NDN Blog

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.

The Economics and Politics of Inequality, Part 2 – The Role of Tax Policy

Economic inequality is an important issue this year, because a growing number of Americans now see it as a threat to their living standards and aspirations.  Mitt Romney and others say that envy, not facts, drives this debate.  But the facts are too large and well-known to dismiss, starting with the astounding one that from 1976 to 2007, the share of the country’s annual national income which the top 1 percent takes home rose from 8.7 percent to 23.5 percent.  Stated differently, over the last three decades, almost 15 percent of annual national income shifted from the bottom 99 percent to the top 1 percent.  To be sure, most Americans found this upward redistribution acceptable so long as their own incomes were rising.  But that changed in the 2002-2007 expansion when for the first time on record, the incomes of most Americans stagnated or fell through ostensibly good times.  And since the average income of the top 1 percent increased 65 percent over those same years, inequality accelerated. 

Does this new inequality reflect simply the way that an advanced market economy operates these days, or has public policy contributed to it?  The truth is, we are not helpless in the face of economic forces, and tax policy in particular is a real factor.  

To understand how and why, we have to start with the distribution of wealth as well as incomes.   The reason is that most of the income of those at the top comes from their wealth, in the form of capital gains, interest and dividends.  And wealth in America is now distributed even more unequally than incomes.  In 2007, the top 1 percent owned nearly 35 percent of all wealth in the United States, and the top 20 percent held 85 percent.  Moreover, this inequality of wealth is even more pronounced for the financial assets that produce the capital gains, interest and dividends.  In 2007, the top 1 percent held almost 43 percent of the value of all stocks, bonds and other financial instruments, including pension plans and retirement accounts; and the top 20 percent held an astonishing 93 percent of all those financial assets. 

Tax policy is a link between the inequalities of wealth and income, because we tax the income from wealth at lower rates than the income that most Americans earn from their own labor.  That is why, of course, Warren Buffett pays a lower tax rate than his secretary – and how Mitt Romney managed to pay only 13 percent in taxes on an income of more than $20 million last year.  Moreover, this tax favoritism for the income earned by those at the top has a compounding effect on the growing inequalities of both income and wealth.  The smaller tax bite leaves more of the income of those at the top to be reinvested in more financial assets, which then generate more income than is taxed at lower rates, and on and on.  

The defenders of these arrangements say that everybody benefits, because low taxes on capital income encourage more investment that raises productivity, which in turn lifts everyone’s wages.  It’s a nice story, but most economists cannot find hard evidence that lower taxes on financial income lead to significantly higher overall investment.  And even if there were such evidence, the link between productivity gains and broad wage increases broke down in the last decade, which is another reason why income and wealth inequalities have reached record levels.

We can see the role of tax policies by comparing what has happened to the incomes of different groups, before and after taxes.  To begin, from 1979 to 2007, after-tax income grew faster than pre-tax income up and down the income distribution.  Tax policy, then, reduced tax burdens across the board.   At the bottom, however, the effect has been distinctly progressive.  The average, inflation-adjusted pretax income of the lowest 20 percent of Americans declined by 7 percent from 1979 to 2007.   But the same group’s average, real post-tax income increased by 14 percent.  Similarly, the average real income of those in the second income quintile fell by 4 percent before taxes, and rose by 23 percent after-tax over the same years.  In short, tax cuts more than offset falling wages at and near the bottom, through especially the expansions of the Earned Income Tax Credit, the deduction for children and the standard deduction.  

The heart of the middle class, the third income quintile, saw their average income grow 11 percent before taxes and 23 percent after taxes over the same years.  That means that about half of their modest economic gains came from the economy and half from tax policy.  Similarly, for Americans in the fourth income quintile – the top 60 percent to 80 percent by income – average income grew 23 percent before taxes and 36 percent after taxes.  The economy delivered faster income gains to this group than to those in the middle, and then Uncle Sam added half again as much through tax policy.  

