On Economic Growth, Hillary Delivers and Trump Pretends

On Economic Growth, Hillary Delivers and Trump Pretends

September 26, 2016

To prepare for tonight’s debate, I decided to think through Donald Trump’s promise to deliver 4% annual economic growth. First off, if this is Trump’s goal, then his program is as much a fraud as his foundation or university. If anything, his proposals would slow our already modest growth. To be sure, no one has a silver bullet to raise the economy’s underlying growth rate. But that doesn’t mean we’re helpless, and Hillary Clinton’s program will almost certainly raise that growth rate.

Four percent growth is not unprecedented. Under JFK and LBJ, the economy grew an average of 5.2% per year; and Bill Clinton produced 3.8 % average growth over eight years, including five years of 4% growth or more. But they were exceptions: Ronald Reagan and Jimmy Carter each managed 3.4% average annual growth; George H. W. Bush and Barack Obama each achieved 2% annual growth, and George W. Bush eked out just 1.6% annual growth. Moreover, the Federal Reserve forecasts that the U.S. economy will continue to grow an average of 2% annually for the next decade. This forecast and the record under Obama and Bush II all suggest that strong headwinds are hampering America’s economic growth.

By the arithmetic, economic growth measures how much more goods and services the economy has produced in one year, compared to the preceding year. That tells us that two key factors for higher growth are how many more people have jobs producing goods and services, and how productive, on average, everyone is producing those goods and services. By the arithmetic, strong growth rests substantially on increasing the number of people with jobs and the productivity of the entire workforce.

One reason for the disappointing growth of the last 15 years is that the number of net new workers each year slowed sharply. For that, blame the decline in U.S. fertility rates that began 20 years ago, rising rates of retirement by aging baby boomers, the slowdown in immigration sparked by the Great Recession, and steady erosion in the labor participation rate (LPR). All told, the Bureau of Labor Statistics reports that the U.S. workforce is now growing .5% per year, down from 1.25% per year under Bill Clinton.

So, which candidate has proposed anything that would expand the number of Americans working? Both agree on spending more on infrastructure, but that will have modest effects on long-term growth. Beyond that, one striking feature of Trump’s immigration, healthcare and other proposals is their secondary effect of shrinking the number of people working in the U.S. economy.

 To begin, Trump’s signature pledge to deport 8 to 11 million immigrants would reduce the workforce directly, for those caught and deported; and indirectly, by forcing millions to take cover outside the mainstream economy. Similarly, his promise to repeal Obamacare would increase the time that millions of Americans have to spend out of work for health reasons.

Nor should anyone believe that his $4.4 trillion to $5.7 trillion in tax cuts will somehow induce more people to work — that particular supply-side hokum is refuted by the rising labor participation rate (LPR) after Bill Clinton raised taxes, and the falling LPR after Bush II cut taxes.

By happy contrast, much of Hillary Clinton’s program would have secondary effects that increase the number of people in the labor force and working. Her path to legalization for immigrants will allow an additional eight million adult immigrants to participate fully and openly across the economy. Her plans to broadly expand access to child care and provide universal pre-K education would enable millions of parents to reenter the workforce or move from part-time to full-time jobs.

Moving along, her pledge to achieve universal healthcare coverage, once fulfilled, will lessen the number of people forced to stay home or even give up their jobs for health reasons. Her commitment to pay equity, once met, will encourage more women to enter the workforce or to increase their hours at work, as should her pledge to expand employment for 53 million American adults with disabilities. Finally, Hillary’s plans for expanding access to higher education will raise the labor participation rate, because that rate tends to rise with education.

The arithmetic of growth also depends on how fast productivity increases – and progress in productivity, which grew 2.8% per year in the later 1990s, has collapsed: From 2011 to 2015, productivity increased just 6% per year; and over the first half of this year, productivity actually fell at a rate of .6% per-year.

Three factors are mainly responsible. First, business investment in equipment and other technologies has slumped. In addition, the gap between the skills many workers have and the skills they need has widened. Finally, it appears that the development and use of new technologies, processes, and ways of organizing and running businesses — in a word, innovation — has slowed.

Here, too, Trump offers nothing.  His huge tax cuts would balloon federal deficits, and so raise the cost for business borrowing to invest in new equipment and technologies. Trump also offers nothing to help workers improve their skills, and nothing to stimulate innovation and the broad use of new technologies.

By contrast again, Hillary’s agenda would actively promote progress in productivity. Her plans for tuition-free access to higher education will expand the skills of millions of young people, and her blueprint to reduce budget deficits will ensure that federal borrowing does not raise the cost for business borrowing to invest. Hillary also supports innovation by calling for expanded federal investments in basic R&D and promoting more public-private collaborations to commercialize that R&D. And since innovations often come from young enterprises, her program to expand bank lending for such companies is also well suited to promote innovation.

On economic growth, as on many other issues that will shape America over the next decade, Hillary delivers while Trump blusters.

 

 



The Politics and Economics of Obama’s New Climate Program

July 1, 2013

The Supreme Court’s blockbuster decisions on voting rights and same-sex marriage attracted most of the attention, but President Obama also moved decisively last week, on climate change. The facts that drove the President are scientifically undisputed. Increasing concentrations of greenhouse gas emissions in the earth’s atmosphere continue to raise global temperatures; and without serious action, the long-term effects on sea levels and climate could be catastrophic. Yet, climate-change deniers on the far right have a tight hold on a majority of congressional Republicans, who now won’t even acknowledge the threat. With no hope of reaching a reasonable accommodation, the President put forward new regulations that don’t need their approval — and ultimately will be less effective and more costly for average Americans than the alternatives which Congress won’t consider.

