A New "American System"

Over the past couple decades, "globalization" in the United States has meant the rise of the Finance, Insurance, and Real Estate (FIRE) sector.  Meanwhile, many other parts of the American economy have been hollowed out.  Manufacturing jobs have been slashed in part due to automation but also due to a global trade system in which various international players are afforded many opportunities to subsidize their industries while the US undermines its own domestic manufacturing sector.  The technology sector has witnessed its own share of outsourcing and offshoring, and job opportunities for US-born workers are also undercut by many companies' use of temporary worker visas (such as the H1B visa).  Further undercutting domestic labor, a flood of illegal workers has placed more pressure on the wages and employment opportunities of low- and semi-skilled workers.  Under these conditions, the US growth rate has substantially declined since 2000; even the high point of the business cycle during the Bush years was well below that of any cycle since World War II, and the economic policies of the Obama administration have proven disappointing by the administration's own standards.  So where to go from here?

In 1791, facing a debt-burdened new nation with relatively little domestic industry, Alexander Hamilton prepared his "Report on Manufactures," which proposed a system of tariffs, subsidies, and domestic investments as a way of ensuring future economic vitality and industrial independence for the United States.  The first Secretary of the Treasury's report provided in many respects the originating germ for the economic policies of the Whig and later Republican parties of the nineteenth century.  Politicians like Henry Clay and Abraham Lincoln and economists like Henry Carey advocated for an "American System" that encouraged the development of a skilled population with economic opportunity and industrial development.  Some variant of the "American System" drove US economic policy throughout much of the nineteenth century until the middle of the twentieth.  During this period, the United States accumulated massive wealth.  This wealth in turn provided the financing for many of the social programs of the twentieth century.

The "American System" has the following insight: the American economy cannot flourish over the long term with merely the financial and resource extraction sectors.  Resource extraction can fuel economic growth, and a sophisticated financial system also seems necessary for a modern economy to work at peak levels.  But the best gasoline and top-notch engine oil will not make a rusty jalopy into a vehicle fit for the Indy 500.  Hamilton and many of his allies were favorable to banking interests but also realized that an economy based solely upon banking would eventually harm those very financial interests.

We might restate this insight and instead note that the greatest form of capital is not simple currency or resources but human capital.  This human capital includes both various social institutions (such as a system of laws, cultural values, etc.) and the accumulated knowledge and talents of individuals.  It depends upon the belief that one's efforts will likely lead to some fruition.

American prosperity was built upon the nurturing of human capital within the "American System."  The evolving system of US laws encouraged prosperity by allowing innovators and producers to reap the rewards of success.  The social safety net of private charity and government institutions helped ensure that a person born into unlucky circumstances could still enrich his or her talents.  Universal education and literacy presented the young with the tools to train their minds and discover the world of learning.  Investment in infrastructure---from roads to canals to railways to highways---allowed for a more efficient transfer of capital, commodities, products, and knowledge.  Tariffs gave an incentive for American residents to try new manufacturing experiments.  The close proximity of manufacturing helped spur on new innovations: working with day-to-day production, Americans were more likely to realize how to do things better, smarter, and faster.  Moreover, the growing cost of labor encouraged further innovation in technology.

It is precisely now that we need a return to the investment in human capital.  As Andy Grove, former head of Intel, has argued in recent years, top innovation often goes hand in hand with direct involvement in production.  Whether the United States can over the long term remain a world leader in innovation after having exported industrial production remains to be seen.  We need to defend forthrightly American interests abroad.  It may no longer be enough to let foreign countries discriminate against American products and violate intellectual property laws even as the US opens itself completely to their products.  (And encomiums about the virtues of "free trade" miss the point that the current trade order is nothing like free trade or the free market.)  Trade policy must move beyond cheap imports uber alles.

We need an education system centered on skills and real learning---not on meaningless test scores.  We need to inspire hope in our youth, creating opportunity for both those with and without college degrees.  Throughout the 1980s and 1990s, many opportunities for workers with only a high school degree declined.  The 2000s have witnessed the closing off of opportunities for many with college degrees.  If young Americans will see no profit from developing certain skills, these skills are less likely to be cultivated.  As a recent Council on Foreign Relations study has shown, almost all the increase in the number of jobs from 1990 to 2008 occurred in non-tradable jobs, which often pay lower wages than tradable jobs.  So one could argue that, in some ways, the current flavor of globalization has made the US economy less competitive, as it encourages the growth of lower-paying, and often lower-skilled, jobs.

We need a sensible policy for infrastructure investment.  Energy policy is a key aspect of this investment.  The easy transfer of goods and people has proven especially valuable in a nation as vast as the United States, and the new ease of transporting information has unleashed the potential for considerable innovation.

I do not here intend to lay out a complete menu of policies that are necessary for the restoration of American economic growth.  Yet it is important to think about the overall contours of a public policy aim.  The precise policy mechanisms of the Hamiltonian "American System" might be outdated, but its basic notion is one with some merit.  We must shift from privileging extraction to rewarding talent, effort, and innovation.  The combination of market rewards and public investment created an economic order of profound vitality, opportunity, and prosperity.  As the American economic engine continues to sputter, it is time to engage in a thoroughgoing renewal---in part, by examining the wisdom of the past.

New Opportunity

Yuval Levin has a new piece worth a read in the Weekly Standard.  Levin hits a point I've been hammering for a while:

There are many ways to describe what appears to be worrying these voters, but if we were to sum up the danger in one word it would be stagnation. After decades of galloping growth, America now faces the prospect of a harsh and sustained deceleration, and therefore of falling behind in the world economy.
In the 60 years following World War II, the American economy grew at an average rate of 3.4 percent per year—a truly astounding persistent pace of expansion. This growth brought with it sustained improvements in income and standards of living—improvements that we have come to regard not as miraculous advances but as the normal course of American life. Our sense of the nation’s overall standard of living takes such growth for granted, so that a period of significantly slower growth feels like a real step down.
We have been living through such a period lately. Annual economic growth averaged 3.5 percent between 1960 and 1999, but only 1.7 percent between 2000 and 2009. In the Obama years, we have averaged 0.6 percent growth. 

I don't agree with all of Levin's diagnosis, and I'm not sure about some of his policy recommendations (for example, it's not clear to me how getting rid of "our 19th-century system of school districts and local boards of education" is really going to lead to renewed economic growth).  But he does raise some interesting points.

Loans and Economics

Kelly Evans reflects on the student loan situation, noting the poor job prospects of many Americans:

And this all comes as globalization and technological change have upended once-reliable career paths, wiped out many mid-level professional jobs and leave low-paying fields in health, food and beverage services, and retail as among the fastest growing job markets over the next decade. 

 Yet part of this might be an economics problem, not just a loan financing one.  Policy makers need to think about how new mid-level jobs can be encouraged.

Inequality: A Double-Edged Sword

James Pethokoukis is trumpeting a study that purports to show that income inequality has not increased (at least according to Pethokoukis's interpretation).  Personally, I have some doubts about what the study cited by Pethokoukis really shows.  But let's put those doubts aside for a moment and turn to another issue.

By the standard that shows growing income inequality since 1980 (the standard of economist Emmanuel Saez and others, which looks at income), Obama's administration has been worse for income inequality than Bush's, as Matt Stoller notes:

Yup, under Bush, the 1% captured a disproportionate share of the income gains from the Bush boom of 2002-2007.  They got 65 cents of every dollar created in that boom, up 20 cents from when Clinton was President.  Under Obama, the 1% got 93 cents of every dollar created in that boom.  That’s not only more than under Bush, up 28 cents.  In the transition from Bush to Obama, inequality got worse, faster, than under the transition from Clinton to Bush.  Obama accelerated the growth of inequality.

Over at Breitbart, Ben Shapiro grasped this dynamic a few days ago:

In other words, the Obama “recovery” hasn’t leveled the playing field – it’s tilted it more. That makes sense, since most of Obama’s measures have been aimed not at providing jobs for working class people, but at subsidizing friends, allies, and union bosses. The rich continue to get richer – and much faster – under Obama, even as he claims the mantle of class warrior.

