers.

Finally, the President can show that he knows how to help Americans prepare for the new jobs that the rest of his program would help create. Nearly half of all working people age 35 and over today still have only the most rudimentary computer skills, leaving them unprepared to perform well in most 21st century jobs. The President could propose a new grant program for community colleges that will keep their computer labs open and staffed in the evenings and on weekends: Any adult would be able to walk in and receive IT training at no personal cost.

This program won’t assuage the Tea Party’s followers — in fact, it will likely incense them. Let’s hope so. The President should welcome a debate — okay, a pitched battle — over a genuine and understandable strategy to improve the lives of Americans. Even if unemployment is still well over 8 percent, a serious plan to bring it down should trump the grab bag of far-right nostrums that passes for policy in the Tea Party.

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The State of the Union and the Real Meaning of Competitiveness

Monday, January 31st, 2011

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

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

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

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

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

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

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

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

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

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Why It Matters So Little that Obama’s Jobs Record is Much Better than Bush’s

Wednesday, January 5th, 2011

The great partisan squabble of 2011 over the economy begins this week with the new Congress. Even if some of the rhetoric seems fresh, the core issues likely to become the stuff of real political fights — the terms of entitlement spending, the shape of the tax code, and the value of public investment — are all familiar from battles during the previous two administrations. There is one important difference, however, which will startle both sides. When we probe the economics and politics, it appears that the real issue for most Americans isn’t jobs and unemployment, but incomes and wealth. The first clue lies in public data which have been almost universally ignored: George W. Bush’s record on jobs was much worse than Barack Obama’s. Both men took office during recessions which had taken shape under their predecessors, but with quite different effects. So far, we have 21 months of jobs data under Obama, from February 2009 to November 2010: Over that period, as the administration took numerous steps to support the economy, American businesses shed a net of 1,975,000 jobs. George W. Bush’s approach was much simpler, relying almost entirely on large tax cuts. Yet, even though the 2001 downturn was barely a blip compared to what Obama would face eight years later, Bush saw 2,852,000 private-sector jobs disappear in his first 21 months. The job losses in Bush’s first two years, then, were nearly 1 million larger than during Obama’s first two years. Set aside the first six months of each president’s term, before their policies could take effect, and the comparison grows even starker. In those subsequent 15-month periods, American business under Bush shed 1,772,000 jobs, compared to job gains of 715,000 under Obama’s program. By any economic measure, the Obama approach has been much more successful with regard to jobs than the Bush program which congressional Republicans now want to repeat.

But the Bush program was much more successful politically, judging by the 2002 and 2010 midterm elections. To be sure, the Bush White House managed to change the subject from its dismal jobs record to terrorism and Saddam Hussein, which helped a lot. But the huge Democratic losses last November, despite Obama’s much better record on jobs, tell us that the main issue for most voters — at least those with jobs — probably wasn’t unemployment at all, but rather their overall economic condition. In this regard, Bush was as lucky as a Rockefeller: He inherited an economy which under Clinton had produced large income and wealth gains for most Americans, giving them a critical cushion to muddle through the 2001 recession without having to cut back much. Obama, on the other hand, had the misfortune of inheriting a much weaker economy from Bush, one which had left most Americans treading water even before the financial crisis and Great Recession of 2007-2009 eroded their assets. Let’s retrace the real conditions. Throughout the Bush expansion, most Americans experienced no income gains, although their wealth appeared to increase. Here, the stock market isn’t very important. The Federal Reserve reports that the top 20 percent of Americans control 93 percent of the value of all financial assets, including pension and retirement accounts. With 80 percent of the country holding only 7 percent of the nation’s financial assets, the falling stock markets of 2000-2001 and 2007-2009 had little direct effect on most people’s economic condition.

But one asset is widely held by Americans: Nearly 70 percent of the country owns their own homes. Bush’s legacy to Obama, then, included not only a half decade of stagnating incomes, but also wealth losses for most people amounting to between 25 and 30 percent of the value of their homes. Layer a deep recession on top of all that, and voters grow very cranky.

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

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

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

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

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At Last, the Net Neutrality Fight Is Over

Tuesday, December 21st, 2010

Official Washington, which usually doesn’t accomplish much at all, is having a week of extraordinary achievement.  There’s the deal on taxes which should boost the economy next year and into 2012, the START Treaty, the long-overdue end to discriminations against gays and lesbians in our military, and now new open Internet rules from the Federal Communications Commission (FCC).  The text of those rules hasn’t been released yet; but based on the Commission’s public discussion and vote today, the FCC has finally resolved a very thorny issue by striking the right balance.  The order adopted today, which hopefully will end the battles over the concept of “net neutrality,” will apply new rules for fairness to broadband network providers, but without impairing the incentives they need to invest hundreds of billions of dollars more in the Internet’s basic infrastructure.

 As I wrote a few weeks ago after FCC Chair Julius Genachowski announced his view of these rules, the Commission’s decision should protect the rights of consumers while allowing broadband companies to manage their own networks and figure out for themselves how best to address online congestion and other quality-of-service issues. All of this will be open for public scrutiny, since today’s announcement includes new transparency requirements that oblige broadband providers to disclose their network management practices.  And if this resolution of net neutrality does lead to greater investments by those providers, as expected, that can only mean more jobs next year as well.

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