NDN Blog

A New Economic Challenge Facing Europe – and the United States

I spent much of last week in Geneva, Switzerland.  Even in that city of global institutions, in the European country most untouched by the continent’s sovereign debt crisis, most conversations found their way to hand-wringing over Europe’s economic decline.  As the Eurozone governments struggle to save their common currency, it is increasingly clear that the misguided austerity policies of many European governments have exacted large tolls on employment and growth.  Moreover, Europe’s economic problems will last much longer than the current debt crisis, even if it ends better than anyone now imagines.  One reason is that capital investment, the foundation of future growth, has been depressed since the crisis of 2008-2009. 

With capital investment persistently slow across most of Europe, political and economic leaders need to ask themselves, where would additional investment produce the greatest benefits?  One part of the answer is the same for Europe as it is here, in the United States.  Perhaps the single most important area of investment today lies in the telecommunication infrastructure, networks and devices on which business and social activity increasingly rely.  Earlier this year, NDN issued a new study I wrote with Kevin Hassett of the American Enterprise Institute on one aspect of this development.  We investigated the impact on job creation in the United States associated with the transition from 2G to 3G infrastructure and devices.  We found that this shift created almost 1.6 million jobs from April 2007 to July 2011, even as overall U.S. employment fell by nearly 5.3 million jobs over the same years.   

The current transition to 4G networks and devices should produce a similar economic bounce, so long as the necessary policies and capital investments are there to help drive it.  For example, since 4G involves more intensive data streams, the transition requires additional spectrum.  It will take strong White House leadership to ensure that the private investment needed to build out more spectrum and related, next generation IP broadband infrastructure are available to support 4G services.  In the process, these advances will promote the President’s larger goals of a strong recovery, job creation and universal broadband.  

Like the economy they enable, these technologies are inherently global.  So, the same dynamics apply to Europe, even in its current straits.  Throughout much of the 1990s, Europe had a real edge over the United States in advanced telecommunications, especially in the mobile or wireless space.  That is no longer the case.  Europe’s transition to 4G, for example, has been much more rocky than ours.  In its latest Digital Agenda report, the European Commission noted that while people and businesses in Europe “are generating enough digital demand to put Europe into sustainable economic growth,” this potential is undermined by a “failure to supply enough fast internet, online content, research and relevant skills.” 

Two years ago, the European Union set a goal of doubling its public investments in advanced telecommunications facilities and skills by 2020, which assumed annual growth in these areas of about six percent.  So far, the actual growth has averaged just two percent.  Moreover, private capital spending on 4G infrastructure across Europe also has lagged the United States.  In 2011 and 2012, American telecom companies invested more than $25 billion per-year in wireless facilities alone.  Yet, since 2007, comparable investments across the European Union, with a GDP slightly larger than ours, have been 15 percent to 40 percent less than in the United States. In response, European Digital Affairs Commissioner Neelie Kroes, warned recently, “Europeans are hungry for digital technologies and more digital choices, but governments and industry are not keeping up with them.  We are shooting ourselves in the foot by under-investing.”

The substantial effects on employment which we documented from the transition from 2G to 3G, and now from 3G to 4G, are signs of larger dynamics at work.  Across professions, industries and nations, Internet technologies have become integral parts of most economic activities and operations.  Moreover, with the advent and dispersion of 4G technologies, wireless Internet has begun to assume a pivotal role in these operations and activities.  National policy and business strategies ignore these developments only at great cost.  

To be sure, both Europe and the United States face special and more immediate challenges today, which neither has yet mastered successfully.  But the task of promoting investment in 4G infrastructure and networks is well within the capacity and understanding of all modern governments and businesses, and should be a national priority.  Fifteen years ago, in the transition to 2G, the United States followed Europe’s example, to America’s benefit.  Today, it is Europe’s turn to follow our spectrum policies and investment strategies. 

 

How Much Credit Can Obama Claim on the Economy?

Presidents regularly get the credit or blame for developments beyond their control.    Sometimes, they also get no credit or blame for the decisions they do take.  Barack Obama fits both molds.   A fresh example of the second pattern is the President’s surprising semi-breakthrough on European debt, at this week’s G20 meeting in Los Cabos, Mexico.  For months, President Obama and Treasury officials have quietly urged Eurozone leaders to do what it takes to avoid a sovereign debt meltdown, before they tackle long-term reforms.  This week, it looks like it might pay off.  According to reports, Obama emerged from a private huddle with German Chancellor Angela Merkel with her grudging agreement to use Eurozone funds to directly support Spanish and Italian bonds.  For the first time since the crisis began more than two years ago, the country with the deepest pockets has tacitly agreed to stand behind the full faith and credit of its member countries.  If these reports are true, this week’s agreement should hold off a full-blown debt crisis for a while, and with it the prospect of a deep global recession this year.   Yet, how many Americans will give Obama any credit for all this, come November?  

In a similar fashion, Mr. Obama inherited an economy seized by an historic financial meltdown.  His predecessor mismanaged the crisis so badly that it drove the country into the worst recession in 80 years.  Steeling himself against opponents united only by their partisanship, the President unleashed a flood of fiscal and monetary stimulus to arrest America’s downward spiral towards genuine depression.  Six months later, growth resumed and private employment began to increase.  Yet, in November, how much credit will voters give the President for avoiding the worst case scenario?

Instead, the President finds his reelection threatened by an economic reality he can do little to change — namely, that an economy shaken by financial crisis usually recovers very slowly.  In principle, to be sure, his administration might have done more to overcome the economic drag he inherited from Bush.  He might have pressed harder to stabilize the housing market with short term loans for homeowners facing foreclosure.  He might have tried harder to nail down a grand bargain for long-term fiscal balance.  