For a while now, most climate experts and economists have broadly agreed that the most efficient and effective way to reduce these carbon and other greenhouse gas (GHG) emissions is the direct approach: Raise the price of fuels based on the GHG emissions they produce, and so raise the price of all goods and services based on the emissions created to produce them. In principle, this approach could attract bipartisan support. It rests on one of the bedrock tenets of conservatism, the power of prices in free markets, as well as the liberal disposition to create national programs to improve the general welfare. Yes, the most straightforward way to achieve such climate-friendly fuel prices is apply a dreaded tax to all forms of energy based on their carbon dioxide (CO2) and other GHG emissions. But even that, in more placid political times, could be a basis for attracting broad support, since the revenues from a climate tax could be dedicated to cutting payroll, corporate and other, more economically-distorting taxes.

The truth is that every other serious approach to climate — from a cap-and-trade system to the President’s new regulations — also would raise prices: Directly or indirectly, they make it more expensive to use fuels that emit more than their share of greenhouse gases, relative to other fuels that damage the climate less. Over time, those price differences should gradually move millions of businesses and tens of millions of households to favor the cheaper, more climate-friendly fuels and technologies, and the goods and services produced using them.p-ajd

The sobering news is, we don’t have much time. Scientists warn that however broadly we might adopt the current generation of cleaner fuels and technologies, the atmospheric concentrations of CO2 and other GHG will soon reach levels that will produce serious climate changes. However, the economics of setting a clear and hefty price on carbon and other GHG would also create new incentives that could extend the frontiers of climate technology. If energy companies, scientists and entrepreneurs can be certain about the price of carbon and other greenhouse gases, looking forward — if they know how much more it will cost people to use climate-damaging fuels, compared to climate-friendly ones — that would create strong incentives to develop and adopt the next generation of climate-friendly fuels and technologies.

The question is, how efficient and effective are each of these approaches, and which is most likely to spur new advances? The question highlights the costs of the extreme right’s current hold on congressional Republicans, which drives the political stalemate on climate policy and has left President Obama with few options apart from executive regulation. His new regulatory agenda has three parts. It includes, first, higher energy-efficiency standards for appliances and buildings, aimed at reducing energy use whether clean or otherwise. There also are new loan guarantees for projects to reduce or isolate the greenhouse gases emitted by fossil fuels, and additional grants to develop more efficient biofuels. These guarantees and grants are designed to promote greater use of more climate-friendly technologies and fuels by reducing the cost of capital to develop them. While these measures provide a sense of the administration moving on many fronts, their combined impact on the climate crisis will be modest.

There is one measure that could matter a great deal more: The President has directed the EPA to develop new CO2 and other GHG emission standards for existing power plants. This follows EPA regulations proposed last year that set similar standards for new power plants. The logic is straight-forward: Set standards that will force utilities to rapidly shift from coal to natural gas and renewable fuels. This makes sense, since the use of cheap coal to generate electricity accounts for about half of worldwide carbon and other GHG. Shifting to natural gas worldwide would cut life-cycle GHG emissions by 20 percent, and shifting to renewable fuels would reduce those emissions by as much as 40 percent.

There is no doubt that sufficient regulation could move the United States to a path under which our GHG emissions would decline in a sustained way. But using regulation in this way will cost Americans a great deal more than a carbon tax with the same result.

Under the new regulation, existing power plants will have to develop and adopt new investments that meet a new, uniform standard by reducing their emissions from fossil fuels or converting their plants to use cleaner fuels. To begin, monitoring and enforcing such regulation will cost a lot more than collecting a tax. More important, the program suffers from the inefficiencies of most regulation, because some utilities will be able to meet the regulation much more cheaply than others, based on the state of their current plants. For example, plant A could reduce its emissions by a required unit by investing $1,000,000, while plant B could reduce its emissions by the same unit for $250,000, and by two units for $500,000. So, reducing emissions by two units under the regulation will cost $1,250,000, while plant B could achieve the same result for the climate under a tax or a cap-and-trade system for $500,000. Under all of these alternatives, most of the costs are passed along to the ratepayers and consumers. But a tax with offsetting tax reductions could return much of those costs to everyone. Based on a simulation from several years ago, those costs could average some $1,500 per-household, year after year.

Finally, while the new regulations should spur technological innovations to enable utilities to meet the standard more efficiently, the incentive to innovate will dissipate once the standard is met. By contrast, the economic incentives to develop and adopt cleaner fuels and technologies never go away under an emissions tax, since every incremental advance would reduce the tax and, with it, the price of energy.

This past weekend, President Obama also devoted his weekly address to his new climate program. He deserves credit for refusing to be cowed by his opponents’ intransigence. He could truly elevate his presidency, however, by taking the case for a carbon/GHG tax with offsetting tax cuts to the country, and beating his opponents on one of the most fateful challenges we face today.

