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The Economic Appeal of the Occupy Wall Street Movement to Middle-Class Americans

Monday, October 24th, 2011

Seemingly out of nowhere, economic inequality is no longer the political issue that dares not speak its name. Since the days of Ronald Reagan, politicians who talk about reducing disparities in incomes or wealth have been promptly charged with “class warfare.” The stunning success of the Occupy Wall Street movement in attracting adherents and sympathizers could change that, at least for the current political season. What lies behind the movement’s surprising middle-class appeal, however, isn’t high unemployment or slow economic growth. The real reason is that the 2008 meltdown and its economic aftermath have cut the wealth of millions of average Americans by up to half — and Washington has been unwilling to do anything about it.

There is little controversy among economists that the fabled U.S. land of opportunity has become one of the world’s most unequal societies. Using the standard measure (the “Gini Coefficient”), America now ranks 93rd in the world in terms of economic equality. That puts us behind places like Iran, Russia and China. The poverty in those places is much worse, but the concentration of wealth is much greater here. According to the Federal Reserve, the top 1 percent of us in 2007 owned nearly 35 percent of everything of value, net of debt — that includes savings, stocks and bonds, real estate, art, furniture, clothing, on and on. Perhaps more important, the top 20 percent of Americans owned 85 percent of the country’s net wealth.
Yet, such striking inequality still cannot explain the appeal of Occupy Wall Streeters — I’ll call it the OWS movement — because comparable disparities of wealth have been around for a generation. Go back to 1983, and the top 1 percent of Americans owned 34 percent of the country, and the top 20 percent claimed 82 percent.

The answer here lies in the particular way that the financial and housing meltdown has affected middle-class families. Consider the following: While the bottom 80 percent held only 15 percent of the nation’s wealth in 2007, most of it was tied up in the value of their homes. We know that, because when we break down that 15 percent figure, we find that the bottom 80 percent held just 7 percent of all financial assets in 2007 but 40 percent of all residential real estate assets. And the housing boom topped out in 2007.

The reason the OWS movement resonates so broadly today lies in the subsequent loss of so much housing wealth.  The 2008 meltdown and its aftermath have driven down the value of residential real estate by about 35 percent. And that 35 percent included most or all of the equity that millions of middle class families had in their homes in 2007.  America already was a place where 80 percent of the people held only 15 percent of the country’s wealth. Now, do the math. About half of that wealth was in financial assets like savings and pensions (the Fed’s 7 percent figure), and the rest was in home equity. So, since 2007, the bottom 80 percent of Americans have lost up to half of their net wealth.

Those losses also aren’t distributed evenly:  Households in their 30′s and 40’s, for example, usually have almost everything they own tied up in their home equity, and which typically adds up to less than one-third of their homes’ value.  They’ve been wiped out, wealth-wise.  Older households, on average, have larger home equity, so they still have some modest increment of wealth. But if they’re approaching retirement or already retired, there’s also little they can ever do to make up their losses.
When middle-class Americans turn to Washington, they see the resounding success of the government’s efforts to stabilize the financial markets – where the top 1 percent derive most of their wealth. The rich are back to becoming even richer. That’s the way America has operated for at least the last generation. What grates on middle-class Americans this time is that they’ve been getting poorer. And Washington has done little to stabilize the market from which they derive most of their wealth, which is housing.

To be fair, President Obama can claim a little credit here, since he has proposed a series of initiatives to support housing, mainly by giving banks incentives to refinance more mortgages at favorable terms.  But the largest force driving down housing prices and wiping out middle-class home equity is sky-high home foreclosure rates.  The President hasn’t yet taken on those foreclosures, but he still has time to champion a new initiative.  For instance, he could call for temporary loans for families whose mortgages are in trouble, financed through lending by the Federal Home Loan Banks.

Mitt Romney, Obama’s most likely challenger, can’t call for anything.  Last week, Romney went to the state with the highest foreclosure rate in the country, Nevada, and made what may turn out to be a very costly mistake.  Embracing GOP dogma that “the right course is to let markets work,” he declared that Washington should let the foreclosure process “run its course and hit the bottom.”

Yet, this is the very process now hollowing out a good-sized slice of the American middle class.  Given Romney’s position, the issue provides a new opportunity for the Obama campaign.  Much more important, however, the problem itself presents a critical challenge for economic policy makers. If they and the next President ignore it, inequality in America almost certainly will enter a very nasty, new phase.