But the President also recognized the new political reality following the 2010 elections.  However hard he pressed or pushed Congress, neither deal was possible with Tea Party members calling the shots in the House, and Tea Party activists threatening to take down any Republican willing to work with the “enemy.”  Obama did successfully block the hard right program of slash-and-burn budget austerity, which almost certainly would have plunged the economy back into recession, as it did in Britain.  But once again, come November, how much credit will he get for avoiding another downturn? 

This President has shown that he can take care of himself politically.  He may not be able to point to the dismal hand he inherited from Bush, at least not without seeming to whine.  But he can point voters to the numerous troubling aspects of Romney’s economic record in Massachusetts and Bain Capital.  Obama also has the political advantage in many policy areas, since the public generally favor his approach to taxes, Medicare and Medicaid, higher education, and the deficit.

Unhappily, however, the economy is still far from safe and sound.  This week’s news from the G20 meeting will not settle the Eurozone’s economic problems. That leaves the President’s reelection still hostage to the sovereign debt crisis. On top of the Obama-Merkel meeting of minds, the other good news is that Greece’s new government should be able to avoid a precipitous default and chaotic exit from the Euro.  Eventually, Greece almost certainly will default and leave the Euro, but hopefully not before the Eurozone has prepared for it.  

The question remains, then, of what additional arrangements Frau Merkel will accept to reassure international investors that Spain and Italy will not follow Greece’s path.  Time is short, because Europe is already in recession, and such deals are usually pricey.  Moreover, at this moment, European leaders cannot even agree on whether the next step should be uniform banking regulation, a fiscal union, or expanded political authority for the Eurozone.  All of these measures are important for the Eurozone to become a stable economic entity.  But first, the Eurozone has to survive.  That will require what the President has called for all along – measures such as Eurobonds or central bank authority to guarantee that after Greece, no other Eurozone country will ever have to default.

Statement on Federal Reserve Report

Since late 2008, NDN and I have urged Congress to help Americans stay in their homes by taking steps to reduce foreclosure rates and stabilize housing prices.  These recommendations reflected basic economics: The worst recession in 80 years would inevitably exacerbate the housing bust as abnormally high foreclosure rates drove down housing values.  This, we predicted, would leave all American homeowners poorer.  Moreover, this “negative wealth effect" would dampen both consumer spending and business investment, producing a persistently slow expansion.  Congress refused to take steps, and unfortunately we were right about the results. 

Today, the Federal Reserve confirmed the negative wealth effect we have warned about.  The Fed calculates that U.S. families' median net worth fell by nearly 39 percent from 2007 to 2010.  Average net worth, which is pulled upward by high-net-worth people at the upper end of the spectrum, also fell by nearly 15 percent.  Moreover, the decline in people’s home equity accounted for 82 percent of the decline in the total median net worth of American homeowners.

Congress must finally act to relieve these pressures.  American taxpayers today own Fannie Mae and Freddie Mac.  One step Congress could take would be to direct Fannie and Freddie to provide temporary bridge loans to homeowners whose mortgages they hold and which are in danger of foreclosure.   To be fair to all homeowners, those who accept these loans would return to the taxpayers 20 percent of any eventual capital gain, in addition to repaying Fannie and Freddie for the loans.  This simple measure will help stabilize everyone’s housing prices and stem the negative wealth effect, producing at last a much stronger and more sustainable expansion. 

Update - Watch Rob talking about the report on the NewsHour tonight! (SR)

 

An Economic Program for the Fall Campaign and the Next Four Years

With the presidential election turning on the economy, the debate has focused on what’s right or wrong with the current recovery, and who’s responsible.  They agree that growth is too slow and deficits are too high; and unsurprisingly, President Obama blames the GOP for both while Mr. Romney blames the President.  The President’s arguments are stronger, especially given Romney’s risible claim that he can balance the budget and cut taxes another $5 trillion at the same time.  The larger point is that the high deficits and tepid expansion are legacies of the financial meltdown, and resolving them would only allow economic policy to finally move past 2008-2009.  The next stage of the economic debate, then, should focus on the two critical issues that have bedeviled middle-class Americans for more than a decade — namely, historically-slow jobs growth, and stagnating incomes.  

A presidential campaign can accommodate only a handful of big ideas.  Here, then, are three new policy initiatives to help reignite job creation and income gains:  1) reduce the cost of creating new jobs by reforming payroll taxes; 2) restore the foundation for middle-class wealth by stabilizing the housing market; and 3) enable everyone to become more productive by providing universal, low-cost access to college education and worker training. 

Tax reforms offer the best way to reduce the cost of creating new employment and keeping those already employed in their jobs.  The focus of such reforms is not the tax on corporate profits.  Yes, the corporate tax is an inefficient mess, but reforming it will do little for those looking for work.  The right target for job creation is the payroll tax, because it directly increases the labor costs of every employer.  The idea here is to stimulate job creation and employee retention by cutting the employer side of the payroll in half, and on a permanent basis.  And we can replace the revenues lost to Social Security with a carbon-based pollution tax. 

The second idea could help address slow job creation and the slow expansion, as well as widening inequality.  Employers have been creating relatively few new jobs not only because of the cost of doing so.  Employers also are not  confident about when Americans will begin to spend again like they used to, creating the demand for the goods and services which additional workers could produce.  The simplest way to boost demand is more budget stimulus – and good luck with that.  A more efficient way, however, is to remove any factors holding back normal consumer spending.  It’s not unemployment, with the jobless rate already down from 9.8 percent to 8.2 percent.  Rather, what continues to hold back tens of millions of consumers is the hard fact that the housing bust has left them substantially poorer.