 



A New Plan to Create Jobs—and Address Climate Change

May 20, 2010

The long-awaited climate proposal from John Kerry and Joe Lieberman (minus Lindsay Graham) is now on the table; and it’s clear already that it has no better chance of being enacted than other failed proposals before it. One informal count this past week finds 26 Senators likely to vote yes and another 11 probable supporters — a total of 37, against nearly as many “no” votes and probably no’s (32) and nearly again as many fence-sitters (31). Despite the lessons of Katrina, the global importuning of Al Gore, and the President’s pledge to solve the problem, support for steps to stabilize greenhouse gas emissions at safe levels hasn’t changed much in the last half-decade. The hard truth is, a serious climate program is unlikely to happen unless its advocates shift their legislative approach and retool their political strategy.

You don’t have to be David Axelrod (or Karl Rove) to appreciate why. In a period of widespread economic anxiety and populist anger, congressional sponsors of climate legislation have persisted in pushing a big, new Washington fix that would raise most people’s energy costs in the near term, on the strength of promises by scientists that doing so will lessen the chances of dangerous climatic changes several decades from now — changes which scientists cannot yet specify in any detail.

The cap-and-trade model long pushed by a handful of national environmental groups and adopted by Kerry-Lieberman and by Waxman-Markey in the House has other features bound to repel most Americans, especially the creation of a new, trillion-dollar financial market in federal permits to emit greenhouse gases, all to be managed and potentially manipulated by Wall Street. How many Senators are prepared to explain today, or any time for the foreseeable future, why the only climate plan they can come up with would raise everyone’s energy bills and enrich energy traders and executives at Goldman Sachs and JP Morgan Chase?

The planet needs a different approach. The answer is to marry a plan to create jobs with a funding mechanism to reduce greenhouse emissions. Earlier this year, the CBO reported that the single, most powerful policy tool available to spur job creation is a sharp reduction in the employer’s side of the payroll tax, targeted to new hires who increase a firm’s entire workforce and total payroll. The catch is that since payroll tax revenues are dedicated to fund Social Security and Medicare, we have to replace the foregone revenues. We can finance this job-creating cut in payroll taxes by enacting a new, carbon-based fee which also would address climate change.

To be sure, the new carbon fee — like cap-and-trade or, for that matter, EPA regulation — would drive up most people’s energy bills. But the cuts in the payroll tax would offset the higher energy costs, and the new jobs and higher wages spurred by those payroll tax cuts would leave most of us better off, along with the planet. While the emphasis on jobs would be new, this general approach is not. Most economists and many environmentalists have long held that a fee on energy based on its carbon content is the most economically-efficient and environmentally-effective way to accelerate the development of new, climate-friendly fuels and technologies, and spur businesses and households to adopt them. Such a “tax shift” is also the long-time position not only of Al Gore, but also such groups as Greenpeace, Friends of the Earth, and the U.S. Climate Task Force (which, in full disclosure, I chair with Harvard professor and former Gore aide Elaine Kamarck).

It’s time for climate activists to respect the priorities of most Americans. Congress should enact broad reforms to create new jobs, boost incomes, and strengthen the economy — and pay for these reforms with a new, carbon-based energy fee that would steadily drive down our use of fossil fuels and their dangerous greenhouse gas emissions.



A New Progressive Economic Strategy, Part 3: Tax Reform

April 22, 2010

The most dispiriting feature of this year’s economic debates, apart from their fierce partisanship, is the absence of a broad and encompassing view of what the American economy needs. In this series of essays, we’re laying out a new, progressive strategy to advance the central goal of an economic policy — namely, to ensure ample job opportunities, strong and widespread income gains, and upward mobility for most people.

The previous two blog-essays described, first, a series of initiatives to equip businesses and workers with much of what they need to succeed economically; and then, a new approach to contain the growth of federal spending, so we can control long-term budget deficits. This week, in part 3, we turn to taxes. The challenge is to rethink and reconfigure the federal tax system, so we can raise the revenues we need in ways which reinforce job creation and income gains.

Progressives should approach this challenge in three ways, covering in turn corporate taxes, personal income taxes, and energy taxes. The first step involves ending the major corporate tax subsidies for influential industries, much as our spending initiative would end large, industry-specific spending subsidies. These corporate tax entitlements range from tax breaks crafted for oil, gas and wind energy producers, and special inventory rules for certain exporters (and not for U.S. firms producing the same products for the American market), to billions of dollars in privileged treatment for insurance companies, credit unions, and housing developers. Ending these and other corporate tax breaks could not only set back influence-peddling for a while and simplify the federal tax code; it also would raise a boatload of new revenues. Half of those new revenues should go to deficit reduction, while the other half goes to lower a corporate tax rate that’s currently one of the world’s highest.

To the modest degree that the lower corporate taxes in Europe and East Asia encourage American multinationals to shift more of their operations abroad, this approach should help create more conditions for domestic job creation. And we can amplify this effect with a measure described earlier in this series, sharp cuts in the payroll taxes of employers who expand their overall workforce and payrolls. In any case, ending tax subsidies for influential interests will make the entire economy more efficient, because companies that never qualified for special treatment would no longer have to compete at a disadvantage with tax-protected companies, for capital and skilled workers.

Next, progressives should apply a similar and more sweeping approach to the personal income tax. The current, staggeringly complicated system is unsalvageable. Nearly 43 percent of all households pay no income taxes at all; and few of the 90 million households that do still pay it can figure out their own liability. What’s more, the responsiveness and accountability of a democracy erode when government is financed by a system that doesn’t affect more than two-fifths of the people and isn’t understood by the rest. The current income tax is also plainly unfair: Since different forms of income and spending are taxed differently, people with the same incomes earned or spent in different ways bear very different tax burdens.