Republicans don't need to run from the inequality fight.  Obama's big-government approach seems to have only exacerbated inequality, as a wealthy few have the ability and influence to manipulate government to benefit themselves.  There's a reason why GE's corporate tax bill is smaller than the sales tax on a Big Mac in New York City.

Some on the left seem to be waking up to the fact that, for all his talking points, Obama's administration might not be the biggest friend of the little guy.  The stagnation of the Obama economy has been felt the most by the working (or at least would-be working) and middle classes.  Republicans can argue for both economic dynamism and egalitarianism.

Pivot Pitfalls

Mickey Kaus, spurred on by other media speculation, wonders whether Mitt Romney will pivot on immigration now that the primary race seems to be drawing to a close.  Kaus fears/anticipates that Romney will switch from his pro-enforcement position to some kind of support for mass legalization for illegal immigrants.

However, numerous political dangers could accompany a Romney immigration pivot.  What heightens the danger of such a switch is that Romney has a limited number of pivots he can make.  Because he needs to ward off the narrative that he is a "flip-flopper," Romney must ensure that his pivots are as few as possible and provide as much utility as possible.  Switching on immigration enforcement might be an electoral waste of a pivot.

Romney's strong stance on immigration enforcement is one of his strongest ties to the conservative grassroots.  His persistent defense of immigration enforcement helped him fend off both Rick Perry and Newt Gingrich.  An openness to amnesty is one of the (many) third rails of grassroots conservative politics. Romney has challenged this slice of the electorate a lot already; he can't afford to pick needless fights with it.  It would be infuriating to the grassroots to see Romney stay consistent on Romneycare while turning his back on immigration enforcement.  Many (though not all) of the conservatives who promised during the primary to stay home if Romney were the nominee are likely to hold their noses and vote for him in November, but, if he pushes too many of them too far, he might lose more than a few disaffected conservatives.

Moreover, it just isn't clear that support for some kind of amnesty will rally "Hispanics" to a Republican candidate.  Few Republicans fought as loudly and proudly for legalizations of all types as did John McCain throughout 2008.  But, when election day came, he lost "Hispanics" by 36 points to Barack Obama  (31-67).  George HW Bush was the Vice-President of a man who pushed through an unambiguous amnesty for illegal immigrants (Ronald Reagan).  Bush lost "Hispanics" by forty points in 1988 (30-70).  Or consider the converse of this: the most pro-enforcement GOP candidate, Romney also convincingly won "Latinos" in both the Arizona and Florida primary races.  His support for enforcement did not sink him.

The fact that support for legalizations might not be politically beneficial does not necessarily mean that it is bad policy, but the Romney camp should not be mistaken in thinking that pivoting to amnesty will be a successful pander to "Hispanic" voters.  Poll after poll after poll shows that "Hispanics," like many other Americans, are interested in much more than just immigration issues: the economy, education, and other issues often rank higher for American "Hispanics."  Furthermore, many "Hispanics" support immigration enforcement.

Instead of slicing and dicing America into ethnic groups with distinct panders, Romney should instead put forward a campaign theme that speaks to the needs of all Americans---"white," "black," and "Hispanic."  Support for immigration enforcement seems a position that appeals to the middle.  Contrary to Beltway spin, opposing a perpetual influx of exploited serfs is a centrist, popular position.  As median wages continue to stagnate if not decline, Americans are anxious about threats to the middle class.  Many Americans see illegal immigration as a wedge used by the wealthy against the middle and working classes, undercutting the wages of the native-born and legal immigrants.  I've suggested before that Romney could use his support of immigration enforcement as part of a broader message for improving the prospects of the American middle class in the twenty-first century.


Gingrich and Santorum made inroads by charging that Romney represented elite monied interests, and Barack Obama seems likely to try to use class warfare and the politics of resentment as a smokescreen to cover up the economic disappointments of his administration.  (Never mind that Obama's own term as president has seen economic inequality grow even more.)  Supporting immigration enforcement could be one way of showing that Romney stands with the middle and could provide a contrast between the GOP challenger and the president.

Defending immigration enforcement need not be a demonization of the other.  Romney could focus his criticisms on those businesses and individuals that knowingly hire illegal labor: focus, that is, on the jobs.  Government benefits going to illegal immigrants could also be a fruitful topic.

Romney can put together a message that both supports the middle class and provides a vision for further economic growth; the decline of the middle class is one of the biggest problems if not the biggest problem the post-2000 economy faces.  Immigration enforcement could play a role in this message of the middle.  Romney might regret trading that electoral tool for a fruitless pander.

Energy Secretary: Lower Gas Prices not an Administration Goal

At least the White House is honest about it:

High gasoline prices will make research into such [energy] alternatives more urgent, [Energy Secretary] Chu said.
“But is the overall goal to get our price” of gasoline down, asked [Rep.] Nunnelee.
“No, the overall goal is to decrease our dependency on oil, to build and strengthen our economy,” Chu replied. “We think that if you consider all these energy policies, including energy efficiency, we think that we can go a long way to becoming less dependent on oil and [diversifying] our supply and we’ll help the American economy and the American consumers.”

Ed Morrissey has more.

CBO Then and Now

Zero Hedge includes a helpful link to the ten-year report issued by the CBO back in early 2001.  Eleven years ago, the CBO predicted that the US would have an improving debt burden with consistent surpluses and relatively solid economic growth.  The CBO got its projection on mandatory spending relatively right: it estimated that mandatory spending would be $1.9 trillion in 2011, when it ended up being $2 trillion.

However, this report was before the Bush tax-cuts passed, before 9/11 (and the resulting conflicts), and before a decade of economic disappointment.  The CBO in 2001 projected an average real GDP growth of 3.1% a year during the decade after 2001; GDP growth did not even come close to that.

CBO: Promise and Peril

The recently released Congressional Budget Office report on the budget for the next ten years has what might at first seem like good news for the US fiscal order.  It estimates that, by 2015, the national deficit would fall to under 2% of the GDP, often hovering around 1% until 2022 (when the CBO projections stop).  If one subtracts net interest payments on the national debt (which the CBO estimates would increase considerably after 2014), the US federal government would often be running surpluses that would, by 2018, reach around 1% of the federal budget.

The current federal deficit runs at around 8.7% of GDP, so a decline to 1% of GDP would be a big improvement.  Moreover, the size of the federal debt relative to the national economy would begin to decline around 2013, so the United States would, in many respects, be on a firmer fiscal footing.  By 2022, the debt held by the public would be only 62% of the national GDP (compared to the projected 75.1% of GDP in 2013).  That 62% figure would be higher than that of any year during the 1952-2009 period, but the trend is heading in a good direction.

However, there's some bad news: that CBO projection depends upon a number of assumptions, including improved economic growth, no "doc fixes" for Medicare, a decrease in defense spending, and the expiration of the Bush tax-cuts.

On growth, the CBO has little hope for the next few years: it projects that real GDP will grow 2% in 2012 and a mere 1.1% in 2013.  It does hope for a considerable increase in growth in the years after 2013, however.  It assumes that real GDP will grow an annual average of 4.1% in the 2014-2017 period, settling down to a 2.5% average rate of increase between 2018 and 2022.  Those growth numbers are possible, but they assume a much stronger economy than the US has had since 2000.  If the economy does not reach this rate, the deficits would likely be even worse.  And if the economy turns around faster and maintains a stronger rate of growth after 2017, we could see the deficit shrink even more due to increased tax revenue and less spending on various income-stabilization measures.

The CBO baseline projection assumes that defense spending will fall from 4.7% of US GDP in 2012 to 3% of the GDP in 2022.  Since World War II, defense spending has never been less than 3% of the GDP.  It also assumes that nondefense discretionary spending will fall from 4.3% of GDP to 2.6% of GDP.  Under this standard, discretionary spending would fall to the smallest proportion of the national economy seen in decades.  Will that happen?  If not, add some more to the deficit.

If payment rates for Medicare do not fall at the rate they are currently scheduled, the CBO estimates that over $300 billion would be added to the federal debt over the next ten years.