From this point until the very top, the gains from tax policy increase with income.  Across the top 20 percent, average income from 1979 to 2007 rose 49 percent before taxes and 96 percent after taxes, or roughly half from economic effort and half from tax policy changes.  The result: pretax gains grew twice as fast as those in the next lower income quintile; and thanks to tax policy, post-tax gains grew three times faster.  Similarly, for the top 5 percent of Americans, average incomes increased 73 percent before taxes and 160 percent after taxes – a split of 45 percent from the economy and 55 percent from the tax writers.  Put another way, the average pretax income of the top 5 percent grew 6.5 times faster than the average income of those in the middle.  Nonetheless, tax policy boosted the post-tax income of the top 5 percent over this period by an additional 87 percentage-points or 55 percent.

For the lucky few in the top 1 percent, most of the gains did come before taxes:  From 1979 to 2007, the average income in this rarefied group increased 241 percent before taxes and 281 percent after taxes.  So, the pretax incomes of the richest Americans grew 22 times faster than the incomes of middle-class Americans, and their post-tax incomes grew 12 times faster.  Stated differently, the very rich saw their incomes soar 241 percent over this period, and tax policy nevertheless further boosted their post-tax income an additional 15 percent or 40 percentage points. 

Over the last 30 years, then, U.S. tax policy has sustained at least two large themes.  As the income gains of many Americans slowed down, Washington has consistently used tax cuts to blunt some of the inevitable public disappointment and resentment.  And second, those tax changes have ultimately reinforced an historic increase in economic inequality, creating a treacherous new political environment for wealthy office-seekers who pay little taxes. 

For more on inequality, please read The Economics and Politics of Contemporary Inequality, Part 1

The Economics and Politics of Contemporary Inequality, Part 1

Barring some unforeseeable event, Mitt Romney is virtually certain to be the GOP nominee for president. Judging by President Obama’s decision to make inequality a main theme of his State of the Union address, the White House has been counting on facing Romney. More than anyone else in national politics, Mitt Romney’s own deeds and words may be said to embody the dynamics which define the top end of contemporary inequality. He spent his adult life accumulating capital assets, he deployed those assets to earn higher returns than those available to middle-class people, and he took aggressive advantage of the highly favorable tax treatment accorded those assets.

Even so, why have wealth and economic inequality become powerful political issues today, when the fortunes of John Kennedy, both George Bushes, John Kerry, and even the billionaire Ross Perot did not? The big difference, of course, is timing. For one, the rich have become much richer, both absolutely and relatively. In 2007, the top 1 percent took home 23.5 percent of all of the income earned in the United States. That’s the same share the top 1 percent claimed in 1928. But for the next half-century, the income share of the top 1 percent fell slowly but steadily, reaching less than 9 percent of national income in 1976. Throughout those years, the incomes of everyone else grew faster than the incomes of those at the top, creating a vast American middle class. But since 1976, incomes at the top have once again grown faster than everyone else’s incomes, restoring their pre-Depression share.

That still doesn’t explain why the very rich in politics inspire so much more wariness and anger today than just 12 years ago, when George W. Bush’s wealth didn’t faze most Americans — and unlike Romney, he didn’t even earn it. After all, one standard liberal meme cites the data on median incomes in 1976 and 2010 to insist that most Americans have stagnated economically for 35 years. Behind those two data points, however, lies a more complicated reality which shows that most Americans did make real economic progress — until the last decade.

First of all, everybody ages; and as we do, most of us see our incomes move from somewhere below the median to somewhere above it. Moreover, real median incomes did increase at respectable rates throughout the expansions of both the 1980s and 1990s, although the recessions which followed took back some of those gains. From 1983 to 1989, real median income increased more than 2 percent per-year, before giving back nearly half of those gains in the 1990–1991 recession and its aftermath. It happened again from 1993 to 1999, when median income rose by nearly 2.5 percent per-year, and then gave back 30 percent of those gains in the 2001 recession and the following three years.

The reason Americans seem so much more skeptical of the very wealthy today, is that this pattern has broken down. Not only did median income fall for three more years after the 2001 recession, that was followed by annual gains of barely 1 percent from 2004 through 2007. Moreover, the 2008–2009 recession and the year following it took back all of those gains, twice over. The result is that by 2010, median income was back to levels last seen in 1996 and 1989.