Progressives should make a clean sweep of this entire mess by creating a single personal exemption of $100,000 to $150,000 that would supplant all current personal deductions, from mortgage interest and child care expenses, to capital gains and employer-provided health insurance. In one swoop, between 84 percent and 95 percent of all families would owe no income taxes, and the system would return to its origins when it affected only the very well-to-do. The affluent also would claim the $100,000 to $150,000 exemption, plus an unlimited deduction for new retirement savings. But every other dollar would be taxed at the 25 percent rate, regardless of whether the taxpayer earned or received it as salary, dividends, stock options, the “carried interest” of hedge and private equity fund managers, foreign royalties, or lottery winnings. This is progressive tax simplification with a vengeance.

Of course, a 25 percent tax on the income of only a small share of Americans will produce much lower revenues than the current system; and taking most people off the income tax could create powerful new pressures for more spending, if they know they won’t have to pay anything for it. So a new tax has to take the place of the income tax for most people; and the best candidate is an 8 percent to 10 percent value-added tax (VAT) that would cover everything people consume, except home purchases and rent, medical care, educational costs, and energy. Since the VAT would fall only on what people consume, not on what they save, it should have the same economic effect as the unlimited deduction for new retirement saving for higher-income people. Together, these provisions come close to eliminating taxes on new savings, enabling the country to finance more of its own investment and deficits without borrowing hundreds of billions of dollars a year from China, Japan, and Middle Eastern oil states. And the Earned Income Tax Credit can be scaled up to offset the cost of the VAT for lower-income families.

We exempt energy from the VAT, because energy is the focus of a third major tax reform, the enactment of a carbon-based tax to address climate change. Economists have long favored this approach over a cap-and-trade program, mainly because cap-and-trade creates more volatility in energy prices, which in turn harms the overall economy and weakens the incentives to develop new climate-friendly fuels and technologies. A direct, carbon-based tax, which will adjust the prices of different forms of energy in direct proportion to their harmful effects on the climate makes more sense economically and enevironmentally.

The last question for progressive tax reform is what we do with the $200 billion a year in new revenues which a serious commitment to address climate change would generate. Since the point of climate policy is not to make people poorer, but rather to induce everyone to use less climate-damaging forms of energy — most notably, coal — the answer is to recycle carbon-tax revenues through other, progressive tax cuts. One obvious candidate is payroll tax cuts, which would further reduce the costs for businesses of creating new jobs or raising the pay of existing jobs.

How much of these carbon-tax revenues could ultimately go to cutting payroll taxes — and how much might be reserved for deficit reduction — will depend on how successful we are in the other parts of this economic plan. If progressives can unwind special-interest spending and tax subsidies, contain health care costs, and put in place a broad VAT, the vast majority of carbon-tax revenues can go for tax cuts. Yet, the final results of all of these changes will also depend on how well we navigate the final issues for this plan, involving our role in the global economy. Those matters, including financial regulation, will be the focus of part four, next week.



Two Thoughts for President Obama on his Way to Copenhagen

December 16, 2009

With the President getting ready for Copenhagen, the EPA did what Congress would not: Put in place a policy to ultimately reduce carbon emissions. The EPA finding that greenhouse gases (GHG) pose a danger and thus trigger a process to reduce the risks through direct regulation has become the president’s only “deliverable” in Copenhagen. More important, the only forces that will ever prod Congress to take action on such difficult matter as climate are broad public opinion and pressures from powerful groups — and that’s where the real importance lies in the EPA finding and a series of additional rule-makings scheduled over the next year.

The finding and rule-makings should bolster the public’s existing opinion that serious measures to reduce greenhouse gas emissions action are required, while putting the fear of God in many business executives (or more precisely, the fear of unaccountable government regulators). And the threat that in the absence of congressional action, EPA may directly regulate the greenhouse gas emissions of every company in America is credible, given the Supreme Court’s recent holding that the law requires that EPA come to some finding about the dangers of those emissions. The only way for all the powerful groups that work so hard to stop or profoundly weaken climate legislation — see their most recent handiwork in the effective gutting of Waxman-Markey — is to enact a serious program that would preempt EPA. Are you listening, Big Coal? And climate activists should be on the same mission, once they consider what such regulation would look like under the next conservative Republican president.

The finding, however, could accelerate the search for new responses to climate change by broadening the debate beyond the cap-and-trade model which Congress has already rejected three times; and, if Kerry-Boxer ever comes to a vote, will almost certainly go down in defeat again. The leading alternative, of course, is a carbon-based tax with its revenues going to cut payroll or other taxes. It’s an approach that’s worked well in Sweden and now is being considered in France, Ireland and Denmark. Economists like it, because it doesn’t introduce additional volatility to energy prices as cap-and-trade does; and environmentalists like it, because a stable price for carbon is a prerequisite for businesses to invest large sums in developing and adopting alternative fuels and technologies. Now, if businesses can come to dislike the prospect of direct EPA regulation with enough fervor, a new consensus could emerge around a new way to address climate change.