The CBO baseline assumes that revenues will climb considerably after 2012; they would jump from 16.3% of GDP in 2012 to 18.4% of GDP in 2013 to 20% of GDP in 2014.  They would stay above 20% of GDP until 2022.  Part of this increased revenue would come from an improved economy, but part of it would also come from higher taxes.  The CBO projection assumes that the Bush/Obama tax-cuts will expire at the end of 2012 and that the Alternative Minimum Tax will not be indexed to inflation after 2011.  Under this scenario, personal income taxes would climb from 7.4% of GDP in 2012 to 11.5% of GDP in 2022, a historic high.

Based on these projections, extending the Bush tax-cuts would add $2.8 trillion to the national debt over the next decade.  Keeping those tax-cuts and indexing the AMT to inflation would add $4.5 trillion to the debt over the next decade.  Those numbers do not include the increased interest payments such an increased debt would also cause.

If CBO assumptions about increased revenue due to tax increases and certain spending cuts are not met, the seemingly rosy scenario of a declining debt burden relative to GDP does not take place.  Under an alternative scenario in which these non-economic assumptions are not realized, deficit spending remains an average of over 5% of the national GDP and the debt burden would increase; publicly held debt would rise to over 90% of GDP by 2022.  The CBO suggests that decreased tax revenues due to tax-cuts would be primarily responsible for this increase: the deficit caused by extending current tax policy alone would equal almost 3% of US GDP during many years.

It's possible that extending current tax policies could lead to new growth unanticipated by the CBO, though it should be noted that Bush's and Obama's tax policies have led to slower growth that the CBO projects during the 2014-2017 period and slower growth than was seen during the Clinton and Reagan presidencies.

The CBO has some interesting information about entitlement spending.  Social Security spending is currently 4.8% of the GDP, and it is estimated to climb to 5.5% of GDP by 2022; it will stay around 5% of GDP until 2019.  Medicare is estimated to climb from 3.7% of GDP to 4.2% of GDP over the next decade, while Medicaid will climb from 1.8% to 2.5% of GDP.  So Medicaid is estimated to be the fastest growing entitlement over the next ten years.

The assumptions made here by the CBO suggest a radically different federal government than we're used to, one that taxes more and one that spends more on various mandatory domestic programs and less on defense and discretionary programs.

Increased growth with an improved employment picture may be one way of keeping some discretionary and military spending while also not having a much heavier tax burden.  Growth seen during the Reagan or Clinton (or Carter or Nixon or Johnson) years could spur enough increased revenue (combined with some tax reform) to allow the government to continue to meet its obligations and not indulge in radical deficit spending.  Some entitlement reform (especially regarding medical spending) might help bend the curve of government expenditures down.  The CBO assumes that domestic discretionary spending will decrease as a percentage of GDP, and a rigorous approach to cutting waste and appropriately focusing federal energies would help ensure that necessary and advantageous discretionary spending will be kept.

This CBO report suggests that the US fiscal situation is not necessarily at DEFCON 1, but it also implies that the stagnation of the past few years is untenable for the nation's long-term fiscal future.  Growth and reform will be necessary components of fiscal sanity.  As they gear up for the 2012 campaign, Republicans would be wise to attend to these crucial details.

(Crossposted at the Huffington Post)

Limits of Wall $treet

Some on the right are concerned that Obama would slam Romney as a denizen of Wall Street and that Romney's wealth would prove a hindrance in the general election. While some worries about Romney's business background are more the product of sympathy for other candidates than anything else, there is an element of real anxiety to them, and they are not completely baseless.

However, there are numerous reasons not to overestimate the potential effectiveness of White House attacks on Romney over Wall Street connections.

Perhaps foremost among them is the White House's own very deep connections to Wall Street. Cabinet figures like Tim Geithner and White House allies like Jon Corzine are the embodiment of Wall Street insiders---they make Mitt Romney look like a secretary at the Merrill Lynch branch office in Fargo, North Dakota. Many of Obama's top advisors come from the world of Wall Street. Any attacks on Romney's Street connections immediately open Obama up to the countercharge of hypocrisy: if Wall Street is so bad, why do you choose to people your administration with Streeters and have Wall Street tycoons as central fund-raisers for your presidential campaign?

Charges of hypocrisy here could be particularly damaging for Obama. Despite a lackluster (to put it mildly) administration, Obama still has a chance of winning reelection in part because of the personal affection that many Americans still have for him. The glow of Obama as a political figure who can rise above petty partisan squabbles has dimmed, but it has not entirely vanished. If Obama becomes painted as just another hypocritical political opportunist, his reelection prospects suffer a considerable blow.

Moreover, attacks upon Romney's wealth would make Obama seem more like Walter Mondale than Bill Clinton. Invective-fueled class warfare might be helpful at the margins, but America is still, despite a decade of trials, an optimistic nation. It would seem out of touch indeed for Obama, not exactly a poor man himself, to be complaining about Romney's wealth when millions of Americans are out of work. The American public would much rather see solutions for the nation's problems instead of complaints about an individual's success.

This suggests another limitation for Obama's potential attacks upon Romney's corporate history. It's true that a number of people were laid off due to the actions of Bain Capital (though many others were also hired due to Bain). The media (and maybe some Republican candidates) will be sure to emphasize the lost jobs and displaced individuals. But millions more have lost their jobs in Obama's economy. The disappointments of the stimulus bill far exceed those of Bain. A comparison of Romney's employment record in the corporate world and as governor of Massachusetts with Obama's is not one that would seem to be in the president's favor at the moment. The president's only hope for reelection is to focus on the future; looking to the past will only emphasize the shortcomings of the administration. Obama may think that his administration's accomplishments may possibly exceed those of Lincoln, but most Americans are a little more pessimistic on that point.

Some rightie activists have suggested that Ted Kennedy's anti-Romney strategy in 1994 offers a devastating blueprint for Obama's 2012 strategy against Romney. This parallel should also not be overstated. Kennedy did hit Romney hard on his record at Bain, but Barack Obama is no Ted Kennedy, and the United States is not Massachusetts. Kennedy's 17-point victory over Romney was a decisive one, but 1994 was the only time Kennedy's reelection margin fell below 20 points. Even with all his Wall Street attacks, Kennedy's margin of victory was over 10 points less than it was in 1988 or 2000. Obama lacks Kennedy's electoral cushion; a 10-point swing would end his presidency.

Moreover, in 2002, Shannon O'Brien, the Democratic nominee for Massachusetts governor, tried replicate Kennedy's tactics, but she was not able to copy his success. A close race with a slim Democratic lead according to most polls ended in a 5-point victory for Romney. It would seem likely that such attacks will be even less effective now.

There are obviously topics in Romney's business background that should be investigated more. But Romney also has a number of years of government and public service upon which to run. Obama may hope that class warfare can distract from the nation's poor economic picture, but there is no reason why Republicans should allow that triumph of rhetoric over reality.

Toward A Foundation-Up Economics

Perhaps the greatest single threat to both conservatism in American life and the nation's economic vitality is not Ivy League professors or Hollywood elites or a sinister "progressive" conspiracy but the economic decline of the middle class. Take away hope in the churning of the free market, and you push many citizens considerably closer to the state as a provider. The turmoil of the markets in 2008 was merely the cataclysmic icing on top of the cake of a decade of lost ground for the bottom 90% of workers. Take that away, and an Obama victory would have been much less of a sure thing (and even such a victory would have been considerably moderated). If insurance premiums and coverage rates had been closer to those of 1993, Obamacare, the bette noire of conservative activists, would not have passed. The economic wasteland of the past few years has pushed more than a few public and private pension plans closer to the edge of insolvency.

The recent Congressional Budget Office report on incomes from 1979 to 2007 has depressing news for believers in egalitarian free-market capitalism. Since 1979, the after-taxes income of the bottom 80% of Americans as a share of the total national after-taxes income has dropped from 57% to 47%; every one of the first four quintiles has seen a drop in its share of the national income. Yet even the gains in economic strength for the top quintile have been unevenly shared. The 81st-99th-income-percentile range has seen its share of the national income stay the same. Meanwhile, the top 1% of earners have seen their share of the nation's after-taxes income climb from 8% in 1979 to 17% in 2007. These numbers suggest that the profits of the national economy (broadly considered) have increasingly flowed to the top.