So far, the bust has cost most homeowners one-third of the value of their homes.  This is a big deal economically, because home equity is the main form of wealth or saving held by most of the middle class.  Consider the following: The bottom 80 percent of Americans, measured by income, own just 7 percent of the value of the country’s financial assets – but they also hold 40 percent of the value of all residential real estate.  The sharp drop in housing values, therefore, wiped out most or all of the home equity built up by tens of millions of Americans.  Before most people begin spending again at the rate required to boost business investment and hiring, housing prices have to stabilize and begin to move up. 

 Washington spent more than $1 trillion to stabilize the financial markets, which generate most of the wealth of the top 1 percent to 20 percent of Americans.  For much less, we can stabilize the housing markets which generate the wealth of everybody else.  The most direct way to do this is to keep people in their homes by bringing down the current abnormally-high foreclosure rates.  Fannie Mae, which taxpayers now own, could extend low-cost, two-year loans to millions of homeowners facing foreclosure.  The funds could be used only for mortgages held by Fannie Mae.  And to control the moral hazard lurking in such relief, 20 percent of any capital gain earned from eventually selling those homes would go back to taxpayers.  

The third initiative would ensure that everyone can build the skills needed to earn a rising income by providing low-cost access to college education and worker training.  First, we could replace student loans with an expanded and upgraded form of national service:  Two years of service in the military or the Peace Corps, or three to four years service in Americorps, would earn any young person in-state tuition at a public college or university for four years.  Young people considering college would be asked to give something of themselves back in service to the country, and would no longer have to face huge debts that can take decades to work off.  In addition, every working American should have access to additional training in the information technologies integral to virtually all industries and jobs.  The plan here is one that Mr. Obama supported when he was in the Senate – provide grants to community colleges to keep their computer labs open and staffed in the evenings and on weekends, so any adult can walk in a receive free instruction. 

This agenda is forward-looking rather than present-oriented, so it does not address the deficit.  In truth, everyone knows perfectly well what to do about it.  Simpson Bowles, Domenici-Rivlin, the Senate Gang of Six all rely on the same formula: Raise new revenues, reform Medicare and Medicaid, cap discretionary spending, and reduce defense spending.  This approach, which President Obama supports, broke the deficit logjams in the 1980s under Ronald Reagan and the 1990s under Bill Clinton.  The only thing standing in its way today is the intransigence of extreme conservatives who would rather see the U.S. default on its sovereign debt than consider raising taxes.  We can only hope that the public will continue to rally around this balanced approach and convince House Speaker John Boehner and Senate GOP leader Mitch McConnell. Once that is done, we can turn to the real business of restoring jobs and income gains.

A Primer on the Eurozone Crisis and How It Could Affect Us

The economic viability of the Eurozone continues to slowly leech away.   The latest iteration of the crisis originated again in Athens.  Last week, voters there chose parties on the left and right that agreed on one thing:  No more austerity, including measures already agreed to in exchange for another bailout this summer from the European Union (EU) and the International Monetary Fund (IMF).  The popular revolt against austerity could not have been a surprise.  Greece has seen its GDP shrink 20 percent, its unemployment rate reach 22 percent, its state pensions and government salaries slashed by 30 percent, and the real hourly wages of Greek workers decline 15 percent.  Yet more austerity, designed to assure global investors that Greece will not default on its debts, could mean another 15 percent decline in wages and another 10 to 15 percent drop in GDP.  The Eurozone plan, in short, asks the Greek people to accept an extended depression and sharply lower incomes in order to reassure European bankers.  

To be sure, most governments have to reassure global investors that their bonds are sound and their private sectors produce healthy returns.   What is unique here is that until the financial crisis blew Greece’s cover, it had deliberately misled the EU and global markets about its deficits and debt.  Using a scheme concocted by its Goldman Sachs advisors, the Greek government moved a significant part of its deficits and outstanding debt off its balance sheets.  And Goldman’s scheme was so complex and exotic that nobody grasped the deception.  Without hard guarantees from the Eurozone, foreign investors are unlikely to trust Greece for a long time. 

This Eurozone crisis has other singular features.  Most important, the basic arrangements of the Eurozone hobble Greece’s efforts to recover.  In good times, the euro gave Greece greater access to capital markets than it could ever manage on its own.  But in the bad times that have followed, Greece has found itself carrying crippling debt and unable to devalue its way to competitiveness.  So, Greece is forced to depend on EU bailouts and the willingness of the European Central Bank (ECB) to accept Greek bonds as collateral for new loans to European banks.  The price for these concessions has been drastic austerity.  Imposing more austerity on an economy already in a deep downturn was a formula for economic depression and political upheaval – and Greece now has both. 

What does this mean for the U.S. economy?  The crisis could reach a climax in matter of weeks, dealing another nasty shock to the recovery.  Both sides, however, have good reasons to delay the day of reckoning at least one more time.  That means that it is just as likely that the next president will have to deal with this shock.  So, if not next month then early next year, it seems likely that the Greek government will formally reject more austerity.  With their credibility on the line, the EU and IMF will almost certainly suspend future bailout payments, and the ECB will dial down its indirect supports for Greek bonds.  Without those measures, Greece will default on its sovereign debt in a matter of days. 

