Barack Obama and Mitt Romney agree on at least one thing: that this election is “a choice between two different paths for America,” as the president put it. Yet when it comes to the economy, many of the basic reasons for our sluggish recovery and the ideas needed to address it have been missing from the debate. Instead, we have been given a choice between the clearly mistaken supply-side tax cuts and deregulation championed by Romney, on the one hand, and the well-meaning but timid proposals of Obama, on the other. Here are five economic ideas that should be at the center of the election debate but are not.
§ Let’s begin with a key point about today’s crisis: we are in what economists call a “balance-sheet recession.” This is the only way to explain why, despite repeated doses of monetary stimulus and large budget deficits, the economy is essentially stalled, producing well below potential with continued high unemployment. The two textbook cases of a balance-sheet recession are the Great Depression and Japan’s “Lost Decade,” which began in 1990. Like those two cases, our recent recession followed a financial crisis involving the bursting of a major asset bubble—in this case, the housing and credit bubble. When it collapsed in 2007, housing and other asset values fell, leaving many households with unsustainable levels of debt. Accordingly, they have had no choice but to cut spending and increase savings in order to pay down debt, thus reducing consumer demand. And with weak consumer demand, businesses quickly followed suit by curtailing investment and cutting the workforce.
The overall effect has been a huge shortfall in demand, which has been worsened by an even more worrying debt and institutional crisis in Europe, and now by a potentially serious economic slowdown in China. The only way the government has avoided depression has been by borrowing and spending to offset the falloff in the private sector.
The problem is that balance-sheet recessions can drag on for years—in this case, until the household sector (about 70 percent of the US economy) has repaired its balance sheet or some major new source of demand emerges in the world economy. By most estimates, we are less than halfway through this deleveraging process. (Household debt as a percentage of GDP has declined from a peak of 97.5 percent in 2009 to 83 percent today, but is still considerably above its pre-bubble level of 65 percent.) And the world economic slowdown will probably continue to weigh on the United States for some time.
The bottom line is that Washington has no choice but to borrow and spend for the foreseeable future. The question is how large this borrowing and spending should be, and what form it should take. But that is not the debate the presidential campaign is giving us. Instead, both parties are trying to impress us with their commitment to cutting the deficit. But even modest steps to reduce the deficit in the short to medium term will bring about the kind of premature fiscal consolidation that prolonged the Great Depression when FDR decided to cut spending and raise taxes in 1937.
§ We need to create “good deficits” by replenishing America’s capital stock. The federal government has been running large deficits; the problem is that they are what some economists call “bad deficits.” Take the fiscal year 2012 shortfall, projected to be $1.1 trillion. That sounds large, yet it is not the result of government spending on things that will make us richer and more productive or put more people to work (such as infrastructure, research and development, and human capital). Rather, the deficit is mostly the result of weak tax revenues arising from slack economic growth; supply-side tax cuts (originating in the Bush era but extended ever since) that reward wealthy Americans but have little stimulative effect; and the lingering costs of two wars of occupation, which have done little to promote economic activity at home. In fact, if one includes state and local government spending, total government investment has actually declined over the past four years—in part because Republicans in Congress have blocked even the administration’s modest proposals in this area.
Given that the government must continue to borrow and spend to allow the private sector time to mend, the question is how to transform bad deficits into good ones. Obama’s efforts to wind down the wars in Iraq and Afghanistan and to let the Bush tax cuts for upper-income Americans expire are part of the answer. Beyond that, one obvious step would be a major public investment program to replenish our public capital stock—roads, bridges, airports, electrical grid, research and development—and to develop our human capital with more spending on training and apprenticeship programs.
Because of several decades of underinvestment, and because the government can borrow at absurdly low interest rates, investment in public capital stock would bring large returns to the economy. Indeed, investment in our transportation, communications, energy and water systems would be the best way to create jobs, make the economy more productive and improve our quality of life. The question is not whether we need such a program, but what kind and with what priorities.
Yet once again, this is not the debate we are having. Instead, the Romney camp is making the nonsensical argument that public borrowing and spending are crowding out private investment, even though trillions of dollars are sitting on the sidelines.
§ We need a public bank for infrastructure and reconstruction. We have underinvested in infrastructure and human capital, in part because we lack the appropriate institutions and mechanisms for doing so. Over the past two decades, the private sector has done a questionable job of allocating capital, overinvesting in the technology sector by more than $3 trillion in the late 1990s and then recycling global surpluses into an even larger housing and mortgage bubble in the early 2000s, all while neglecting pressing infrastructure needs. Today, the banking and financial sector is sitting on more than $2 trillion, largely content to “arbitrage” the difference between near 0 percent short-term rates and somewhat higher longer-term rates rather than make new loans and investments in the real economy.
Clearly, our financial system requires fundamental reform. The two candidates, of course, do offer a choice on regulation, with Romney pledging to roll back much of the Dodd-Frank financial reform law that is now being implemented. But both candidates have largely been silent on the fundamental question of how to ensure adequate investment in infrastructure and human capital.
The answer of an earlier generation of reformers was to create what economic historian Michael Lind calls public-purpose financial institutions to complement the private banking system. Beginning in the 1930s, the New Dealers created or expanded a host of public credit agencies, including the Reconstruction Finance Corporation, to ensure that capital was delivered to depressed sectors of the economy by making investments that private banks were unwilling or unable to make. Many of those institutions served us well until they were either privatized (such as Fannie Mae and Freddie Mac) or shut down (the RFC).
President Obama did propose creating a national infrastructure bank, but he never put serious energy into fleshing out the idea or moving it through Congress. Consequently, it has largely disappeared from the national conversation. Yet the creation of a public bank (or a series of regional public banks to mirror the Federal Reserve System) could do more than any other single act to meet our most pressing infrastructure investment needs in a fiscally responsible way.