There are broader policy reasons that explain this change. For much of the past decade and beyond, the prevailing Republican (and, frankly, bipartisan elite) orthodoxy has been as follows: lower wages, lower prices, and an empowerment of capital over labor. The CBO numbers reflect this dynamic, as they show the share of income due to labor declining since 1979, while the share of income due to the combination of capital and business income increasing. The claim made continually on behalf of statist globalization over the past twenty years has been that lower prices on various goods through cheaper labor would reward the American consumer, and that the increase in spending power on tchotchkes would exceed the decline in wages due to outsourcing. Similar claims have been made on behalf of massive amounts of illegal immigration: poor workers in the shadows enrich Americans as a whole through providing a plentiful peon class to act as babysitters, home-builders, fast food workers, and other assorted "service" positions.

This decline in labor cost provides a de facto empowerment of capital: if you earn money from investing rather than collecting a paycheck, having cheaper resources of labor allows your dollar to go much further. The "ownership society" sought by President Bush attempted to leverage this dynamic. By making as many Americans investors as possible (especially through investing in the housing market), the Bush administration tried to place hundreds of millions of Americans in the position of the victorious investor class in order to compensate for the decline of the labor class.

However, there are noticeable shortcomings to this model. First of all, not all Americans can join the investor class, so a substantial number of Americans lose out in an investor-centric model. Moreover, housing, the investment vehicle favored by the Bush administration, is a dangerous institution on which to base an investor-centered economy: an individual house is nowhere near as fluid an investment vehicle as a stock portfolio, and the fact that most people need somewhere to live complicates the role of a house as an investment commodity. Since most people need to take on a mortgage in order to buy a house, using the house as the doorway to the investor market requires Americans to take on considerable amounts of debt, and the debt needed to keep the housing-investing game going will balloon (as the 2000s proved).

And the decrease in prices due to cheaper labor is not spread equally across all sectors of the economy. Those sectors least undermined by outsourcing and domestic and international low-skilled workers, such as health-care, have seen some of the biggest price increases over the past decade. Jeans at Walmart may be less, but your health insurance premiums have doubled. With wages stagnating or declining, health-care bills and others like them eat more and more into a worker's paycheck. So the decline in wages is not fully compensated for by cheaper goods and services.

A final limit for the low wages=low prices model is that the consumer often does not feel the full price benefits of the decline in worker wages. Instead, the "savings" that many companies find through shipping work abroad or otherwise cutting labor costs are translated into bigger compensation packages for elite management and the investor class. While current "globalization" has witnessed the decline in wages for the middle and working classes, it has also seen the the pay of upper management (those who control large amounts of capital) increase. The recent history of American business is saturated with stories of companies that close down their American factories while giving upper management colossal paydays. So many of the presumed benefits of declining wages are accruing to an increasingly narrow band of the population.

With wages shrinking and the spigot of easy credit turned off, it's no wonder that public demand has withered.

What might be slightly more interesting, though, is a movement among some factions on the right and left toward a policy reversal: using higher wages and not lower wages as a stimulant for economic growth. Under this model, rising incomes for working- and middle-class workers would increase consumer demand. Rather than the cost of jeans production going down, workers would have more money to spend on jeans---and housing and cars and medical care and foreign trips. Economic growth for the bottom 90% of wage-earners would in turn provide new opportunities for the top 10%. Things weren't exactly bad for top-tax-bracketers during the egalitarian 1950s and 1960s or during the later part of the 1990s, when the income of a broader range of Americans increased in real terms (though income inequality increased in the 90s, as well). Rather than trickle-down economics, we would instead have foundation-up economics.

Nurturing this foundation in part depends upon increasing the skill level of the American workforce, so that workers can make the most of cutting-edge technologies. Education as driving future economic growth has perhaps acquired the somewhat dusty ring of tired dogma, but, like many things that may seem trite to the jaded, it has some truth to it. Reforming our immigration system, making new investments in fundamental research, and pushing back against social dysfunction (among other policies) would go a long way in the direction of improving the skills of America's workforce and would likely improve the wages of many workers.

But mere training is no panacea. With all due respect to current education "reform" movements, people are not mere containers for educational inputs; they exist in vibrant, heterogeneous communities, where all do not all have the same aptitudes. America will not and probably cannot be a nation populated solely by Facebook founders and investment bankers and political pundits. It will have maids and clerks and factory technicians and farmers and truckers, too. We can and we should have an economic system that offers advancement to all productive enterprises of worth and merit.

(And make no mistake: the People's Republic of China is witnessing great economic growth not because some of its students are doing well on international standardized math and science tests but because it has pursued an aggressive policy of protecting and developing Chinese industry. The decline of the US economy has less to do with the notion that it is graduating "insufficient" numbers of math and science majors and more to do with the fact that whole sectors of the economy have withered.)

Part of foundation-up economics also thus depends on protecting the livelihoods of so-called "lower-skill" workers (though, in reality, it does take considerable skill to build a house or run complex machinery or sundry other tasks). It may be true that the current statist flavor of globalization may increase inequality somewhat, but the extent of this inequality is in part due to other domestic policies. Our immigration and trade policies in particular have allowed those on the higher end of the ladder to leverage worker against worker in the pursuit of maximizing profits. Moreover, many of the gains for the wealthiest have been due not to the fair functioning of a free market but to the manipulations of state power.

It is possible to realize an economy that combines the exuberance of the market with a sense of popular prosperity. However they may differ in their methods of reaching this goal, many Republican and Democratic presidents have aimed for it. For a number of years now, we have empowered capital through cheapening labor; now may be the time to increase the value of labor in order to find new opportunities for capital.

From a conservative perspective, an egalitarian economy, where all may have ready hope of living a comfortable life and of advancing economically, is far better than either an economy where the vast majority of workers need government checks to survive or an economy where the super-wealthy plunder the resources of the public and leave the populace as a whole to malinger. Some extremists of the left and of the right would push the economy in one direction or the other. Neither extreme is sustainable. A happy, prosperous workforce is not only the best environment for defending the free market; it is also one of the greatest promises of the free market.

(Crossposted at FrumForum)

Eight Steps to Renew America's Economic Architecture

America is now coping with the debt binge of the past decade and stagnating incomes across the board. Trying to provide some cushion for those left economically behind may be a good short-term strategy. But policy makers also need to work toward a restructuring of America's economic architecture. Unless America's economic vitality is restored, all plans to reduce the weight of the national debt are moot. A perpetually failed American economy will lead to skyrocketing debt levels, an ever-diminished standard of living, and a weakening of the ability of the United States to project power across the globe.

To borrow a phrase from Governor Huntsman, America's "core" needs to be renewed. The economic renewal of this core would require the increase of America's skill level, the defense of American jobs, and the development of a regulatory structure that incentivizes production and innovation instead of gambling and borrowing.

In light of this project of renewal, here are some thoughts about big-picture goals to keep in mind for the restoration of America's economic architecture.

Regulate the financial system. Perhaps because it was bailed out with untold billions of dollars, Wall Street has been least hurt by the current recession. But deep structural problems remain. In the decade or so before the crash of 2008, many regulations that had been crucial to the nation's financial system had been repealed. Meanwhile, various government departments gave special privileges to numerous connected banking institutions. Our financial regulations give bankers and traders the capacity to be more reckless, and the history of bailouts and insider loans gives the appearance of a safety net, at least to the chosen few. So our financial system grows increasingly less stable. Regulations must be put in place so that, for individual banks, individual failure will not lead to the collapse of the whole banking system; too big to fail must go by the wayside. Bankers used to be renowned for their prudence and circumspection. It would be helpful to put in regulations encouraging that tradition.