Speaking of Copenhagen, let’s cut through the nonsense about the whole project foundering unless rich countries agree to pay for the climate efforts of poor countries. Climate change is almost entirely the business of the world’s developed and large, fast-developing countries, because poor countries simply don’t have enough electricity generation, factories, capital-intensive farming and automobiles to produce significant amounts of GHGs. In fact, the world’s three economically-dominant places — America, the European Union, and China — account for 55.5 percent of all emissions. Include twelve more nations — Russia, India, Japan, Canada, South Korea, Iran, Mexico, South Africa, Saudi Arabia, Australia, Brazil, Indonesia, — and you cover 85 percent of global emissions. Among those twelve, the only, barely plausible cases for assistance are India and Indonesia, although both are on sharply-rising growth and development paths that could soon generate the incentives and resources required to become more climate-friendly on their own. Ensuring that the world’s 120 or so other countries, most of them small and many of them poor, share some responsibility for addressing climate change is truly a secondary issue.

It’s also clear that at this time, virtually no country seems prepared to shoulder the cost of making even its own economy truly climate friendly, much less pick up the bills to make other countries less carbon-dependent. The best course is probably a business form of technology sharing, in which governments support the formation of joint ventures between developers in the United States, the EU and the other 12 or so large GHG emitting nations — especially, of course, China and India — to develop, produce and sell climate-friendly fuels and technologies. Then saving the planet could end up being good business for everybody.



Scoping Out “Plan B” for Climate Change

October 22, 2009

Beyond the public’s view, major players in the climate change debate are reassessing their options. In fact, as the prospects of Congress approving a cap-and-trade system fade, discussion is shifting to “Plan B.”

One reason is that the version of cap-and-trade which just barely passed the House of Representatives a few months ago, the Waxman-Markey bill, made so many concessions to polluting interests that its support among environmentalists has eroded badly. Here’s one indicator of just how weak the bill is: When it passed the House, bond ratings for coal companies improved — a remarkable development given that coal-generated electricity is the single largest source of greenhouse gas (GHG) emissions. In the Senate, progressives are said to be determined to oppose any legislation that ends up as weak as Waxman-Markey. And the moderates and conservatives who make up a majority of the Senate remain wary of climate-change engineering in a cap-and-trade form, since it would both raise energy prices for average Americans and make those prices more volatile for business. The upshot is that the prospects of corralling 60 votes for the Kerry-Boxer cap-and-trade bill in the Senate have faded to nearly zero.

In truth, the support for a cap-and-trade system always has been limited largely to a handful of sources. There are two large environmental groups — the Natural Resources Defense Council (NRDC) and the Environmental Defense Fund (EDF) — wedded to the notion of dressing up a regulatory cap on emissions with market-based trading in the emissions permits, and the Wall Street institutions eager to get a piece of all that trading and the speculation and derivatives it would throw off. In addition, a few large energy companies with major business lines in trading energy futures, including British Petroleum America and Shell, have been active supporters, as have some other companies confident they can exact the kinds of special exemptions for themselves that ultimately hobbled Waxman-Markey. Even that limited base has been shrinking: Wall Street support has become a big negative in the current political context, and there are reports that in the wake of Waxman-Markey, NRDC is now internally divided over the basic strategy.

With the fate of cap-and-trade in the Senate pretty much sealed — in effect, cap-and-trade’s third successive rejection by the Senate — the debate behind the scenes is moving to the alternatives. The two leading options are direct EPA regulation of GHG emissions or a revenue-neutral carbon tax. The courts recently held that EPA already has the authority to regulate GHG emissions, and the eclipse of cap-and-trade will shine a new spotlight on this approach. The alternative is one which a good share of the environmental community, most economists, and climate-change leaders like Al Gore have all supported: Apply a tax to energy based on its carbon content, and recycle the revenues as cuts in payroll or other taxes. Given how economically costly direct regulation can be — and the uncertainties about what such regulation would look like under the next conservative president, compared to our present liberal one — its prospect could quickly expand support for a carbon tax program. That approach also has the virtue of a successful record: While Europe’s cap-and-trade system has yet to reduce European GHG emissions, Sweden’s 15-year experiment with carbon-based taxes cut the country’s emissions sharply even as its economy grew 50 percent larger.

For its supporters, a carbon tax is simple, transparent, and produces a steady price for carbon which businesses can use to plan large investments in developing and adopting more climate-friendly fuels and technologies. To its opponents, it’s just another tax. That objection should be at least partly neutralized by recycling the revenues through other tax cuts — if the debate remains reasonable. In the end, environmental and business leaders, and ultimately the White House, will have to defend a carbon-based tax against the forces of politics as usual, which in this time seem dominated by the power of entrenched interests and the partisan politics of just-say-no-to-everything. If we can’t manage that, we may well lose the best chance in a generation to take serious action to defend the climate our children and grandchildren will inherit.


Read Rob Shapiro’s latest contribution to “Planet Panel,” The Washington Post’s online discussion on climate change policy: “What’s Really in Doubt.”



Noticing and Solving the Problem with Jobs and Wages

July 22, 2009

America’s vaunted job-creating machine has been breaking down, and the administration is finally noticing.