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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.

 

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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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President Obama Wins the First Round with Paul Ryan

Thursday, April 14th, 2011

Yesterday’s presidential address on fiscal policy was a very striking scene. The venue was a small auditorium at George Washington University. Invitations went out just two days earlier; and with so little notice, GWU students made up more than half of the audience. Former Democratic economic policy officials — myself and perhaps 10 others — directors of Democratic-allied policy shops, and a smattering of CEOs and senior Senate staffers filled up another row.  Just before the President took the stage, his economic team filed in — Bill Daley, Tim Geithner, Gene Sperling, Jack Lew — along with Vice President Biden and his new chief-of-staff, fresh from directing the Simpson-Bowles Deficit Commission.  Alan Simpson and Erskine Bowles were there too, along with other Commission members — here’s what added drama to the scene — including Representative Paul Ryan, this year’s Republican guru on the budget sitting uncomfortably in the first row. The moment the President finished — without exaggeration — Ryan bolted for the exit. Perhaps he suspected that the President’s plan is smarter, fairer, more balanced and more credible than his own.

Both blueprints would reduce deficits by $4 trillion over the 10 (Ryan) or 12 (Obama) years, but the real difference lies in revenues. The Congressman would give away another $1 trillion in new tax cuts to high-income Americans and business, while the President would collect an additional $1 trillion in revenues. The consequent $2 trillion difference explains how the President, unlike Ryan, can stabilize federal debt as a share of GDP while preserving the basic guarantees of Medicare and Medicaid.  And there was one telling moment during the speech which demonstrated how new revenues change the choices that Americans face with the debt: The President was interrupted by applause only once, and it was when he said, “They [Republicans under Ryan’s plan] want to give people like me a $200,000 tax cut that’s paid for by asking 33 seniors each to pay $6,000 more in health costs. That’s not right. And it’s not going to happen as long as I’m President.”

Obama’s plan, then, recasts the issue from the GOP choice between spiraling debt and drastic cuts in Medicare, Medicaid and all domestic spending, to a new choice between higher taxes on the top one or two percent of Americans and preserving health care coverage for elderly and low-income people while also controlling the debt.  That choice can be cast even more starkly: Control the debt by forcing seniors to pick up two-thirds of their own health care costs by 2030 (CBO’s estimate of the impact of Ryan’s plan) or deny wealthy Americans their most recent and future tax cuts.  If you believe the polls, Americans today overwhelming favor President Obama’s priorities over Representative Ryan’s.

With his additional revenues, the President still has to find $3 trillion in spending reductions.  One big chunk of cash would come from broadening and strengthening the cost-control measures in his signature health care reforms; including, reimbursing hospitals and doctors based on results rather than volume and authorizing a new federal board to mandate rather than merely recommend the use of proven, cost-saving approaches to treating Medicare patients. He also calls for a new version of an old budget mechanism, from the late-1980s, which would trigger automatic, across-the-board cuts in domestic spending whenever the deficit exceeds a certain level.

In the end, OMB number crunchers believe that these and other measures would shave $2 trillion from spending over 12 years, and the lower deficits would save another $1 trillion in interest payments on the debt.

President Obama’s approach also allows him to preserve the substantial new public investments in education, infrastructure, clean energy and basic R&D which he called for in his latest budget.  By putting together a plan to control deficits while increasing public investments — the “cut-and-invest” approach championed by Bill Clinton in the 1990s — he assumed an optimistic, can-do attitude that recalls Ronald Reagan. And the implicit contrast with the Republican “the sky is falling” recipe of large sacrifices may serve his reelection nearly as well as it did Reagan’s.

These choices will not be resolved anytime soon.  GOP leaders immediately rejected the President’s blueprint.  Yet, they and their Democratic counterparts know full well that any resolution will require real compromises that include both additional revenues and some paring of entitlements. They also know, based on the deficit struggles of the 1980s and 1990s, that it will likely take several years for both sides to find and comfortably claim some common ground.