Let energy multiply. Since the Industrial Revolution, cheap energy has been a bedrock of economic growth. Unlike President Obama, I do not believe that the government should aim to make energy prices skyrocket. One of the major accomplishments of probably the greatest Democratic president of the twentieth century---Franklin Delano Roosevelt---was to spread electricity across America, to the poor and rural classes, in order to improve the living standards of the nation as a whole. If Democrats want to surrender that legacy, Republicans should pick up the banner of cheap, egalitarian energy and run with it. Investment in energy infrastructure could be one of the greatest improvements in the American economic architecture---and that investment would include oil, nuclear, and alternative energies. Current proven US oil reserves will not be sufficient to meet all national demand for the long term, but the Congressional Research Service estimates that there could be over a hundred billion barrels more worth of oil that further exploration could reveal. Further exploration and innovation could discover even more resources. But drilling for more oil will not alone solve America's energy problems. Nuclear is most sustainable and massively scalable non-fossil fuel energy source we yet have in place in an expansive way, so investment in nuclear power plants would be an easy route to expand America's energy prospects. Solar, wind, and other energy sources are also worth investing in; some of these technologies are in the experimental stage, but the the normal of today was once the experimental of yesterday. Gains in efficiency are good, but the sweet spot of economic growth is found when improved efficiency meets cheaper energy.

Get a twenty-first-century trade policy. This isn't the 1990s anymore, when we could trust in a technological leap to compensate for other countries using neomercantilist strategies against us. "Tradeable jobs," often the most value-adding, have been pummeled in the US over the past decade or so. Unilateral trade disarmament in the face of other countries' neomercantilist tactics (currency manipulation, tariffs, regulations that de facto prohibit American-made products, and so forth) is not free trade. The past couple decades have shown the effects of this neomercantilism for the American workforce.

Get a twenty-first-century immigration policy. The current immigration paradigm was put in place almost fifty years ago, after a great lull in immigration and in a time of great prosperity and economic growth. This paradigm may need to be revised. Current immigration policy often rewards law-breaking and family connections. A revision of immigration policy could focus on increasing the skill level of the American workforce and improving the conditions of the the workers currently in the United States. We should work to make the US immigration system resemble Habsburgian dynastic politics less and instead push it in an egalitarian, skills-oriented direction. While prioritizing the minor children and spouses of immigrants, a revised system could move towards a basket of skills, refugees, and extended family members (with increased emphasis upon the "skills" portion).

Invest in the future. Despite propaganda to the contrary, government investment in science, technology, and distant innovations can actually work out. The nuclear age was greatly accelerated by government spending during World War II, advances in telecommunications are in part due to NASA, and early pioneers of the internet---one of the great drivers in growth over the past two decades---included government agencies and institutions backed by substantial government funding. In a time of economic turmoil, many large businesses are unlikely to invest in long-range projects that may never pay off; government investment can help redress that lack of funding for first-principles research. We cannot look for large institutions to provide all advances (much has been accomplished by a few lonely and talented individuals working on their own), but history has shown that some of that long-range spending can have dividends for decades in the future.

Revise the regulatory state. Many national regulations are economically onerous and often counterproductive. For example, many environmental laws put burdens on local manufacturers, even as our trade and tax policies encourage these very same manufacturers to ship their work out of the country (to nations with far fewer protections); it's hard to call such a result a win for the American economy or for the global environment. (I'm not here arguing against environmental regulations as such, but I am suggesting that we need to think of the broader implications of them and work to correct some of the negative results of these implications.) The 70s witnessed the acceleration of the dismantling of the New Deal regulatory state, but new layers of bureaucracy have taken its place. We must do what we can to ensure that projects (both private and public) of great vision and power can be advanced quickly.

Renew infrastructure. Regulatory reform could also streamline and make more possible broad improvements to the American infrastructure. Much of the backbone of our infrastructure (highways, bridges, etc.) is in disrepair, and much (such as America's rail system) could also take the leap into the twenty-first century. In an era of new experiments with energy sources, updating and rendering more flexible our electricity grid and other energy delivery systems could have considerable gains for the future.

Revitalize health-care. Medicare's long-term trends may eventually break the federal bank, but the cost of health-care inefficiencies are being felt throughout the whole economy today. Americans pay a lot for health-care, far more than do the citizens of other industrialized nations. More needs to be done to increase the supply of medical care and push America's health-care system in the direction of a functioning market. Health-care is perhaps the section of the economy with the most government interference; it is also one of the most inefficient. The British National Health System shows that it is possible to provide some level of national coverage at relatively low cost through socialized medicine. The US could instead go in the direction of unleashing the power of the market to provide cheaper, better health-care; the current faux-market of health-care in the US is not working as well as it might. And unleashing the power of the market means far more than putting senior citizens on Medicare vouchers. It means tackling the lack of transparency in the field of medical spending, updating the insurance-financing system, allowing doctors to focus more on giving care than defending against frivolous lawsuits, taking on health-care oligarchical structures, and opening up the ranks of medical providers.


Obviously, these thoughts are partial and open to debate; they are more posed in an experimental tone than a dogmatic one. But experiment is often the first step on the path to success. If the GOP is to offer a true competing agenda to the policies of Barack Obama, it needs to move beyond a fixation on tax cuts to a broader emphasis on growth, job creation, the defense of the middle class, and structural renewal.

Economic Geographies

Via Tyler Cowen, I came across an interesting essay by Noah Smith discussing possible causes for the recent economic stagnation. He adapts a theory of economic geography from Paul Krugman:

The basic idea of the theory is this: It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other ("agglomeration"). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial "Core" and a much poorer agricultural "Periphery" that produces food, energy, and minerals for the Core....

So this could explain why people in the rich world are getting poorer. In the 50s, America was the only industrial "Core" on the planet. But since the 60s, we have seen successive "growth miracles": Japan and Europe in the 60s/70s, then Taiwan/Korea/Singapore in the 80s, then China since then, and now even India. In a New Economic Geography world, we would expect these successive relocations of manufacturing to hold down income growth in the U.S., even if technology was advancing as usual. And now Japan and Europe are feeling the pinch as well.

Smith further expands upon the situation of the USA:

It may be that American manufacturing strength was due to a historical accident. Here is the story I'm thinking of. First, in the late 19th and early 20th centuries, our proximity to Europe - at that time the only agglomerated Core in the world - allowed us to serve as a low-cost manufacturing base. Then, after World War 2, the U.S. was the only rich capitalist economy not in ruins, so we became the new Core. But as Europe and Japan recovered, our lack of population density made our manufacturing dominance short-lived.

Now, with China finally free of its communist constraints, economic activity is reverting to where it ought to be. More and more, you hear about companies relocating to China not for the cheap labor, but because of the huge domestic market.

There are many good points here, especially the role of sudden shocks to the economy in changing events; the essay is well worth reading in full.

However, I'm somewhat skeptical of this theory of economic geography.

First of all, I think it may overvalue the cost of transporting goods. Shipping costs were a much bigger weight in 1830 than they are today, and producers are less tied to the physical territory of potential consumers now than they were. After all, the past few decades have seen many factories close down in the American market only to relocate thousands of miles away to sell to this very same market. The story of globalization over the past twenty years is in part the story of the diminution of shipping costs (broadly considered), which I think may complicate the narrative of this model.

Moreover, this theory of economic geography seems to suggest in some way that the most densely concentrated areas are likely to be destined to be the richest (I admit that this is a simplification of the model). However, often very densely concentrated countries are very poor, while there are plenty of wealthy less dense countries. I wonder whether density of population is really the most crucial variable for discussing national wealth or national capacity for wealth.

Smith's reading of the US economic path is interesting, but I think it also has some limitations. While our closeness to Europe might have allowed us to serve as a "low-cost manufacturing base" (though the US was much farther from Europe than many poorer nations), the growth of American industry in the nineteenth century was also accompanied by the increase of American living standards over those of many wealthy European nations (such as Great Britain); this combination of high wages with industrial growth differs from current low-wage trends. And the US had a huge manufacturing capacity even before the other great powers destroyed themselves during the two World Wars.