Even if the result is inevitable, a delay of several months will let everyone prepare for a Greek default and exit from the Eurozone.  The Eurozone has no rules or provision for kicking out a member.  But without the Eurozone’s continued support, Greece will have to quit:  Only by leaving can Greece reissue the drachma and let it devalue sharply.  Everything Greek will be available at fire sale prices, which will attract foreign investors and make Greek exports price competitive.  Greece and its people will be left a lot poorer, but that’s also now inevitable. 

For everyone else, the main danger is contagion.  Once the Eurozone lets Greece go, global investors may decide it is time to get out of all risky, European sovereign debt.  That would include the huge markets for Italian and Spanish sovereign debt – and if that happens, the crisis would quickly go global.  Every bank in Spain and Italy carries large portfolios of its own governments’ bonds.  That’s why many big depositors at those banks are already shifting their funds to German banks.  Already weakened, the Italian and Spanish banks would be bankrupted by a sharp drop in the value of their government bond holdings.  The Eurozone’s emergency bailout facility can spend up to € 500 billion buying up falling government bonds and providing capital to faltering banks.  But if Italy or Spain teeters on default, that won’t be nearly enough to rescue them. 

That would bring the world, including the United States, back to 2008.  French and German banks also have huge holdings in Spanish and Italian government debt.  Our banks do not.  But once again, nobody knows how many credit default swaps our institutions have issued for European sovereign debt and the Eurozone banks that hold them.  If U.S. financial institutions issued those swaps in large numbers, or simply have large transactions going with European banks caught up in the contagion, the meltdown could lead to a new American financial crisis.  After this week’s revelations about the reckless bets taken out and lost by J.P. Morgan Chase, there should be little doubt that our financial system would be very exposed to a full-blown Eurozone crisis. 

The Eurozone could have resolved all of this some 18 months ago, and at relatively modest cost.  That would have required that German Chancellor Angela Merkel accept the basic rule of every monetary union, that the full faith and credit of the whole stands behind the full faith and credit of its parts.  And the instrument for doing so would have been the ECB.  But that posed short-term term political costs for Merkel. 

Last week, the President of the Federal Reserve Bank of Kansas City, Esther George, noted in the Globalist that, “the current [Eurozone]crisis is following much the same pattern of previous financial crisis – an inability or unwillingness to see the warning signs and take preventive action, followed by massive damage …”  So, we have been have been here before, substituting the ideological blinders of Henry Paulson and his colleagues in Bush administration for those of Merkel and her confederates.  We all know how that worked out last time. 

A New Way to Boost Job Creation -- and Help Save the Planet

U.S. growth slowed sharply in the spring of both 2010 and 2011; but it looks like this year, the economy may have fin ally shaken its good-weather jinx.  New home sales are up and foreclosures are down.  Housing prices are still falling, but at a progressively slower rate which may signal that home prices are bottoming out.   Businesses added only 130,000 new jobs last month, but the jobless rate and first-time jobless claims keep falling.  Perhaps, it’s a case of, “been down so long it looks like up to me.”  But it is a recovery.  Yet, it can still use a boost.  As the Financial Times wrote last week, “in the US, the case for fiscal stimulus is strong.”   

That case is based on what economists call the “output gap.”  An output gap is the difference between the value of everything the economy produces, and what it would produce if it operated at peak efficiency, making the best use of its available labor and productive capacity.   This output gap today is probably 5 to 6 percent of GDP, or a growth shortfall of $770 billion to $930 billion.   That’s why the Federal Reserve continues to keep short-term interest rates near zero, and why global investors have kept U.S. long-term rates at historical lows.

Such a large output gap also helps explain why job growth is so slow.  In the 34 months since U.S. growth first resumed in July 2009, private-sector jobs have increased by just 3 percent.  Compare that to nearly 12 percent gains in private sector jobs in the first 34 month following the deep recession which ended in November 1982.  Part of the reason for much slower job creation this time lies in the “batten down the hatches” response by most middle-class Americans to the destruction of much of their wealth in the housing crash.  However, another part of the reason lies in structural problems evident in the last expansion.  In the first 34 months following the 2001 recession, private sector employment grew by less than 1 percent -- and whatever caused such tepid job creation has not gone away.  

So, the American economy needs today a dose of short-term stimulus plus initiatives to help spur job creation on an on-going basis.  And whatever is done cannot make long-term deficits worse.  The candidate who can solve that puzzle would earn the White House.  

Here are some ideas as a start.  First, shift the tax burden off of job creation and work, with a big, permanent payroll tax cut.  That will reduce what employers pay when they create jobs and what workers and companies pay when people work.  Over the next 10 years, payroll tax revenues for Social Security retirement will average $770 billion per-year.  Cut that in half, and you reduce the tax burdens on job creation and work by some $385 billion per-year.  

The government can raise that kind of money in only three ways – higher income taxes, a new value-added tax, or a new energy tax.  Nobody has ever claimed that higher income taxes or a new VAT help create jobs – but the right energy tax just might do so.

The right energy tax here is a carbon-based fee.  It could be phased in over several years, which combined with lower payroll taxes would give the economy some short-term stimulus targeted to both job creation and consumption.  It could be phased up until it replaced all of the lost payroll tax revenues, ensuring that it wouldn’t make deficits worse over the long-term.  And most Americans would be no worse off with the higher energy prices, because their payroll tax payments would shrink by at least as much.  

Business, including big energy companies, also could come out ahead.  One of the few things that economists, energy experts and environmentalists generally agree on is that a carbon-based tax is the most efficient way to limit climate-warming, greenhouse gases.  That means a broad carbon tax program could preempt future EPA regulation of greenhouse gases – just like the cap-and-trade program that passed the House of Representatives in 2009 did.  