Also, while the recessions of the 1980s and 1990s drove down median income, those losses were fairly concentrated near the bottom and at the top. The people most likely to lose their jobs in recessions are those in the second and third income quintile, and their incomes fall fairly sharply. At the top, most income comes from financial assets. And since recessions drive down both stock markets and interest rates, they cut sharply into and the capital gains, dividends and interest that especially enrich the top 1 percent. So, for example, the 1990–1991 recession and the initially slow recovery that followed cost an average household in the second income quintile more than 2 percent of their annual incomes. Moreover, the average household in top 1 percent saw their annual capital income fall by nearly 20 percent. In between, most Americans kept their jobs and held on to most of their incomes gains from the 1980s and 1990s.

So, from 1983 to 2000, the average income of the first three income quintiles — covering the less affluent 60 percent of Americans — grew steadily by an average of 1.3 percent per-year. People in the fourth income quintile — the equivalent of a $90,000 income today — did better. They registered average income gains of nearly 1.7 percent per-year from 1983 to 2000. Households in top-earning quintile did better still, with annual income gains of more than 4 percent from 1983 to 2000. And consistent with the top 1 percent’s outsized share of total income, those households way outpaced everyone else: Their incomes grew by nearly 10 percent per year from 1983 to 2000.

After 2000, most people’s gains first turned to losses, then grew slowly for a few years, and then fell back sharply in the 2007–2009 recession. But once again, the story is different for those at the top. To be sure, the incomes of the top 1 percent fell by nearly 30 percent from 2000 to 2002, along with stock and bond markets. From 2003 to 2006, however, those markets recovered, and the incomes of the top 1 percent increased 65 percent. More recent income data for the very wealthy are not yet publicly available. But while everyone else struggles to regain their financial footing, the top 1 percent has seen the S&P 500 and other market indexes already recover. And if all of this wasn’t enough to make Americans pause before making one of the country’s richest men the president, federal tax changes pressed by presidents over the same period have exacerbated the inequalities. That will be our topic for next week’s blog.

John Kennedy famously reminded us that life can be unfair. JFK’s focus, unsurprisingly, was on matters of greater import than wealth: To illustrate that “[t]here is always inequality in life,” he notes, “[s]ome men are killed in a war, and some men are wounded, and some men never leave the country. Life is unfair.” Mitt Romney has had a lion’s share of extraordinarily good luck in his life. Now, he will have to make his run for president at a time — perhaps the first such time in generations — when millions of Americans will be very wary of a candidate who grew rich while everyone else struggled just to hold on.

The State of the Union and the Power of Technological Change

President Obama made inequality a major theme of his State of the Union address last night, an unsurprising choice as he prepares to face Mitt Romney. Everyone now knows that just last year Mr. Romney paid a smaller share of his $21 million income in taxes than the average American paid on a $50,000 salary. But if inequality was the President’s theme, his main subject was jobs. For Obama, faster job growth depends on more government. We need Washington, for example, to retrain workers, reduce college costs, and provide special supports for manufacturers. For Romney, the answer for job creation is, what else, less government: Washington needs only to cut regulation and reduce taxes, especially for the wealthy people and corporations who, in the Romney worldview, create the jobs.

But not so fast — there are other options as well. A new report from the NDN think tank suggests that certain kinds of new technologies can spur job creation more effectively than most government programs or tax cuts. The new study, conducted by Kevin Hassett of the American Enterprise Institute and myself, found that the rapid spread of new 3G wireless devices from 2007 to 2011 led directly to the creation of nearly 1.6 million new jobs. And those job gains occurred even as the overall economy was shedding 5.3 million other jobs.

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

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

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

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

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

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

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

The Bankruptcy of Austerity Economics

Conservative conventional wisdom collided this week with a dose of economic reality, and the winner is reality. For two years, every Republican congressional leader and presidential hopeful has proudly insisted these days that austerity is the cure for a sluggish economy like ours. It is an approach embraced most memorably, of course, by Herbert Hoover, although Angela Merkel also pushes it today for the faltering Eurozone. In fact, austerity in the face of high unemployment, slow investment and weak demand has been decisively refuted by a half-century of economic analysis and policy. The best medicine for a slow economy is usually measures to jump-start investment and consumption funded by more private or public debt.