Even so, the President’s speech will have more immediate consequences, because it may well make the GOP’s position on the debt limit politically untenable. They no longer can argue credibly that they have to hold the full faith and credit of the United States hostage, in order to force the President to get serious about the debt.  The country now has a choice, and the Republicans can no longer say, our way or no way, when it would risk pushing up U.S. interest rates and possibly shaking the global economy. The current impasse over debt limit will be resolved with some face-saving commitment by both sides to begin negotiating in good faith.

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Forget about Spending and Get Serious about the Economy

Thursday, March 31st, 2011

Washington today, especially the Congress, has a textbook case of cognitive dissonance. A confluence of black swan developments may well threaten the American and global recoveries. There’s the civil war in Libya and unrest across much of the Middle East that could disrupt world energy supplies, the natural catastrophes in Japan may upend the world’s third largest economy, and several European governments are flirting with junk-bond status. On top of all this, recent data on housing, investment, and consumer spending all point to a still-fragile U.S. expansion. Yet, with all of this, Congress spends its time bickering over funds the federal government needs week to week just to keep operating.

This debate has become almost willfully wrong-headed. An economy not yet recovered fully from a historic financial meltdown and deep recession, and now facing possible major shocks from three directions, is no candidate for budget cuts. In fact, a new National Journal survey of 44 Washington economists and “economic insiders,” Democratic and Republican, found only one of the 44 who sees immediate spending cuts as the highest priority. (Full disclosure: I am one of the 44 surveyed.) If there are still any doubts about what happens when governments ignore this basic economics, consider Great Britain and Germany. Both embraced the austerity snake oil and plowed ahead with sharp spending cuts and tax increases. Two quarters later, the recoveries in both countries are stumbling badly.

Of course, these debates are not about economics at all. Here and in Europe, they’re driven by anti-government factions inside the base of each country’s conservative party. Congressional Republicans might take note, however, that this approach no better politics than it is economics. After enacting their programs, the governments of David Cameron and Angela Merkel find themselves hemorrhaging public support.

There is a time for serious debate about the role of American government in our economy and daily lives. The 2012 elections could provide a platform for real public deliberation about how much the government should do in the future to provide health care for elderly and poor people, ensure access to higher education for young people unlucky enough not to be born into affluence, or support the weapon systems, manpower and womanpower needed to wage multiple wars. At a minimum, the campaign should include some serious talk about whether the Obama administration did the right thing in driving health care coverage for most Americans.

Right now, however, is the time to focus on the clear and present dangers to the jobs and incomes of average Americans. The President made a good start this week with proposals to make the U.S. economy less energy intensive and especially less dependent on imported oil. Dealing with the continuing problems in Japan and Europe will be tougher. As we outlined last week, if the crisis in Japan persists for another month or longer, it will disrupt production here of everything that uses parts or elements made-in-Japan, from automobiles and electronics to medical equipment and even pharmaceuticals. Congress should take this time to consider steps that will help our manufacturers keep their U.S. workforces intact through such supply chain disruptions — for example, a temporary tax break on foreign earnings brought back home by manufacturers who expand their U.S. jobs. If Japan’s crisis deepens, it also will absorb all of Japanese saving, and then some. That development would likely drive sales of U.S. stocks by Japanese investors and sales of U.S. government securities by the Japanese government, creating new downward pressures on U.S. stock prices and new upward pressures on our interest rates. All of this means that the Federal Reserve and Treasury should take this time to prepare for another round of quantitative easing.  

A new debt crisis in Europe would threaten the balance sheets of our large financial institutions, yet one more time. They don’t have large holdings of Greek, Irish, Portuguese, Belgian or Spanish government debt, all of which now hang in the balance. But our big banks do have hundreds of billions of dollars in normal business with the large European banks that do carry huge portfolios of those bonds — and which might find themselves unable to carry out their contracts with our banks if another crisis hit. That’s what happened, in reverse, in September 2008, when American banks couldn’t honor their contracts with many European banks in the post-Lehman panic. Today, instead of arguing about PBS funding, congressional leaders should be quietly talking with the administration about ways to contain another financial crisis without bailouts which the public would never support again.

If the Congress and administration could refocus their current debate around these real and pressing issues, perhaps they could then move on to the longer-term problems that matter to most Americans outside the Tea Party. To begin, what can Washington do to help American businesses create new jobs at the vigorous rates we all considered merely normal, until the last decade?  There might even come a time for a serious public discussion about what steps might help reverse the corrosive income patterns of the last 30 years, which have seen a small minority of very rich and very highly-skilled Americans capture nearly all of the nation’s income gains, while middle class people stagnated and poor people lost ground.