If properly designed, a public infrastructure and development bank with the ability to issue its own debt would allow the government to leverage much larger sums of private capital for vital projects without large increases to the federal deficit. In this sense, a public bank would be a budget multiplier, enabling investments in public-private infrastructure that the private sector would not undertake without government support or federal guarantees. In the end, the federal debt would increase only to reflect the risk that some of these projects financed by the public bank might fail.
As noted earlier, the problem now is not lack of capital; it’s the inability of the financial system to put this money to work in a way that creates jobs and expands our productive capacity. A public bank would solve that problem.
§ We must increase wages and employment. If a shortfall in demand is the biggest drag on the economy, then increasing wages and incomes should be a critical policy goal. Higher incomes would increase the purchasing power of households and thus accelerate the deleveraging process. Yet wages and incomes have barely figured into the election debate, except as an occasional talking point for Romney supporters about how bad the economy is. Instead, most of the focus has been on taxes and how to use the tax code to benefit the middle class. Progressive tax policies are needed to reduce inequality, but the future of the middle class will be determined by the kinds of jobs the economy creates and what level of wages those jobs command.
According to Census Bureau data, median household income actually declined by 4.1 percent from 2009 to 2011, from $52,195 to $50,054. Real median wages have also fallen. Indeed, the same trends that helped cause the crisis are continuing in the weak recovery. Wages for the great majority of Americans are stagnating or even declining, while upper-income professionals and capital owners are capturing most of the gains from national income growth. The only difference now is that many households can no longer borrow to maintain their standard of living or make ends meet.
A robust and sustained recovery is not possible without a rise in real wages and incomes. One obvious place to begin would be to increase the minimum wage, which, as Roosevelt Institute senior fellow Richard Kirsch points out, buys 30 percent less than it did forty years ago. Raising the hourly minimum wage from the current $7.25 to $12 would immediately help millions of Americans, and would boost economic growth because most of it would be spent on basic goods and services.
Another essential step would be to increase public sector employment by expanding public services along with infrastructure investment. We could expand popular programs like the Army Corps of Engineers and AmeriCorps, and then add other programs to meet serious public service needs. One reason for the decline in household income has been the loss of middle-income jobs, especially in the government sector. Normally, government hiring helps the economy recover in a recession—at this point in other postwar recoveries, public sector employment had increased by an average of 8 percent. But since this recession ended, government jobs at all levels—federal, state and local—have been cut by about 570,000, a huge drag on the recovery.
To his credit, President Obama has proposed increasing federal assistance to state and local governments to retain teachers, cops and firefighters. But he has not yet made the larger case for more public sector employment, which is increasingly necessary, as automation and rising productivity continue to eliminate employment in manufacturing and business services.
§ We need a Plan B for the world economy and globalization. This is perhaps the biggest missing debate of all: how to respond to the world economic crisis. Except for the usual election-year pledges to get tough with China on trade, expand American exports and fix the tax code in order to encourage more investment at home, the two candidates have been silent on the world economy, as if there were no eurozone crisis, no overinvestment and property bubble in China, and no talk of a new round of currency wars.
Plan A for the world economy, from both Obama and Romney, seems to make some very questionable assumptions: that the crisis in Europe will be overcome through continued austerity and ad hoc management led by the European Central Bank; that China will be able to engineer a soft landing despite the collapse of its export markets and the incipient deflation of its property and overinvestment bubble; and that all three major economies—Europe, China and the United States—will be able to fiscally consolidate and export their way to growth at the same time.
If this is Plan A, then we urgently need to ask the candidates what their Plan B is. At best, the recession in Europe and the economic troubles in China will create serious difficulties for the US economy. At worst, the deleveraging and institutional crisis in the eurozone and the overinvestment crisis in China will spell the end of the second great try at globalization (the first having ended with the Great Depression and World War II ).
During the 1997–98 world financial crisis, the United States was able to stabilize the system with an expansive macroeconomic policy and by keeping its markets open to troubled Asian exporters. But this crisis is larger than any since the Great Depression, and the United States is now a much smaller player, given the increase in size of the global economy over the past decade. It is therefore unlikely that the old playbook of crisis management will work. And even if it does, it will not work without inflicting great harm on the US economy.
One possibility for Plan B would be a truly coordinated world economic recovery, with each major region committing itself to fiscal expansion and with the IMF and World Bank helping to channel resources to depressed countries. We got a pale version of this in 2009. The other, more realistic—or perhaps parallel—option would be a North American strategy that would seek to insulate the US economy from the worst effects of the crisis in Europe and China by doing more to develop the growth potential of our own neighborhood—for example, by expanding the continental transportation, production and energy infrastructure and by increasing trade with our Latin American neighbors.
One could argue that it is hardly realistic to expect the candidates to take up these ideas. After all, they are not part of the mainstream debate. But that, of course, is precisely the problem. Whatever the two campaigns debate or promise, it is widely believed that if Obama is re-elected, he will immediately turn to the federal budget and the “fiscal cliff” and, under pressure from groups like the Fix the Debt Campaign, seek a new “grand bargain” on the deficit, because that’s what conventional wisdom believes he should do. But as suggested here, the real world has a way of intruding on political calculations. Long after the election, the US economy will probably still be struggling to stay above water, and the world economy could be well into a more dangerous phase of the global crisis. At that point, it will matter whether we debated Plan A or Plan B for the world economy and discussed the merits of a major public investment program for creating jobs and supporting stronger growth.
Also in this week’s issue, Ken Ward Jr. writes that, despite Romney’s claims, Obama poses little threat to the coal industry.