Congress has refused to let Washington play that role since the 2010 elections, so finally American households are stepping into the breach. Last week, we learned that employment rose sharply in November, and this week we found out why: Borrowing by American households jumped $20.4 billion in November. That’s the largest increase in ten years. This new willingness by Americans to take on new debt is the main reason why consumer spending is finally picking up, which in turn is the main reason why the jobless rate keeps on falling.

It would be rash to read too much into these new data, but they could be a powerful signal of stronger growth ahead. For three years, Americans have saved in order to reduce the burden of their outstanding debts. New Federal Reserve data show that it is working. In 2007, payments on mortgage, consumer and auto debts claimed a larger share of the incomes of an average household than at any time since 1980. But by the third quarter of last year, this household indebtedness had fallen to the lowest levels since 1994, providing a reasonable basis to begin borrowing again.

Moreover, the renewed willingness of average Americans to take on new consumer debt may also signal that housing values have finally bottomed out. Falling housing values — and Washington’s inability to do anything to help stabilize them — have been the single largest obstacle to a strong recovery. When home prices fall month after month, that not only increases the net debt of most homeowners; it also makes American homeowners poorer, month after month. And people who see their assets shrink, month after month and year after year, cut back on their spending. So, recent signs that consumer borrowing and spending are heating up again suggest that housing values may have finally stabilized. If that’s the case, the recovery may finally accelerate.

America’s new acolytes of austerity could still screw this up. In the last year, they tried to block payroll tax relief and extended unemployment benefits, and the truest believers among them even hoped to block an increase in the legal debt limit. All three of these matters will come back to Congress in coming months. The political landscape has shifted, however. The public now holds Congress in such low esteem — and especially House conservatives — that even fervent advocates of austerity may hesitate to repeat their wildly unpopular 2011 performance in an election year.

A stronger U.S. recovery could still fall victim to the European austerity caucus. Merkel continues to press austerity on the Eurozone governments, even as Europe slides into recession. Moreover, piling yet more austerity on economies in recession can only worsen the sovereign debt crisis which already threatens to pull down the Euro and major banks across Europe. Sometime next week or in the next few months, global investors may conclude that Merkel’s attachment to austerity will finally preclude meaningful steps to stabilize Italian and Spanish government debt. If that comes to pass, the ensuing financial crisis almost certainly would short circuit a strong American recovery.

For now, that recovery is in the hands of America’s households. Thankfully, they display more economic sense than many members of Congress or leaders of the Eurozone.

Statement on the Jobs Report

I released the following statement today:

"Today’s report that the U.S. economy created  200,000 new jobs, net of layoffs, certainly counts as strong gains for this recovery.  Of course, what constitutes strong job growth today would have seemed, at best,  moderate in the 1990s and 1980s, when the United States routinely created more than 300,000 new jobs per month.   Still, for the first time since the 2007-2009 recession, decent levels of job creation seem sustainable.  Business investment is growing nicely, creating jobs directly.  The trade deficit keeps falling, slowing the drain of U.S. jobs overseas.  And while consumer spending is still fragile, household debt continues to fall, setting the stage for a stronger recovery.  

If Washington would take steps to help stabilize housing prices, as Ben Bernanke called for this week, and if the Eurozone manages to avoid a financial meltdown, Obama could find himself presiding over a decent recovery by November."

You can find Rob's statement on Thursday about the promising ADP report showing similar numbers here.

Statement on the Economy

A word of caution to President Obama's critics:   American families and businesses may be finally recovering from the economic beatings they suffered in the 2008 financial crisis and the extended unwinding of the 2002-2007 housing bubble.  The giant payroll company ADP, whose surveys have a good record of anticipating the official jobs reports, said today that private sector employment grew by an estimated 325,000 in December.  This follows several months of encouraging news on jobs from the Bureau of Labor Statistics.   Business investment and corporate profits also have shown renewed strength.   

Yet, GDP growth has been modest, mainly because consumer spending is still fragile.   Americans want proof that job creation is back and the value of their homes has stabilized.  The first factor may now be in place.   If housing prices stop falling - and Europe avoids a financial meltdown -- the American economy in 2012 is likely to be the strongest since 2007.

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

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

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

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

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

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

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

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

Here are three ways to begin.

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

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

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

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

The Truth about Job Creation under Obama and Bush

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

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

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

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

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

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

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

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

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

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