And one point should be very clear: Budget cuts are no more of an answer to these long-term issues than they are for the more immediate problems facing the American economy.

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The U.S. Economic Debate Gets a Failing Grade at the IMF

Wednesday, March 9th, 2011

At the private conference this week convened by the International Monetary Fund (IMF), 30 world-class economists talked for two days about “Macro and Growth Policies in the Wake of the Crisis.” Their discussions provided a reality test for the current economic debate in Washington, and the last decade of U.S. policymaking flunked. Economic ideology not only blinded American policymakers to the seeds of a financial crisis that never had to happen; it also has led to wrong-headed responses for both the short-run and the long-term.

While the United States and other advanced countries embraced large-scale stimulus in 2008 and 2009 to avoid a global depression, the panelists pointed out that the world’s advanced economies are now moving in the opposite direction, without regard for the consequences. Across a group of economists who normally argue over every assumption and decimal point, a genuine consensus emerged that the American and European economies remain too fragile today to successfully absorb major deficit cuts.

While congressional Republicans wield a meat axe over the budget, and many Democrats would apply a scalpel, nearly all of the economic notables gathered at the IMF concluded that additional spending and tax breaks would be much more sensible. The 2009 and 2010 stimulus programs came in for plenty of criticisms, especially for their emphasis on tax breaks for households:  The financial meltdown and deep recession left most households with so much debt relative to their incomes that much of the stimulus just went to reducing their debt loads. Household debt today is considerably lower; but it hasn’t fallen as far as most people’s assets, because the value of their principal asset, their homes, has kept on declining month after month. This time, the experts agreed, any stimulus should be better targeted, for example through investment tax breaks and spending on education and infrastructure.

To be sure, there were repeated calls for a long-term “fiscal consolidation” program, which is how economists describe entitlement reforms and other measures that can limit a nation’s public debt to a reasonable share of its GDP. But they weren’t encouraged by what they’re hearing out of Congress, where politicians regularly conflate the need for long-term deficit reduction with a short-term opportunity to roll back the size of government. Nowhere is this confusion more obvious, several noted, than in a misguided focus on cutting current discretionary appropriations. And particular scorn was heaped on calls for cuts in education and infrastructure investments, which economists have long promoted as the best way to support future expansion and provide a lifetime of healthy social returns.

The most stinging critique, however, was reserved for the years of policy and business misjudgments which brought on the financial crisis and ultimately triggered the worst recession in 80 years. Starting with the opening remarks by Dominique Strauss-Kahn, the head of the IMF, a long line of economic luminaries laid out how policymakers here and in Europe misunderstand the very nature of modern financial capitalism. Again, there was rare unanimity for the view that markets today, which work so well in allocating resources, lack the means and the information to recognize bubbles and evaluate the economic risk of complex financial instruments.

Nor do policymakers have the excuse that this challenge represents something new. Hundreds of savings and loans went under in the 1980s, because financial markets couldn’t evaluate risk very well. Moreover, the 1990s saw three bubbles slowly take shape and then explode, first in Japan, then across much of East Asia, and finally in the Nasdaq tech sector. Yet, policymakers at the White House, the Federal Reserve, the Treasury and their counterparts across Europe sat by placidly, just a few years later, as leading financial institutions recklessly accumulated enormous leverage for financial instruments based on an obvious bubble and whose riskiness they couldn’t begin to assess.

Yet, these misjudgments weren’t universal: The financial meltdown was limited to the advanced economies, while much of the developing world learned the painful lessons of the 1997-1998 Asian financial crisis. So, their policymakers imposed new limits on leverage, and their financial institutions passed on investing in the toxic assets that brought down the U.S. and European economies. That’s why, at least for now, the developing economies have become the engine of global growth.

The Great Depression produced a large sheaf of institutional reforms which have helped the world avoid a repeat ever since. Yet, the Nobel Laureates and other experts gathered this week by the IMF also agreed that the United States and Europe have yet to undertake comparable reforms that would make another global financial crisis less likely. If we don’t, they warned, another financial crisis almost certainly will befall America and Europe in the foreseeable future.