A broad carbon-based tax would make all low-carbon fuels – solar, wind, biomass, and nuclear – more price competitive.  Embed those price changes in an economy as innovative as ours, and entrepreneurial resources and energy would quickly flow into ventures to improve those fuels and make them widely available.  All of those new ventures would create new jobs.   

Finally, we could give this whole process a turbo-charge.   Today, any family or small business can generate its own energy by installing solar panels, as can farmers and larger businesses with larger solar or wind facilities.  And when they generate more energy than they can use, they can sell the excess back to the local utility.  Few families, farmers or businesses do so today, because fossil fuels are still relatively cheap, and the alternatives require hefty initial investments.  

The carbon tax itself will make those fossil fuels less price-competitive, relative to the cleaner alternatives.  Moreover, as Germany and Britain have demonstrated, entrepreneurs will buy and install solar or wind energy for homes and businesses at no charge – so long as government guaranteesw that the utilities will pay a decent rate for the excess power, and the entrepreneurs can get a reasonable cut of those payments.

The mechanism to create those conditions is called a “feed-in tariff,” and Germany and Britain borrowed it from a U.S. program enacted under Jimmy Carter.  It didn’t work here last time, because alternative fuels weren’t sufficiently developed, and oil prices fell sharply in the 1980s and 1990s.  Both of those stumbling blocks no longer apply today.  

In a country as innovative and entrepreneurial as the United States, the combination of a carbon-based tax and a feed-in tariff should drive enormous new investments and advances in renewable energy, with unknown but possibly large-scale economic benefits.  And a widespread dose of decentralized, renewable energy production would create a lot of new jobs just to install and maintain the equipment.

Everybody wins.  The economy gets a short-term boost as taxes on job creation and work go down.  The revenues for social security are replaced with a new arrangement that reduces the risks of climate change, without restrictive new regulation.  Innovation accelerates in areas likely to generate lots of new jobs down the line.  In a sensible political environment, it could be the kind of idea that a smart politician might use to win the presidency. 

Is the United States Really Facing Economic Decline?

A growing chorus of pundits and politicians, along with a few policy intellectuals, are pressing a new debate over whether the United States is in economic decline.  The question is usually posed as a yes-or-no proposition, but the economic facts tell a more complicated story.  The United States is experiencing an economic transition; and while that transition may actually make American stronger economically, it involves serious and unanticipated costs for the majority of Americans.  The result is a real specter of decline that threatens not the U.S. economy, but the American middle class.  The best answer, therefore, lies in helping the middle class without running roughshod over the economy. 

The current sense of economic decline is closely linked to new concerns about economic inequality.   As we have discussed in this space before, income inequality has been gaining steam for nearly 30 years.  From 1977 to 2007, the share of income earned in the United States which the top 1 percent claims every year soared from 8.7 percent to 23.5 percent.  Yet, until the last decade, most middle-class Americans and those striving to join them still made progress.  From 1983 to 2000, Americans in the third income quintile, smack dab in the economic middle, and the two quintiles below them saw their real incomes grow, year after year, by an average of 1.3 percent per-year.  To be sure, those in the fourth income quintile did a little better, registering annual income gains of nearly 1.7 percent, and Americans in the top-earning quintile did better still with annual gains of more than 4 percent.  And, of course, the top 1 percent way outpaced everyone else by a country mile:  Their incomes grew by an average of nearly 10 percent year after year from 1983 to 2000.   So, steady progress for most middle-class Americans accompanied growing inequality. 

That progress ended a decade ago.  From 2000 to 2007, the middle-class and those below them saw annual income gains averaging less than one-half of one percent; and those meager gains turned to big income losses in the financial crisis, deep recession and slow recovery which followed.  The sense that the economy itself is in decline has been reinforced by comparable income stagnation and then losses by those in the fourth quintile.   Only the top 10 percent, and especially the top 1 percent, saw healthy income gains from 2000 to 2007.  And while the wealthy suffered big setbacks when the markets crashed in 2008, those markets have recovered, as have those incomes. 

Yet, for all those problems, the evidence also shows that the overall economy is not in decline.  Over the last 10 years – and the last 15 and 20 years, too -- the United States has posted the strongest growth and, by far, the greatest productivity gains of the large advanced economies.  From 1990 to 2010, through two serious recessions and one mild downturn, the American economy grew by an average of more than 2.6 percent per-year.  That growth compares to annual averages of less than 1.5 percent for Germany and Japan, 1.8 percent for France and 2.4 percent for Britain.  And those differences were just as large for the last decade.

Over the same two decades, multifactor productivity across the U.S. private economy increased by more than 60 percent.  The Bureau of Labor Statistics reports that real U.S. output, per-hour worked and dollar invested, grew at an average annual rate of 2.2 percent in the 1990s and then accelerated to 2.6 percent per-year from 2001 to 2010.  That’s the best record in 50 years.  The OECD has its own measures for multifactor productivity.  It also reports that over this period, the average annual productivity gains of the American economy outpaced those of Japan by 30 percent, those achieved in France by 40 percent, and those seen in Germany by an astounding 70 percent.  