Also, I think Smith may underestimate the role of human agency in his claim that "you hear about companies relocating to China not for the cheap labor, but because of the huge domestic market." The appeal to the giant Chinese domestic market has merit, but we should not forget that the Chinese government often requires companies to invest in factories and other places of employment in the PRC in order for them to have access to the broader Chinese market. Beyond the "natural" appeals of economic geography, state coercion plays a considerable role in this narrative of Chinese expansion.

Though I'm doubtful about many of his policy suggestions, Smith is right in his recommendation that American update its transportation infrastructure. I think there's more to economic destiny than population density, and the "historical accident" of American wealth is in part the result of the deliberate choices of American policymakers in the past (even if some of these policies, such as tariffs, may run afoul of contemporary orthodoxies).

Update: Matt Yglesias has some more observations on the China market here.

Picking a Battleground

With the national debt skyrocketing, a faction on the right is hoping to turn the 2012 election into a debate on entitlement reform. No doubt, many Democrats are hoping the very same thing. Democrats would view that development as a chance to gain politically, while some Republicans would see it as a chance to demonstrate their purity.

Charging forth under the motto of William F. Buckley, standing "athwart history, yelling Stop," many conservatives have an affection for martyrdom. And it is not a uniquely conservative mistake to believe that, if something is hard, it is also worthwhile.

Running on entitlement reform would be very hard. Social Security, the centerpiece of American social insurance, is far more popular than tax cuts for the wealthiest Americans or other beloved positions of supposed fiscal hawks. Though many Americans recognize that Medicare is on an unsustainable course, they also want to ensure that the elderly can have sufficient medical care. And bromides about "self-reliance" apart from "socialistic" government intervention can be grating when they come from millionaires who have collected many years' worth of government paychecks. Moreover, it's hard to run a presidential campaign, a genre of the broad brush, with the mechanical pencil of policy minutia.

Yet the difficulty of running on entitlements should not obscure the fact that running on entitlements and focusing excessive energy on curbing entitlements will not solve what truly ails the economic health of the nation and drives our immediate and medium-term deficits: the poor employment picture. Hundreds of billions would be shaved off of the federal deficit with a revitalized economy, and a rotten economy is accelerating our entitlements crisis.

If you want to destroy the sustainability of Social Security and other social insurance programs, ignoring the economy is a good first step. Of course, economic stagnation also imperils the ability of the United States to project power, diminishes the standard of living, and makes it harder for Americans (and others across the globe) to have a lifestyle of comfort. Economic despair would have profound ripples throughout the American social fabric and the global order. Conversely, if the US can transcend the economic doldrums of the past decade, Social Security would require relatively little reform to become indefinitely sustainable, and even Medicare reform would become much more manageable. Solving the economy will help solve entitlement issues, but curbing the growth of Medicare, etc. will not, alas, solve our economic problems: very few businesses are refusing to hire because they fear the escalating costs of Medicare two decades down the road.

Furthermore, running on the poor economy has the additional advantage that this economy is immediately tangible. There's no need for Republicans to get caught in the weeds of arguments about projections, revenue metrics, and benchmarks for growth when they can instead simply tell voters to check the unemployment rate, to look at their diminishing paychecks, or to see how their neighbors are doing.

Republicans would have much to gain by making the economy the door to a broader critique of the Obama administration: that this economic frustration is representative of a broader failure to channel the energies of a free people; that, rather than focusing on the practical trials of American workers, this administration chose instead to use this crisis to indulge in ideology; that its rapid expansion of regulatory power has served not to level the playing field but instead to provide a vehicle for favoritism and political payback. Many of the excesses and limitations of the Obama administration can be seen in its economic policies, so Republicans can make a broader, principled case against Obama while also being anchored in the economic realities of the moment.

Republicans can say to voters, In 2008, you voted in Barack Obama and scores of Democrats in hopes of a new way forward. Disappointment has been the recompense for all your hopes. We can offer a better path. Growth built not on debt but on innovation and production. An economy based not on hollowing out and corporate raiding, where the profits go to an ever-shrinking minority, but on the productive labor of the broad range of the American workforce, where a true rising tide will lift all boats. We can offer an economy of freedom, where opportunity is not the purview of the few but the promise of the many. The world has changed over the past decade, but the thinking of many in Washington has not kept pace with that change. Well, now is the time to renew the American spirit of freedom, innovation, and prosperity---not for some Americans but for all Americans.

Such an aspirational, forward-looking message has, I think, more in it electorally and intellectually than do hectoring declarations that the Democrat party (or the RINO establishment or the federal government as a whole) is a hive of traitorous socialists who hate the United States and freedom. It also has a lot more zip than endlessly insisting, No, I really don't want to push Granny off a cliff. In fact, based on current actuarial projections, at the rate of current spending, the Social Security trust fund will be depleted by such-and-such a date, unless we start to adjust COLA standards and....

(Crossposted at FrumForum)

S&P: Dysfunctional Politics and their Price

S&P has now downgraded the US government from AAA to AA+, a historic downgrade. The effects of this downgrade will no doubt echo throughout the US and global economy.

Zero Hedge posts the full text of the S&P statement. Contrary to what you might read in some quarters of the media, the statement regarding the downgrade does not merely focus on the inadequacy of the recent debt deal to reduce the long-term debt. Instead, it offers a broader critique of the structure of American fiscal politics.

The statement hammers away at what it views as political gridlock. The battle over the debt-ceiling has exacted a considerable toll, in S&P's eyes:

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade....

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability

Many wanted a "battle" over the debt-ceiling and hoped for more "battles" in the future; S&P suggests that this might not be a good idea for the long-term fiscal situation of the United States.

Though the report does vaguely ask for reforms to various entitlements, it mentions Republican intransigence on raising taxes multiple times. Unlike earlier reports, this new one, with its projections for an accelerating amount of federal debt, assumes the extension of all Bush tax cuts "because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act." This report emphasizes tax hikes at the end, as well:

As our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction--independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners---lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government's debt dynamics the long-term rating could stabilize at 'AA+'.

The report notes that other sovereign nations will have greater debts as a percentage of GDP for years into the future, but it still insists on downgrading the US:

When comparing the U.S. to sovereigns with 'AAA' long-term ratings that we view as relevant peers--Canada, France, Germany, and the U.K.--we also observe, based on our base case scenarios for each, that the trajectory of the U.S.'s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.

So part of this analysis is based on long-term trends, an analytic assumption that may or may not be warranted.

Part of S&P's justification for the downgrade is premised on the fact that the economy is much weaker than was earlier thought. Ironically perhaps for some, this report may further damage the national economy by leading to an increase in various interest rates and heightening a sense of uncertainty in the nation's finances.

S&P makes the following recommendations for the United States: increase revenue, improve the economy, and ensure that government can fulfill its routine fiscal responsibilities. Those aren't exactly bad points. High-wire political knife-fights may make for riveting blogging and TV, but they do not always reflect the utmost of fiscal prudence. Perhaps the US government should not dance to the tune of (far from infallible) ratings agencies, but S&P does have a worthy point in this: in order for our government to work in the long term, it must have some kind of governable consensus. We must also have an economics anchored in reality and not in ideology, and a fiscal politics of compromise and empiricism instead of flamboyance and wrath.

Turnaround Techniques

David Frum puts forward some ideas on how to turn around the employment picture:

1) Cheap money, a low dollar, and moderate inflation.

2) Tax relief aimed at stimulating private consumption, such as a big payroll tax holiday.

3) Income support for people in need.

4) Modest and temporary subsidies to state building projects.

5) An immigration moratorium.

6) Agreement now on a plan to balance federal budget to begin only after such time as unemployment declines below 8% or the 10-year US Treasury bond goes north of 5%.

Of Downgrades and Ratings Agencies

The suggestion that the US needs to cut $4 trillion in projected debt over the next ten years in order to avoid a downgrade in its debt rating, posed here in an S&P report, has gained significant traction among many on the right. Erick Erickson, when he's not denying "absolution" to the falsely faithful in the GOP, has emphasized this cut of $4 trillion as crucial to avoid a downgrade.