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The Economics and Politics of Cutting Deficits

Wednesday, February 16th, 2011

The 2011 battle over the budget brings to mind the U.S.-Soviet nuclear arms talks of the 1970s and 1980s. The issue is not whether the antagonists can settle everything at once, but whether each will accept modest concessions and keep on talking until the next round, when more incremental compromises can be reached, and so on into subsequent rounds.  The negotiations to contain deficits in the 1980s, early-1990s and latter-1990s all proceeded in just this way, one step at a time once the two sides had found a common frame of reference. This week shows that any meeting of partisan minds is still a long way off, since President Obama and congressional Republicans haven’t found common ground to begin the process.

Both sides agree that whacking away at deficits running at 10 percent of GDP is an economic necessity, but they remain far apart on what those economics actually portend. The President sees the effort as part of the larger challenge of bolstering the competitiveness of American businesses and workers. So, his administration’s case hinges on combining targeted public investments with targeted spending cuts and tax increases for upper-income Americans. This “cut-and-invest” approach with a side order of taxes comes directly from Bill Clinton’s 1992 campaign program, and it’s no coincidence that Obama’s top economic adviser, Gene Sperling, helped manage economic policy in that campaign.

The approach is drawn directly from mainstream economics: Invest in things that support growth across industries and regions — basic R&D, infrastructure, and education and training — while gradual deficit reduction frees up capital for private investment. As the public investments nudge up the returns on private investment, businesses will use the freed-up capital to develop new products and services, expand operations and hire more workers. Finally, the deficit cuts should come gradually so they don’t squelch the natural upswing in Americans’ demand for everything businesses produce.

The best argument for the President’s approach is that it worked last time. When Clinton followed this script, what followed included the longest expansion on record, as well as the strongest gains in business investment, jobs and incomes in 30 years. To be sure, Japan demonstrated in the 1990s that waves of infrastructure spending for a slow economy can be wasteful, especially when powerful interests determine where that spending goes. And the United States isn’t immune from that dynamic —  the 2009-2010 stimulus had less long-term benefits than it might have, once Congress substituted its own parochial priorities for the broad public investments that Obama had laid out in his original plan.

The Republican budget proposals are targeted very differently. Defense and entitlement programs are still off-limits; and since those two areas account for most federal spending, the GOP cuts for everything else are much deeper and don’t distinguish between public investments and other kinds of spending. Moreover, the GOP economic logic doesn’t accommodate either higher revenues or a gradual glide path to lower deficits. Much like David Cameron in Britain, they believe that without draconian cuts very soon, investors will give up on the United States and America could face a Greek-style default of its public debt.

The trouble with the conservatives’ case is that the markets don’t buy it. If investors believed that America’s credit worthiness is at any genuine risk, we would see sharp increases in the interest rate on long-term federal bonds as those investors demanded higher returns to offset that risk. That’s simply not happening — though not because those investors don’t take deficit projections seriously. Rather, based on the historic record, they still trust that the two parties will find a way to contain those deficits, just as they always did in the past.

Despite this week’s threats by both sides, the markets are probably right that the economic costs of ignoring huge, unending deficits will eventually nudge the antagonists to the negotiating table. The calendar suggests that Democrats may well blink first: The prospect that House Republicans may really refuse to raise the debt limit will likely extract larger spending cuts from the President and congressional Democrats, if only because they know that voters would probably hold the President responsible in 2012 for any economic cataclysm that might follow. After that, it will be the Republicans’ turn to swallow higher taxes, much as Ronald Reagan did in 1982, 1983 and again in 1984. The base will howl, but John Boehner and Mitch McConnell know that without more revenues, they’ll be forced to embrace program cuts that would make most Americans recoil. And broad tax reform may give them some welcome cover — for example, to bring down the corporate rate in exchange for measures to raise more revenues from the same high-income households that will benefit most from lower corporate taxes.

All of this would be the prelude to a later round of even more consequential discussions, when entitlement reform takes center stage. Serious talks on Medicare and Social Security almost certainly will require a foundation of trust absent today, built on prior agreements on other spending and taxes. And if that trust remains unattainable, there will be no deus ex machina of the sort that finally resolved the nuclear arms race —  the Soviet Union’s collapse under its own economic deadweight —  to bail out the American economy in the next generation.