We have some idea about why this is happening.  Much of it, as expected, involves innovation.  Especially critical here are the successive advances in information and communications technologies and, even more important, their successful application by virtually every business across the U.S. economy.  This is the essence of an on-going transition to what is popularly dubbed the “idea-based economy.”  Stated a bit more precisely, the American economy is developing in ways which increase the intellectual capital and consequent value embedded in most economic goods, services and activities.  This has been happening not only in manufacturing, but across service industries from retailing and hospitality to traditional business services.  There is even evidence that public organizations, including education and government itself, have begun to successfully absorb these new technologies and new ways of doing business.   And for many reasons, the United States is better than Japan and most of Europe at broadly applying these technological and organizational innovations. 

That’s why the productivity advantages of the U.S. economy, compared to most other large advanced economies, have actually increased.  The result is that per capita income in 2011 was between 26 percent and 40 percent higher in America than in Germany, France, Britain, or Japan.  And those gaps take account of the cost of living in each country, as well as the sharp income declines seen here in 2009 and 2010. 

Setting aside the sustained recklessness of America’s most sophisticated financial institutions, the U.S. economy has clearly performed well for the last generation.  Yet, for reasons we do not fully understand, this ongoing transition to a highly-productive, idea-based economy is altering how the benefits of that productivity are distributed.  A piece of the answer lies in the changing value of people’s skills.  Those who can neither produce new ideas that generate value, nor work efficiently with ideas and the technologies that manage them, find themselves struggling in every sector.  Their numbers include most of the bottom 40 percent or so of American workers.  Beyond that, much of the value of the strong productivity gains produced by this economy is eaten up by rising fixed costs for most businesses, especially the fast-rising costs for energy and health care seen since 2000.  The people whose incomes are squeezed by those forces include the rest of America’s middle-class.

The best response here is to lift up the middle class without undermining this productive economy.  That means expanding public and private investments in research and development, infrastructure and, above all, the education and skills of working people.  It also means serious measures to ease the burden of health care and energy costs on businesses and families.  Through taxes, regulation or new incentives, it’s time to drive much greater energy efficiency in American workplaces and homes, and to bend the curve of rising health care costs.  That is where the next President will have to start, if he hopes to head off the real decline of the American middle class.

 

The Costs of Overturning the President’s Health Care Reforms

Partisan politics and constitutional principles received equal billing in last week’s showdown over health care at the Supreme Court.  Much of the commentary has tried to interpret the questions, gestures and tone of the Justices, in hopes of divining which party and vision of government will likely prevail.  Such divinations are notoriously unreliable in controversial cases.  But whatever the Justices decide, the decision will have enormous long-term economic effects on how much medical care average Americans receive and how much they pay for it.  

It has been clear for some time that without major reforms, the U.S. health care system will soon impose unmanageable burdens on millions of middle-class Americans.  By 2016, the average family is expected to earn about $54,000.  In that year, moderately-priced, family health-care insurance coverage will cost about $14,700.  Employers will pick up much of that tab for most middle-class families.  But all of those employer payments come out of people’s wages and salaries.  So, adding the value of that coverage to the average family’s income in 2012 -- $54,000 + $14,700 = $68,700 – we see that the cost of the health care insurance alone will soon claim more than 21 percent of an average family’s annual resources.

On top of that, by 2016, the average family’s co-payments and other uninsured expenses are expected to come to another $5,100.  Our average family also will pay taxes to help cover other people’s health care – 2.9 percent of their wages for Medicare ($1,566), plus perhaps $1,000 more in federal and state taxes for Medicaid and Medicare costs not covered by the payroll tax.  Add all of that to the cost of their insurance, and health care will claim $22,366 from an average family in 2016, or 32.5 percent of their adjusted income of $68,700.

Why should the average American family have to pay nearly 33 percent of its income for a health care system which by 2016 should claim about 18 percent of GDP?  Part of the answer is that the average worker earning $68,700, a manager making $150,000, and the CEO earning $5 million all pay roughly the same $14,700 for their family coverage.  The result is that middle class families spend a much larger share of their income on health care than wealthier families.  

One of the reasons why health insurance costs middle-class families so much, however, is that their bill includes a good share of the costs of treating those without insurance.  The tab for treating the injuries and illnesses of more than 50 million Americans with no public or private coverage will come to about $68 billion this year.  Government picks up some of those “uncompensated costs,” and doctors and hospitals eat some of their costs.  But most of the rest is passed along in lower payments to insurers, who in turn pass along those losses to their customers in higher premiums or reduced coverage which drives up out-of-pocket costs.  A reasonable estimate of the costs of treating the uninsured which are passed along to average policyholders is about $300 per-person, or some $1,200 for an average family.

The President’s plan to end those pass-along costs by mandating universal coverage was, of course, the central issue in this week’s arguments at the Supreme Court.  And behind the high-minded debates over principle lies the harsh politics of who is to pay for it.  The President’s reforms shift most of the costs of the uninsured to the government by expanding Medicaid and providing subsidies to uninsured people and families mandated to get coverage.  These costs ultimately will be financed through non-payroll taxes – the personal and corporate income tax – which in turn fall disproportionately on higher-income Americans.  That is the choice, and it helps explain the vehemence of the partisan battle over the mandate:  The President’s reforms will shifts tens of billions of dollars in annual costs from middle-class families with private insurance to more affluent taxpayers. 

The good news for the well-to-do if the President prevails is that the new reforms also include measures to contain the future costs of covering those without easy access to insurance.  To begin, covering the uninsured should reduce the cost of their care, at least over the long-term.  Uninsured people are much more likely to suffer strokes, for example, because they are much more likely to have undiagnosed hypertension, diabetes and high cholesterol.  Or, among people with cancer, the uninsured today are much more likely to be diagnosed later, and so require the most expensive interventions.  Uninsured people also are less likely to fully recover from many injuries, making them more likely to suffer subsequent medical problems that require more treatment.   Ensuring that everyone has insurance, therefore, should reduce those costs. 