However, digging into the S&P report reveals some details that might be more problematic for many seeming "deficit hawks." Though this report does suggest that $4 trillion in cuts/increased revenue over the next ten years would be enough to keep an AAA rating, it also says that its baseline for savings assumes the expiration of the Bush tax cuts in 2012. Will many of these "deficit hawks" abandon those tax cuts in order to appease S&P and keep an AAA rating?

This report also makes an interesting---and perhaps unwarranted---logical jump (emphasis added):

Congress and the Administration might also settle for a smaller increase in the debt ceiling, or they might agree on a plan that, while avoiding a near-term default, might not, in our view, materially improve our base case expectation for the future path of the net general government debt-to-GDP ratio. U.S. political debate is currently more focused on the need for medium-term fiscal consolidation than it has been for a decade. Based on this, we believe that an inability to reach an agreement now could indicate that an agreement will not be reached for several more years. We view an inability to timely agree and credibly implement medium-term fiscal consolidation policy as inconsistent with a ‘AAA’ sovereign rating, given the expected government debt trajectory noted above.

Really? Right now, we have had a House filled with new members who have a radical antipathy to the sitting president, his party (which controls the Senate), and (Democratic) deficit spending. I would think now might be one of the times when a long-term agreement was least likely. Things could be radically different 2 years from now. If Obama wins reelection, the Republican majority in the House would likely be quite diminished, if not destroyed. Meanwhile, the Senate, a more consent-run institution, would likely have a narrow Democratic or Republican majority. Wouldn't that situation be more likely to have a bipartisan agreement? Likewise, a Republican victory in November 2012 could very likely lead to Republicans controlling both houses of Congress and the presidency. Surely that scenario would also be likely to pass a long-term debt-decreasing strategy---or at least more likely than the present. S&P might be guilty here of setting a false deadline. This is not the first time S&P has made mistakes in its analysis.

Moreover, it's worth noting that S&P does seem not overly concerned about the current amount of US debt as a percentage of GDP. After all, many countries (such as Germany and France) have debts that are greater fractions of their economies than the USA does by many estimates (S&P currently estimates that the US debt-to-GDP ratio is close to 75%). Moreover, US bonds constitute nearly 60% of AAA-traded government bonds. And interest rates on long-term government bonds are very low, indicating that investors feel quite safe buying US treasuries. Much of the market seems to believe that US debt is a safe investment.

What S&P is concerned about---and we should be concerned with---is the trajectory of debt as a percentage of GDP, which has shot upwards in recent years. One of the biggest drivers of our debt problems in the short term is the poor economy (Medicare is one of the biggest in the long term). And S&P warns that refusing to raise the debt ceiling could lead to a worsening of the economy and further degrade the US debt outlook. This S&P analysis suggests that raising the debt ceiling without $4 trillion in savings and the repeal of the Bush tax cuts might lead to a downgrade (nowhere does it say that it will downgrade US debt if cuts are less than $4 trillion), but refusing to raise the debt ceiling would very likely lead to a downgrade.

The miserable employment picture and resulting diminished tax revenues probably accounts for at least half (and perhaps much more) of the current deficit---over $700 billion dollars a year. Getting back to a fully functioning economy would shave trillions off the debt over the next decade. Anything that gets in the way of a real economic recovery would likely worsen, not resolve, our debt crisis.

(Crossposted at FrumForum)

Limits of Tax Cuts

Harry Graver looks at some state-by-state unemployment numbers and finds that low taxes are not the only factor for economic growth:

For example, Nevada, leading the nation in unemployment, has the fourth best tax environment, according to the Tax Foundation. Of the states without an income tax (nine in total), six have lower unemployment than the national average (Alaska, New Hampshire, South Dakota, Texas, Wyoming), two are roughly keeping the national average (Tennessee and Washington) and two are above (Florida and Nevada). Of the seven states with a flat income tax, three are at the national average, three are below, and one (Michigan) is above.

As Graver rightly notes, economic growth depends upon a vast range of factors---including human capital, natural resources, infrastructure, and regulatory policies. Pro-growth tax policies can be helpful but they are not sufficient for economic growth.

Diminished Expectations

Many political analysts are focusing on the consequences of the poor economy for Barack Obama's re-election chances. High unemployment rates and an economy limping along (with a few spurts from massive deficit spending) are hardly propitious circumstances.

Yet these troubles have much deeper roots. According to government calculations, we have been mired in an anomalously extended period of poor economic growth since 2001. Many writers have focused on stagnating middle-class incomes, but looking at GDP numbers tells a similarly disappointing story. Since 2000, GDP growth has lagged well below historical averages. Based on Bret Swanson's calculations, GDP growth from 2001 to 2010 averaged only 1.6%; GDP growth averaged 3.5% from 1947 to 2000. No decade since the 1930s has shown worse average economic growth.

The fact that the economy suffered a huge setback in 2008 and 2009 might skew the averages for the 2000s down, but not by that much. Even before the most recent recession, economic growth still lagged far behind historical precedent. The boom times of the 2000s would be seen as hum-drum in earlier decades.

Here's an overall view of the growth of the American economy since 1930, with numbers drawn from the federal Bureau of Economic Analysis:

Now, to close up on the past three decades:


During the Bush years, 2004 was the only year when GDP growth exceeded the average growth rate of 1947 to 2000, and that was only by a fraction of a percent (3.6% vs. the average 3.5%). With 3.1% growth, 2005 was the only other year where economic growth exceeded 3%.

By way of contrast, there were only 2 years during the Clinton presidency when growth was less than 3% (2.9% in 1993 and 2.5% in 1995). After 1982, Reagan's presidency never witnessed any economic growth rate less than 3%. One-termer George HW Bush had as many years when the economy grew over 3% as his two-term son.

Perhaps an even starker piece of economic spin: until 2000, almost every president since Franklin D. Roosevelt saw multiple years when the economy grew faster than 4% (Bush 41 being the only exception). We have not witnessed that kind of growth in almost twelve years.

Under an extended era of the lowest top marginal tax rates since 1932 (with the exception of the brief period between 1988 and 1992),* we have also seen the most protracted period of economic stagnation since the Great Depression. Whatever the other implications of this fact, it does suggest that tax cuts alone will not be enough to restore the health of the American economy. Tax cuts could be part of a plan for economic renewal, but not the plan itself.

Nor is cutting spending an easy panacea. Federal spending as a percentage of GDP was higher during the Reagan administration than it was during the quiet stagnation of 2001-2007. Again, spending cuts may be part of the solution for our economic travails (government spending as a percentage of GDP was lower in the 1950s and 1960s), but they are not the solution itself.

The implications of this diminished growth are significant for the national body politic. The modern American state, as understood by presidents from Roosevelt to Reagan, is based on the marriage of strong economic growth and generous social insurance. Social Security, Medicare, unemployment insurance, and so forth are the privileges of a wealthy society, and, properly calibrated, they can contribute to this wealth. The ability of the United States to project martial force across the globe and to take a prominent role in the community of nations is also predicated upon national wealth.

Our national finances especially show the strain of this slow growth. At least half of our current deficit is due in some way to the poor economy, and economic stagnation imperils many of our leading social insurance programs. Moreover, many deficit reduction plans on both the left and the right assume economic growth that well outpaces that of the past decade: if growth doesn't improve, we'll need an army of chainsaws to begin to approach fiscal sustainability.

If the next twenty years see the same kind of anemic economic growth as the past ten, any reforms to "save" Social Security and Medicare will have a huge portion of pain. Those programs will become shadows of themselves, as the American economy is crippled with stagnation. A strengthened economy, on the other hand, would likely make the reforms of these programs much less painful. For example, while the trustees of Social Security estimate that the retirement program will exhaust its trust fund some time around 2030 under (comparatively) slow growth expectations; if average GDP growth reaches close to 2.9% per year, Social Security trustees estimate that the program's trust fund will be in the black for the foreseeable future. Reforms might need to be made eventually (especially for Medicare), but increased growth would provide a cushion for them.