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What the Obama-Hu Meetings Can Mean for the U.S. Economy

Wednesday, January 19th, 2011

Barack Obama and China’s President Hu Jintao have genuinely important economic matters to talk about this week, even if there’s little prospect for any agreements that could materially improve our own economy anytime soon. But President Obama can –– and certainly will –– use these meetings to hammer home his long-term priorities for the U.S.-Sino relationship. And so long as Hu continues to see the United States as the “indispensable nation” for China’s economic development –– Hu’s own words –– a U.S. President’s priorities matter. And in acknowledging China’s increasing success in the global economy, the President can also remind Americans why they have to raise their own economic game –– and how his domestic policies can help them do just that.

A few of these discussions may produce quick benefits. For example, Obama will press Hu on China’s lax enforcement of the intellectual property (IP) rights of American companies in the Chinese market. A lot of Americans still see such enforcement as a parochial issue for a few big pharmaceutical and software outfits. It’s true that Chinese producers regularly try to rip off U.S. patented drugs, mainly for third-world markets; and until recently even the Beijing government used a pirated version of Windows. But there’s much more at stake here for us. The fact is, the only promising, long-term strategy that the global economy offers the United States today depends on our outsized national capacity for developing and adopting economic innovations –– from new products and technologies, to new ways of financing, marketing and distributing goods, and new ways of organizing a business and running a workplace. IP rights in the world’s second largest market, then, affect everything from movies, machine parts and genetically-enhanced foods, to computer slates, Internet business processes, and nanomachines.

China already is legally obliged to protect the IP rights of American companies inside China under the rules of the World Intellectual Property Organization. So, Obama will press Hu to actually meet those obligations; and since China has recently begun to build its own R&D establishment, it’s an area where China’s interests and ours are beginning to align. The truth is, this is ultimately non-negotiable for the United States. But it also should prove to be a small price for China to pay for a solid economic relationship with the country that is not only one of its largest markets, but also its leading source of foreign direct investment into China –– including new technologies and business methods that are at issue in IP enforcement.

There’s less prospect of real progress on nudging China to revalue its currency, a recent hot-button issue for some prominent members of Congress. A stronger renminbi certainly would appear to be in our interest, since it would cut the price of U.S. exports inside China and raise the price of their exports inside the United States. In practice, it probably would make little difference to our economy. A stronger renminbi mainly would help companies in places which produce the same things as domestic Chinese companies –– places like Bangladesh and Thailand, not Michigan or Alabama. Yes, it would shave the price of U.S. products inside China –– but it would do the same for the products of our Japanese and European competitors.

Anyway, Hu has no intention of taking major steps in this area. Chinese leaders have always approached the value of their country’s currency as a matter of national sovereignty –– and the truth is, we don’t react very well either when China or the government of any other country criticizes U.S. monetary policies. And even if Hu approached this matter less dogmatically, it wouldn’t change that fact that the cheap renminbi is a critical part of the country’s basic strategy for strong, export-led growth; or that Hu and his fellow leaders see the success of that strategy as a lynchpin of their own political legitimacy. And while it won’t be mentioned this week, China’s long-term goal in this area is to claim for the renminbi part of the U.S. dollar’s role as the world’s reserve currency, which at our expense would help insulate the renimbi itself from future pressures to revalue.

Obama may get a more receptive hearing when he presses Hu to engage with the United States –– and the rest of the world –– on climate change. Both men know very well that China is now the world’s largest greenhouse gas emitter. That’s mainly because China has the world’s most ambitious program for building new electricity-generating plants; and since its only significant domestic energy source is coal, that’s what those plants run on. Hu also knows that the world will address this threat sooner or later –– and when they do, China cannot afford to sit on its hands. Obama’s challenge is the same one he faces with many Americans –– come up with a strategy that will raise the price of fossil fuels without imposing serious costs on the economy. Here at home, the answer to that riddle is a carbon-based tax with the revenues recycled for tax cuts in other areas. For China, Obama’s approach will have to be more subtle –– for example, intimating about a future agreement to promote joint ventures by U.S. and Chinese companies to develop and sell new alternative fuels and climate-friendly technologies.