It was in 2003 when I first asked myself whether the dynamics that normally produce lots of new jobs when the economy expands were changing in some fundamental way. I had noticed that job losses during the mild 2001 recession were five to six times as great as expected, given the modest drop in GDP. Then we saw that in 2004, two years after the recession ended, the number of employed Americans was still falling, compared to the two months it took for job creation to turn around after the 1981–82 recession and the 12 months it took after the 1990–91 downturn. The evidence that America’s labor markets were undergoing structural changes of a nasty sort continued to accumulate. Just as employment had fallen several times faster than GDP during the 2001 recession, so once job creation finally picked up in 2004, private employment gains remained weak. Over the same period that saw 14 million new jobs created in the 1980s expansion and 17 million new jobs created in the 1990s expansion, U.S. businesses in the last expansion added just 6 million new jobs. Manufacturing was hit especially hard: From 2001 to 2004, manufacturing lost more jobs than during the entire “deindustrialization” years from the late 1970s through the 1980s, and those losses continued throughout the entire 2002–07 expansion.

With job losses in the current recession already two to four times greater than seen in the downturns of the early 1980s, 1990s and 2001, these dynamics are finally getting broader attention. Late last week, Larry Summers, the President’s chief economic advisor, acknowledged publically that what’s known as Okun’s Law has broken down. Arthur Okun, JFK’s economic advisor, observed in the 1960s that employment during recessions regularly fell by about half as much as GDP, in percentage terms, which he attributed to the costs employers bear when they fire workers and then have to hire and train again once the downturn ends. Nobel laureate Paul Krugman also weighed in last week, positing that recessions triggered by bursting bubbles — that would be 2001 and this one — affect jobs much more than those triggered by tight monetary policies to fight inflation (the 1974–75 and 1981–82 recessions, for example). It’s an intriguing thought, but it doesn’t appear to really jive with the evidence. The IT-Internet bubble that burst in 2000 certainly helped trigger the 2001 recession, but the downturn’s job losses, and the subsequent delayed and slow job creation, swamped the direct and indirect declines in demand that followed from the implosion of so many Internet and IT companies.

It’s much more complicated than that — and consequently, will be much harder to address. To begin, the changes in the way our labor markets work also have affected everyone’s wages. During the 1990s expansion, productivity increased by about 2.5 percent per-year, and average wages rose accordingly by nearly 2.0 percent per-year. That’s the way free labor markets are supposed to work: As workers become more productive, employers become willing to pay them more (and which competition forces them to do). But in the 2002–07 expansion, even as productivity grew 3 percent per-year — the best record since the 1960s — the average wage of American workers stagnated. And the most popular political explanation, blaming U.S. multinationals for outsourcing jobs abroad, doesn’t hold up here: Over this period, the number of workers abroad employed by those multinationals hardly rose at all.

This change is also getting more official attention. Last week, President Obama reminded everyone that economic expansion isn’t enough — and we’re still quite a way from any real expansion — since most middle-class Americans weren’t doing well even before the crisis hit and the economy tanked.

The administration’s agenda could go a long way to addressing these structural changes, if it’s done right. The most plausible explanation is that American jobs and wages are being squeezed by a combination of fierce competition created by globalization and our own failures to control health care and energy costs, two big fixed cost items for most businesses. The competition has made it much harder for businesses to pass along these higher costs in higher prices — an important reason why inflation has been so low for more than a decade, here and around the world. But that also means that when companies face higher health care and energy costs that they can’t pass along, they have little choice but to cut other costs. And the costs they’ve been cutting are jobs and wages.

The only way to ensure that the next expansion won’t be like the last one, but instead will create more jobs and bring higher wages, is to make medical cost containment the center of health care reform and make the development and broad use of alternative fuels, from biomass to nuclear, the center of energy and climate policy. That’s not where Congress seems headed. The House-passed climate bill will do little to drive alternative fuels for at least another decade, when a simple, refundable carbon tax could do the trick. And the most promising aspects of health care reform for cost-containment — a public insurance option and performance-based reimbursement — are both under serious congressional attack. If the President hopes to see more job creation and wage gains than under George W. Bush, these are the places where he should take his stand.



Sensory Overload Produces Sloppy Policy

June 24, 2009

Washington policymaking is caught in its own version of sensory overload. All at once, there are too many problems that seem — and actually are — urgent, mind-bogglingly complex, and politically ultra-sensitive to handle well. The result now emerging could be waves of ill-considered decisions.

Exhibit A is climate change. Taking serious measures to protect the planet’s climate and ecosystems by driving down greenhouse gas emissions comes as close to an imperative as exists in science-based policy. But a small group has used this imperative to try to force a decision quickly, without preparing the public or most representatives for how their cap-and-trade scheme would affect everybody — for example, by increasing the volatility of energy prices, and setting off frenetic Wall Street speculation in the emission permits created by cap-and-trade. That’s just the start of the sloppiness: the process of corralling the support to pass the measure in the House of Representatives — the vote is expected this week — has become a frenzy of giveaways that have cost the program most of its teeth and all of its bite. The result is the worst of both worlds: a measure that most environmentalists agree (at least privately) would do little about climate change, while unnecessarily harming the economy. Thankfully, the Senate is unlikely to go along. Once it fails there, perhaps we can get on to more serious and public deliberations about what will be required from all of us to shift to a less carbon-based economy.