The reforms also include a package of measures that may begin to slow the health-care inflation which for years has been eating away at everyone’s insurance coverage.  These measures range from the push to establish uniform electronic medical records, to a more results-based reimbursement process for doctors and hospitals, and steps to encourage them to adopt more cost-efficient medical protocols and practices.  To be sure, the reforms do not include the most controversial and partisan cost-saving measures, including tough medical malpractice reforms and an option for public insurance in places where competition among private insurers is weak.  Still, they are a beginning.  

After Bill and Hillary Clinton’s push to reform health care failed in 1994, it was 15 years before another President and Congress took up the issue again.  If the Supreme Court unravels what they did, it almost certainly will be many more years before anyone tries again.  The economic consequences of that scenario would be inescapable.  The number of uninsured people and families will continue to grow.  The costs of their treatment will continue to squeeze coverage and increase the costs of private insurance for most middle-class families.  And without measures to “bend the curve” of medical cost increases, average families will find themselves forced to spend one-third or more of their real incomes on their health care.  

A Modest Proposal to Help the U.S. Avoid an Economic Train Wreck

The United States is headed for an economic version of a Wall Street “triple witching hour.”  In finance, a triple witching house comes along four times a year, when options contracts on stocks, options contracts on stock indexes, and futures contracts of those indexes all expire at the same time on the same day.  Washington’s own version will unfold at midnight, December 31, 2012.  That is the moment when, at once, all of George W. Bush’s tax cuts expire, President Obama’s payroll tax relief ends, and the grace period before $1.2 trillion in across-the-board cuts runs out.  If the President, Congress and the two parties cannot finally agree on what to do about spending and revenues, their doing nothing will actually solve most of the U.S. deficit problem.  But all of that austerity coming at once would also shut down the U.S. economy.   

We actually face something close to a quadruple witching hour, because sometime in late-December or early-January, within days or weeks of everything else, the U.S. debt limit will run out again.  The irony is that if the lame duck Congress and possibly a lame duck President cannot resolve these matters, the United States could face a technical sovereign debt default even as its political gridlock carves out a sustainable path for its government debt.  Given how tortuously difficult it has been to resolve any one of these issues thus far, on even a temporary basis, the health of the American economy demands some new political thinking.

The range of scenarios for the post-election period is mind-boggling.  For example, conservatives might be tempted to trade a multi-year extension of payroll tax relief for permanent status for all of the Bush tax cuts.  A newly-reelected President Obama might consider agreeing if, say, the Republicans also would agree to find some new revenues from other sources and fold in a multi-year extension for the debt limit.  (Good luck with that.)  And if Romney wins the White House, congressional Democrats could call his bluff, let him enter office with a sinking economy, and then force him to negotiate with a Senate Democratic caucus able to block whatever a GOP House passes.  Or, in what would pass for a rosy scenario here, everyone may be so exhausted from the years of political trench warfare that all sides agree to extend everything for several more months, so the new Congress and whoever is President can try to work it all out. 

Whatever the election results, the debate over taxes and the budget will dominate our politics and government through at least the first half of 2013.   In fact, that happens nearly every four years.  Since Ronald Reagan’s first term, most Presidents have figured out that they can use their initial budget and tax initiatives to carry most of their agenda – and that their sway with Congress will likely only erode with time.  To be sure, this initial focus on budget and taxes made more sense when Washington still knew how to forge bipartisan compromises.  The question today is, can any president get the current crop of Republicans to sign on to any plan that includes new taxes?  And without that concession, could any president persuade congressional Democrats to reform Medicare and Social Security?

If taxes and entitlement remain off-the-table, there can be no grand bargain and no resolution.  For the short-term, the United States instead will face auto-pilot austerity.  More important, the patience of global investors with our stumbling political process could run out, which would mean rising long-term interest rates.  If that happens, the U.S. expansion will end before it can generate any benefits at all for most Americans.

The next president needs a game changer, one that might entice each side to make painful concessions, say, in exchange for control over the impact of those concessions.  As president, Bill Clinton could intuit the terms of such mutual concessions.   We will have to settle for a new process – or for putting an old one to new use.  

For many years, certain aspects of taxation have been seen as too complex and esoteric for even the professional tax mavens at the Senate Finance and House Ways and Means committees.   The taxation of mutual and stock life insurance companies is an example.  So when Ronald Reagan raised corporate taxes, the tax writing committees parceled out several billions of dollars in new revenues to the life insurers and told them to figure out how to raise it in ways that would be least disruptive economically.   Those were simpler times politically, to be sure, but the same model could be adapted to our current problem.

Let’s assume that the lame duck gives the President and Congress a few more months to work out everything.  Next January, the President and the leaders of both parties in both houses agree – tacitly, of course -- on how to broadly allocate another $4 trillion in budget savings over 10 years, under new rules.  Say, for example, that $1 trillion would come from new revenues, $2 trillion from entitlement reforms, $200 billion from discretionary defense spending, $300 billion from additional discretionary non-defense programs, and the rest from interest savings.  By agreeing to $1 trillion in new revenues, Republicans get the right to design whatever reforms they deem best to achieve the target.  Similarly, by agreeing to $2 trillion in entitlement savings, Democrats gain the right to fashion whatever Medicare and Social Security changes they deem best.  Similarly, Republicans could allocate the additional defense cuts, and Democrats would parcel out the additional, discretionary non-defense cuts.  And the looming threats from the expiration of everything, combined with the knowledge that each party would control the terms of the changes it fears most, might just be enough to get both sides to agree to the underlying allocation of pain. 