These issues also give Obama the opportunity to drive home his case for new public investments at home –– in education and training, for example –– to expand America’s modest comparative advantage in fielding a workforce that can adapt easily to new technologies and business methods. This week’s meetings also could provide a platform to highlight his tax incentives for businesses, so they can make the investments required to better compete with Japanese and European companies in the Chinese market. And any meaningful U.S.-Sino discussions on climate change will dovetail nicely with the administration’s calls to expand R&D in this area, and so establish a more commanding position for the United States –– with or without China –– in global markets for green fuels and technologies.

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The Pitfalls of Economic Nostalgia

Wednesday, December 15th, 2010

The United States faces economic problems as daunting as any seen since the 1930s. GDP growth and job creation remain slow in the early stages of the current recovery, when both should be strong.  Moreover, the pressures of globalization, along with technological advances, have reduced the capacity of American businesses to create new jobs even when demand is strong.  These changes have boosted productivity, but most people’s wages and incomes remain stalled.  And in the most dynamic sectors of our economy, those technological advances increasingly demand skills beyond those of most working Americans.  These developments also have produced rapidly widening gaps in incomes and wealth, so that 20 percent of Americans now own 93 percent of the nation’s financial assets.  And the one asset that most families can claim, their homes, has lost an average of 30 percent of its value in the last three years.

Yet, Washington continues to respond to these challenges through an economics of nostalgia.  The economic agenda of most conservatives today consists mainly of tax cuts for those at the top who earn, save and invest the most, resting on an unflagging faith that markets are self-correcting and invariably produce the best possible outcome.   After all, this approach seemed to work in the 1980s — even if its reprise under George W. Bush led to nearly a decade of historically anemic job creation and stagnating incomes, and culminated in a disastrous financial meltdown and long deep recession of 2007-2009.   The progressive response amounts mainly to a series of stimulative spending and tax measures bolstered by virtually unlimited and free loans for large financial institutions to stimulate their own lending.   And while similar approaches worked in the 1960s and 1990s, the current iteration has produced the weakest recovery in decades.

The progressives are closer to the mark than the conservatives, because when the private sector underperforms as badly as ours has over the last 18 months, it needs stimulus of the sort currently promoted by the President and likely to pass the Senate this week.   But in an economy hampered by serious structural problems, stimulus alone cannot ignite strong and self-sustaining gains in growth, jobs and incomes.  To accomplish that, both sides need to put aside their traditional responses and consider new approaches that can directly address the structural problems holding back real prosperity.  Ironically, the most significant initiative to do so is the one program that the Administration gets the least credit for – the health care reforms or at last those parts which over time should slow the rate of increase in medical and insurance costs, and thereby help provide a foundation for faster job creation and wage gains.

These nostalgic economic nostrums seem to blind most of Washington to the necessity for a new economic strategy.  For example, it should be evident to all but the most ideologically-blinkered free marketers that the housing market has been dysfunctional for nearly a decade.  Moreover, the sustained decline in housing values has produced a “negative wealth effect” which continue to dampen consumer demand when the various stimulus measures run out.  Conservatives argue for letting those markets work their will, which would amount to another two years of slow demand and declining assets for most Americans.  A better strategy begins by acknowledging that declining housing values are a real problem, now driven by high levels of home foreclosures.  We can try to fix that with a new loan program to help families facing foreclosure keep their homes.  And if that strengthens consumer demand, it should also trigger significant increases in business investment – and together, both should generate real job gains.

The problem of slow job creation isn’t limited to our current circumstances – in the expansion of 2002-2007, American businesses created jobs at less than half the rate, relative to GDP growth, seen in the expansions of the 1980s and 1990s.  Much of this problem comes from the intense competitive pressures unleashed by globalization, which limit the ability of businesses to pass along higher costs by raising their prices, and therefore forces them to cut costs when, for example, their energy, health care or pension bills go up.  A reasonable response to this problem would be measures to lower the cost to businesses of creating new jobs.  For the short term, for example, we can give U.S. multinationals 18 months to bring back their foreign profits at a lower tax rate, but only if they already expand their U.S. workforces by 5 percent to 10 percent.  That would produce an estimated 750,000 to 1.3 million additional jobs.  For the longer term, we should consider cutting the payroll tax for employers on a permanent basis and using a carbon fee to restore the revenues for Social Security.