Financial regulation is Exhibit B. The minimum for sound policymaking here has to be a genuine recognition of how our capital markets came to melt down and what irreducible steps can prevent it from happening again. We now know, to start, that the most prominent institutions in our financial system have operated for years in ways that create unsupportable levels of risk. We also know that their risky behavior wasn’t an accident, but the result of thousands of calculated responses to real incentives. The toxic combination here is what insiders refer to as limited liability plus leverage: the executives, managers, traders and dealmakers at Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup, Bank of America, AIG, Goldman Sachs and others could borrow unlimited amounts of money (the leverage) to enter into almost unlimited numbers of risky deals. For the deals that worked out, they pocketed enormous profits and additional compensation; and for those that went south, only the shareholders suffered. If the bottom fell out on thousands of deals at once, they also all believed that they would be both too big to fail and not too big to save — and but for the incompetence of the Bush Treasury in the Bear Stearns and Lehman Brothers cases, they were right.

Today, after $3 – 4 trillion in federal bailouts and federal guarantees, these incentives for undertake risky deals are even greater than they were before. And if the latest OECD forecast is right, and we should expect at best a weak and fragile recovery next year, the incentives to go for a killing will be even greater still.

Yet, most current proposals for new regulation would do little to head this off. Part of the problem with the financial system comes from simple size — firms that are too big to fail — yet none of the proposals even approach this issue. For example, we could debate scaling up a firm’s capital requirements with its size: The bigger it is, the less pure risk it can take on. And with the collapse of so many large institutions, the survivors are now even bigger. So here’s another thought we haven’t heard from the administration or Congress: Shouldn’t the rules of antitrust apply to finance?

We also know that part of the problem is the nature of the risks taken by these huge institutions: complex derivatives being traded outside regulated markets, and so not subject to the normal capital and governance rules applied to those issuing them or to the normal disclosure and transparency requirements applied to all transactions in regulated markets. So, requiring that all derivative-like instruments henceforth be traded on regulated public markets seems like a no-brainer. Perhaps sensory overload can help explain why the leading reform proposal preserves the right of those undertaking “large private transactions” in these derivatives to operate outside the regulated markets. If this sloppy decision stands, another element for the next market meltdown will be in place.

We also know that part of the problem lies in compensation arrangements that reward executives, managers, deal makers and traders for the highly-leveraged risks that pan out, but exact no costs for those that don’t. The issue here is not how big the bonuses are — that’s their business — but rather a structure that actually drives decisions to take unreasonable risks because they carry no personal price. Yet, for all of this issue’s urgency, addressing it among the hundreds of others demanding attention has apparently been too complex and politically-sensitive. Why can’t we have a serious discussion of creating a new SEC rule that would require a shareholders’ vote approving any compensation over, say, $1 million? Better still, how about a genuine debate about compensation arrangements that would claw back previous bonuses to reflect large losses by the same people?

Maybe everybody needs a break to clear their heads — and remember their principles. Let’s hope it happens before the new regulatory reforms for climate change and finance become law.



The Downfall of the Waxman-Markey Bill: Politics-as-Usual Meets Climate Change

June 2, 2009

The House Energy and Commerce Committee’s recent approval of the Waxman-Markey cap-and-trade bill presents a crucial test for serious advocates of measures to control climate change. It won committee approval with backing from some environmental groups that have promoted cap-and-trade for 15 years, as well as industry groups representing companies that produce most of our greenhouse gases. The disappointing fact is, the bill combines the inherent problems of cap-and-trade long noted by economists, with a long catalog of giveaways and exceptions for industries now supporting it.

By any measure, the bill would do little to address the climate challenge. For example, the International Panel on Climate Change figures that the United States will have to reduce its greenhouse gas emissions by 2025 to 25 percent less than in 1990. The official line is that the bill would cut emissions in 2020 to 17 percent less than 2005 levels — and that comes to just 3 percent less than the 1990 levels. Moreover, the actual reductions would be even less: Greenpeace has calculated that because the bill provides “offsets” to power companies and energy–intensive industries — letting them emit more greenhouse gases so long as they take “offsetting” steps such as planting trees — its actual caps “could be met without any reduction in fossil fuel emissions for more than 20 years.”

Or consider the bill’s implicit price for the permits to emit carbon. Climate scientists figure that a price of $50 per-ton of carbon dioxide should be sufficient to discourage people from using carbon-intensive fuels and encourage businesses to develop and adopt more climate-friendly energy and technologies. The bill, however, would end up pricing carbon dioxide at less than $20 per-ton, less than half the level needed to spur the green changes necessary to protect the climate. To make matters worse, it would give away 90 percent of the permits to the utilities and other industries that produce most of the emissions. The result, in the judgment of Carl Pope, head of the Sierra Club, is a “congressional bailout” for carbon-intensive industries, as well as a bonanza for Wall Street institutions that would happily reap windfall profits from the trading and speculation in some $1 trillion in new permits.

The bill also does nothing about the deep economic drawbacks of all cap-and-trade schemes. It has no provisions to prevent insider trading by utilities and energy companies or a financial meltdown from speculators trading frantically in the permits and their derivatives. It also ignores the basic conundrum of capping emissions when we don’t know what the demand for energy will be in any year — because we can’t predict how cold the winter will be or how fast the economy will grow. The result in every cap-and-trade system ever tried has been enormous volatility in permit prices. For example, the price of permits in the European cap-and-trade scheme moves up and down by an average of more than 20 percent per-month. Imagine that on top of normal fluctuations in energy prices, gasoline moved up or down by another 70 to 80-cents per-month. And without a predictable price for carbon, businesses and households won’t be able to calculate whether developing and using less carbon-intensive energy and technologies makes economic sense.