Memo to American Conservatives: America Is NOT Greece

European leaders next week will sign off on another $172 billion bailout for Greece, one small step back from a disastrous debt default. When the deal is signed, brace yourself for a chorus of charges from President Obama’s critics that his policies will make America the next Greece. These Chicken Littles are talking nonsense. They misunderstand Greece’s real weaknesses and our genuine strengths, along with government’s role in each. Moreover, they miss the issue in the Eurozone crisis that matters most to America — the new bailout will not prevent a broader European financial crisis that could tip the United States back into recession.

By the critics’ primitive reasoning, Greece has large deficits and public debt, and so does America, so the two countries must be headed for the same fate. If that were true, most of the world would be headed for default, since most nations today have large deficits and public debts. The economic fact is, the grave problems facing not only Greece, but also Italy, Portugal, Spain and Ireland lie much more in their economies than in their national budgets.

Yes, Greece’s deficits skyrocketed when the 2008–2009 financial crisis stalled out its economy — as in most of the world’s countries. And yes, the public debt of Greece, and Italy too, was large already as a share of GDP, so the burden of financing the new debt came on top of the burden of regularly refinancing their existing debts. But even that doesn’t explain much, since Spain and Ireland’s existing national debts were modest by world standards. At the same time, Japan’s public debt is larger than almost anyone’s as a share of GDP, and no one worries about a Japanese default.

The economic issue in sovereign debt defaults is not the size of a nation’s public debt, but its economy’s capacity to finance it. The problem that Greece faces — followed closely by Italy, Portugal, and Spain — is that its economy is relatively unproductive and uncompetitive. When its financing burden soared in the deep recession following the 2008 meltdown, its businesses and people found themselves financially strapped, and so unable to generate the additional savings to finance the new debt. And Greece cannot become more competitive and boost exports by depreciating its currency, because it no longer has a national currency to devalue. Along with Italy, Spain and the other countries facing debt peril, Greece uses the Euro — and the Euro exchange rate is set by the larger, more productive economies of Germany and France. Nor can Greece spur new investment in its economy with easy monetary policies, since the European Central Bank controls that for Eurozone members.

So, it is not simply Greece’s large deficits and government debt that raise the possibility of default. Rather, that prospect rests on what can be called a perfect storm in public and private finance. Yes, Greece has fast-rising public debt. But one of the key reasons is that the Greek economy hasn’t been strong and productive enough to come out of a deep recession now four years old and running. That’s the main reason why Greece’s national debt soared from 113 percent of GDP to 163 percent in the last three years, despite its recent austerity. It’s also why Greek businesses and households cannot generate the additional savings to finance that new debt.

Greece’s low productivity, on top of its continuing recession, also has discouraged foreign investors from buying its bonds. Once the risk of default took hold in the minds of those investors, they have demanded much higher interest payments on new Greek government bonds to offset that risk. Those higher interest rates only compound Greece’s problems, since they greatly increase the burden of both financing the new deficits and refinancing the government’s prior debts. To top off all of this, Germany has turned these grim conditions into an imminent crisis by insisting that Greece embrace harsh austerity, right now, to reduce its deficits. But as the International Monetary Fund has warned, additional austerity in an economy already in recession or just recovering from one will only expand deficits.

Whatever President Obama’s economically-untutored critics may claim, America’s circumstances are different from Greece’s in every respect. The U.S. recession ended in mid–2009 thanks to stimulus from the President’s program and the Fed. Savings by both American businesses (retained earnings) and households shot up, providing additional resources to help finance our rising deficits. Moreover, the U.S. economy is the most productive in the world, attracting hundreds of billions of dollars in foreign funds to help finance both our business investments as well as our deficits. And the lowest long-term interest rates in generations signal clearly that global investors are confident America will stabilize its national debt as a share of its GDP. The only time that the United States has ever flirted with default came not from the economy or deficits, but from the reckless behavior of conservative extremists last year who threatened to block the debt ceiling legislation. And for the record, the U.S. public national debt as a share of GDP is considerably less than half that of Greece.

Credible signs are now appearing that the U.S. expansion is finally accelerating. The greatest threat to that upturn is a Greek debt default which then spreads to Italy or Spain. Unfortunately, that threat is very real. The conundrum here is that the new Eurozone bailout of Greece is predicated on the Athens government implementing yet more austerity — and that’s a losing strategy. Additional austerity almost certainly will only increase Greece’s deficit and debt, not tame them, requiring more bailouts in the future.

At the same time, much of the Greek public unequivocally opposes more austerity. It’s hard to blame them. Greece’s GDP has contracted 25 percent through the last four years of savage recession, and unemployment there is now over 20 percent. Moreover, wages have fallen at least 20 percent — the Eurozone’s only answer to Greece’s low productivity and non-competitiveness. Now, Germany’s Angela Merkel is insisting they accept another large dose of austerity. They just might say no, at which point a genuine default probably cannot be avoided.

That leaves Merkel with a clear choice. She can finally accept that the European Central Bank must stand behind the sovereign credit of every Eurozone member, or pray that a Greek default won’t spread to Italy or Spain and threaten the solvency of most large European banks. Our own banks would probably survive a new European banking crisis, but there’s little doubt that this scenario would cost the U.S. economy. So, while America has little in common with Greece fiscally or economically, our own short-term fate may still rest in its hands.

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