This current turmoil provides an opportunity. Societies can gain new vitality by recognizing the limitations of the current status quo and by adapting to changes in the broader political-economic environment. Some might suggest that the United States must or should accept diminished growth. But it seems to me that, after all the storms this nation has weathered, there is no reason to give up on the American project's hope for popular enrichment. After all, Americans in the late 1970s faced an economic paradigm that had outlived its usefulness and an increasingly fractured geopolitical order. But, as Jim Manzi has explored, Ronald Reagan, working with Democrats and fellow Republicans, was able to forge a new consensus that helped lead to a renewed nation. We can cope with our troubles, if we have the imagination to challenge old assumptions and the daring to take new paths.

The Democratic stimulus has failed to meet expectations, and even a return to the conditions and policies of 2001-2007 would be a surrendering of the tradition of American economic growth. There is both an opportunity and need for Republican and conservative leaders to rethink contemporary orthodoxies. Reaganomics, extended past its time, becomes a zombie: rather being a set of policies of vital engagement, it degenerates into dogma and rigid ideology. The world and nation are not the same as they were in 1981. Conservative economic policy needs to recognize that fact.



*Moreover, federal revenue as a percentage of GDP was higher during much of the Reagan, Bush I, and Clinton administrations than during the period since 2000. This lowered revenue may be partly correlated with post-2000 economic stagnation.

Globalism, Neo-Mercantilism, and the US

Polemical assertions in a contrarian key

The American economy has entered a period of turmoil unlike any it has seen in decades. The solutions, to me at least, do not seem radically easy or clear, but the first step in finding a solution is to clarify our language in talking/thinking about the problem. If we are serious about finding ways of addressing some of the serious structural problems of the economy, we must be willing to offer a thoroughgoing analysis of the whole economic order.

The trends of "globalization" have had a huge impact on the American economy in the past twenty years. Yet I think there have been some confusions in our contemporary discussions of globalization, so here are a few* (mildly polemical) challenges to contemporary assumptions, focusing on trade and manufacturing policies.

The decline of manufacturing is not like the decline of agriculture. The shrinking manufacturing sector is often mistakenly analogized to the drastic drop in the number of Americans working in agriculture from 1870 to 1950. The current trade deficit, driven by manufactured goods, disproves that analogy. The story of the Industrial Revolution in America is not the replacement of agriculture by manufacturing but the incorporation of agriculture into a new, broader economy. Throughout industrialization, Americans still produced enough food to feed themselves and those in other nations. For the most part, we still do produce enough food to do so. The number of Americans working in agriculture has declined drastically, but, due to increases in productivity, the output has only increased. While it is true that productivity has increased in manufacturing and that automation has cut down on the number of needed factory jobs (the US still does produce a lot), such an increase in efficiency does not tell the whole story of the decline of American industry: if it did, we would still be producing huge quantities of shoes, computers, tools, and countless other items. The fact that factories are closing down while our trade deficit has skyrocketed over the past twenty years is a sign of how different the fates of manufacturing and agriculture have been.

We do not live in an era of free trade. (Or: Cheap imports do not equal free trade.) Some of those who criticize the reigning trade hegemony counterpose "fair trade" to the dominant "free trade." This criticism is mis-aimed. We may not have "fair trade," but we certainly don't have "free trade," either. The current global trade order is not free trade but actually a species of neo-mercantilism. Many developed nations have opened up their economies to an influx of goods from poorer, often autocratic, mercantilist countries. Most importantly for the case of "free trade," there is often a great disparity in openness between trading partners. These disparities are especially stark for the United States. US policymakers have in a variety of ways unilaterally opened up the American market while allowing other countries to stack the deck against US businesses and workers. We are told that this flood of imports is "free trade" when, in fact, numerous barriers are put up against American products.

Consider our relationship with the People's Republic of China, our second-largest trading partner. It would be a stretch to declare that this relationship is "free trade." The PRC manipulates its currency as a de facto tariff against US goods and piles further outright tariffs on US goods. The price of entry into the Chinese market is often, in part, a joint-venture agreement, in which a foreign company provides intellectual property and other advanced technologies while local Chinese contacts supply workers and land for factories. Mandating that businesses open up factories in a nation in order to have access to it is not exactly classical free trade.

These agreements are very often deleterious to US workers and US companies. The office-supply manufacturer Fellowes, for example, opened up a joint-venture manufacturing facility in the PRC. For a few years, this factory led to some considerable profits for Fellowes. In August 2010, this stream of profit came to a sudden end, when Fellowes's Chinese partner moved to take possession of the facility:

The dramatic moment was in early August 2010, when Zhou, under the aegis of Shinri, blocked the gates of the joint venture facility with security guards and trucks, preventing people from going in and goods going out, effectively shutting down production. Shinri expelled and confined the managers, moved funds from the joint venture to a Shinri-controlled bank account, sent packing the 1,600 joint venture employees, and at night, drove a truck into the facility and stole Fellowes-owned injection molding tools, some of them weighing several tons.

Fellowes's former partner now has taken possession of millions of dollars of equipment and technological know-how---all without paying a cent (or a yuan) for it. The Chinese government appears to be giving cover to what many would consider theft. Fellowes is but one of many companies that have had their investments and technologies confiscated by the politically connected of the PRC. Without a basic respect for property rights, there can be no capitalistic free trade.

Trade policy does not happen in a vacuum. In part to cope with the throes of industrialization, the United States passed various worker and consumer protections in the twentieth century: regulations for environmental protections, worker safety, wages, and other areas. When the US economy was bounded by tariffs, these regulations helped ensure that an increase in industrial production went along with an increase in the standards of society. However, in our new era of neo-mercantilist globalism, the role of these standards has become considerably more troubled for US workers.

Consider the case of environmental standards. As the decades have gone on, our environmental standards have become increasingly invasive and onerous. Government more and more regulates chemical usage, energy sources, waste disposal, land use, and other aspects of environmental production that affect industrial policy. The presumed beneficiary of these regulations is the public at large through the protection of the environment. Our laws tell companies that, if you manufacture in the USA, you must face numerous obligations and pay increased costs due to all these regulations. Our trade policies, however, tell those very same companies that, if they manufacture their products abroad, they need not worry about any US environmental or worker regulations. One might wonder how the environment is helped when US policies incentivize heavy industry leaving a country with some environmental regulations (such as the USA or many European countries) and going to a country with far fewer (such as the PRC or India).

I recognize that economic prosperity is often correlated with an increase in environmental protections, so a wealthier India may eventually introduce further environmental protections. But there seems to be an often radical disproportion between how politicians talk about environmental policies and what our trade policies actually encourage. The debate over "global warming" reveals this disproportion at the height of its absurdity. In the name of "global warming," the federal government has banned the classical incandescent lightbulb in order to cut down on carbon emissions; meanwhile, through trade policies, it has encouraged a gross increase in carbon emissions through encouraging manufacturing to move to nations with radically less efficient and more polluting forms of industrial production. "Global warming" advocates often stress that the world is at a tipping point for carbon emissions and forecast the deaths of potentially hundreds of millions of people if carbon patterns do not change right now. Many of these same advocates, however, seem to see no problem with the continued destruction of American manufacturing. A "cap-and-trade" scheme or carbon tax, without any attention to broader global industrial questions, would do little for American employment or lower carbon emissions. If environmentalism is more than NIMBYism and self-righteousness, we need to consider the effects of our current trade policies upon domestic policies.

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To acknowledge (or to wonder about) the limits of neo-mercantilist globalism is not to embrace isolationism; on the contrary, this kind of critique opens up further ways of engaging with the broader community of nations. It would be foolish to turn our economic or political backs on the world, and a tariff war would very likely create more problems than it would solve. But it would equally foolish to allow our thinking to be frozen by hazy myths and knee-jerk assumptions.

The theory of free trade does have much of value to it. Under the right conditions, trade between nations does lead to a rising tide for all boats. There have also been many benefits to the current neo-mercantilist order, though some of the implicit tensions of this order have risen to the surface during the last few years of economic turmoil. Yet, living within this order, the United States must find ways to renew its competitive edge and successfully compete with mercantilist powers. It might also, with its allies, consider how best to revise this order so that it better advances the ideals of freedom and prosperity.

*UPDATE: A few points have been moved to a forthcoming discussion.