There’s a much better, more fair and progressive way to deal with climate change: Apply a steady tax of $50 per-ton of CO2 and use the revenues to cut payroll taxes and help average Americans deal with the higher energy prices, and to support climate-friendly R&D and technology deployment. It’s the approach long supported by Al Gore, by Jim Hansen, the NASA scientist who first drew public attention to climate change, by a growing number of environmental groups, and most recently, even by some large energy companies. Its only drawback is political: It can’t be easily gamed by powerful industry groups, and it’s not the approach a few environmental groups have used for a generation to recruit new members. With the planet’s climate lying in the balance, politics-as-usual has to give way to sound environmental and economic policy.



Efficient Markets and the Economic Meltdown

May 7, 2009

I found myself this week addressing the chairman of the SEC and three other commissioners at a forum on short sales, and the discussion illustrated how much the attitudes of some lag behind the realities of our current crisis. After the repeated meltdowns of numerous markets over the past year, the open minds at the forum belonged to the members of the SEC and not the other economists on the panel, who repeatedly cited now-outdated research to bolster their disdain for regulation and faith in the optimal outcomes of markets.

Plenty of people believe in “free markets,” but markets are never free, because without elaborate rules and regulations, they regularly run amok. Truly unregulated markets have no place for fiscal stimulus in deep recessions or even for central banks which regulate the supply of credit. Yet, without them, our business cycles could consist mainly of long recessions and runaway inflations. Thankfully, all but the economic version of wingnuts accept that over time, we learn many useful things about how economies behave and can craft rules that reduce the incidence of developments which can needlessly impoverish a society and increase the likelihood of other developments that enrich us.

Yet, in the face of the evidence all around us that, just to start, our many multi-trillion dollar markets for housing, mortgage-backed securities, and credit default swaps all had become profoundly dysfunctional, an esteemed professor from Columbia University, another from Ohio State, and a Nasdaq senior economist all insisted that regulation would interfere with our best of all possible worlds. This adamant refrain seems to be heard most often from those who study and participate in financial markets. While in our current condition, it seems to bespeak serious cognitive dissonance or a touch of economic insanity, it may come down to the simple fact that in recent years, those markets have been the special province of America’s richest people and companies. Regulation which could constrain their freedom to get even richer seems to be an offence against economic nature.

The particular context for this week’s SEC forum involved short sales, which some blame for turning blue-chip firms like Bear Stearns, Lehman Brothers and Merrill Lynch into penny stocks. They’re partly right and partly wrong: Short sellers weren’t responsible for the collapse of those firms and others, but certain abuses of shorts sales accelerated the process, with very damaging results for all of us.
First, a brief primer in how short sales work. Short sales are stock trades in which an investor bets that a stock will go down. He places that wager by borrowing a company’s shares from another investor (for a fee) and then selling them. If the stock declines, he can purchase new shares in the market to replace those he borrowed and pocket the difference between the lower price and what he sold them for originally. Short sales are a good thing for a market, because they signal that some investors have negative information or intuitions about the outlook for a company, a sector or the overall economy. The result is that a stock’s price can reflect all of the information available to the market.

But some short sellers don’t play by the rules and distort those prices. The biggest abuse is what’s called “naked short sales,” where an investor sells the shares, receives payment, but fails to borrow and deliver the shares. The system has a way of papering over the problem: The organization that clears and settles most trades in U.S. markets, the Depository Trust and Clearing Corporation, “borrows” the shares from its depository of all shares, settles the trade, returns those shares, and waits for the short seller to borrow them himself. Naked short sales contribute nothing to the market, since the value of the negative information depends on the short seller putting up the ante for his bet by actually borrowing and delivering the shares. Otherwise, short sellers can flood the market with so many “sales” that it drives down a stock’s price.

That’s part of what happened with Bear Stearns and Lehman Brothers. As they began to sink, their short sales went up four-fold — and their naked short sales increased 150 times. By the time of their collapse, each had tens of millions of naked shorts out against them. Those firms would have failed without naked shorts, but the flood of those abusive trades helped drive their sudden, chaotic, and unmanaged collapse. Imagine how much better off the economy might be today, if smart regulation had prevented the avalanche of naked shorts and the last administration had managed the demise of Bear Stearns and Lehman Brothers in much the same way that the current administration is managing the final days of Chrysler.

By the way, naked shorts aren’t just a problem of a few firms during a crisis. SEC data show that on any given day in 2007 or 2008, large scale naked shorts afflicted between 1,200 and 3,500 companies, across every sector and on all exchanges. And the number of outstanding “failures to deliver” — that’s the shares sold nakedly short — on any given day totaled between 500 million and 1 billion shares.

There’s a simple solution which other countries use: Require that short sellers borrow the shares before they sell them. At the SEC forum, some such answer seemed to hold some appeal to the new chair of the SEC, Mary Schapiro, and some of her colleagues. But suggest it as a way to protect average shareholders who unwittingly pay for stock that isn’t delivered until the price has already fallen, and to safeguard the rest of us from markets running amok, and the wailing about the optimal outcomes of unregulated markets can overwhelm you. This time, hopefully, it won’t deafen the SEC, the President and his economic advisors.