Similarly, neither stimulus nor the market alone can affect the growing mismatch between the IT skills required to excel at most well-paying jobs today and the training of most American workers over age 30 or 35 years.  For $300 million to $400 million a year – a fraction of the smallest bank bailout of 2008 or 2009 – Washington could provide grants to community colleges to keep their computer labs open and staffed in the evenings and on weekends so any adult could walk in and receive free computer training.  It’s also time to join the rest of the advanced world in recognizing that higher education has become as much a public good as elementary and secondary education.  Our idea-based economy now requires that government also ensure genuine low-cost access for both undergraduate and graduate training for anyone attending public colleges and universities, tied perhaps to a requirement for a year or two of public service.

This leaves us a major structural problem that at least Washington acknowledges – the prospect of damaging long-term deficits once the economy recovers, tied to fast-rising entitlement spending for retiring boomers.  The economics of nostalgia will be of little use here as well, but a view of a more effective strategy will require a separate discussion.

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Taxes and the Art of the Possible

Wednesday, December 8th, 2010

Barack Obama exhibited this week what Machiavelli called the essential quality of a successful statesman, “virtu,” or the capacity to advance a society’s vital interests while respecting the constraints of conditions beyond his control. The vital interest at stake here is a decent economic expansion that improves the circumstances of the vast majority of Americans, and the critical condition beyond the President’s control was the Republicans’ ability to block any tax increase for a very small minority of high-income households. While this week’s tax deal isn’t nearly enough to drive a robust recovery, it should be good economic news for most Americans.

Yes, the President agreed to two more years of the Bush tax cuts for very well-to-do people, covering their overall incomes, dividends and capital gains, and sheltering all but the very richest estates from inheritance taxes for two years. But those were concessions to conditions beyond his control, since without them, there would have been no action at all. Moreover, in return the President won the GOP leaders’ acquiescence to some significant help for nearly everyone else.  Beyond two more years of lower tax rates for average Americans, he secured expanded tax credits for parents putting their children through college, a one-year payroll tax reduction for working people, an expanded Earned income Tax Credit for working poor families, and an additional year of unemployment benefits for millions of out-of-work Americans.  

To be sure, that won’t be enough to drive a strong expansion. That still requires difficult measures to correct the distortions that brought on the original financial crisis and still continue to dampen the expansion.  A strong revival of consumer spending, of the sort that powers most early expansions, still depends on steps to stabilize housing prices. And while this week’s deal includes another dose of tax breaks for business investment, a surge in business spending will have to wait for consumers to begin spending freely again and for lenders to clear their books of billions of dollars in real estate-related investments that continue to deteriorate. Nevertheless, the deal passes the basic test of sound economic policy by moving the economy in the right direction, and should help nudge the jobless rate down a bit. 

The temporary nature of these measures also provides intriguing opportunities for Democrats.  The payroll tax reduction would expire one year from now, just as the 2012 campaigns get going.  Ultimately, neither party would let that happen, but the President could use its prospect to drive progressive social security reforms. For example, the 2 percent cut in the payroll tax rate for employees could be phased out very gradually, and the lost revenues could be offset by raising the cap on the wages subject to the tax. The 1983 social security reforms set the cap to cover 90 percent of all wages, rising each year at the same rate as average wages. But since the wages of those at the top have grown much faster than the average, today the cap covers only 85 percent of wages. Push it back to 90 percent, as the Bowles-Simpson Commission has proposed, and we could phase out the “temporary” tax rate reduction over a decade’s time and take a big step towards guaranteeing the system’s long-term solvency.

Moreover, the tax cuts for high-income Americans could be more vulnerable politically two years from than they are today. It’s safe to say that the deficit will be a hot-button issue in 2012, and with the Bush tax cuts now set to expire in January 2013, the election-year deficit debate will include heated arguments over who should have to pay higher taxes. According to current polls, at least, the public’s answer is those high-income folks. 

While the loudest complaints about the deal have come from progressive Democrats, the real question is why the Republicans agreed to it. For all of the GOP’s talk about jobs and deficits, the deal exposes their real bottom line: Preserve at almost any cost lower taxes on the incomes of the top 2 percent of Americans and on the estates of the top 0.5 percent. The deal equally highlights the President’s priorities — tax relief for the middle class, and help for the unemployed and the poor. And if the economy finally begins to gather steam by 2012, the contrast embedded in this week’s deal might well boost the President’s prospects.

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