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 user 2006-11-16 at 12:17:00 pm Views: 35
  • #17222

    Can Anyone Steer This Economy?
    forces have taken control of the economy. And government, regardless of
    party, will have less influence than everSometime next year–perhaps
    around Christmas 2007, if current trends continue–the U.S. will hit a
    milestone. For the first time in recent memory, the cost of imported
    goods and services will exceed federal revenues. In other words,
    Americans will soon pay more to foreigners than they do to their
    national government.We’re almost there now. Imports cost us about $2.2
    trillion a year; the federal government collects $2.4 trillion in
    revenues. Why is that important? Because for the past 70 years,
    Washington has been the 800-pound gorilla, more powerful by far than
    any other force in the U.S. economy. That’s not true anymore. The
    federal government remains plenty influential, but the global economy
    is more soThis will come as a rude shock to Representative Nancy Pelosi
    (D-Calif.), the presumptive Speaker of the House, Charles B. Rangel
    (D-N.Y.), the likely chairman of the House Ways & Means Committee,
    and other newly enfranchised leaders in the Democratic Party. Sure,
    they’re likely to have the power to pass legislation, including
    boosting the minimum wage. But such a measure, even if President George
    W. Bush signed it, would help only a small fraction of the workforce.
    It would do almost nothing to ameliorate the weak wage growth that has
    plagued most Americans, including college graduates, in recent years.
    The broad-based drop in incomes is being driven more by the rise of
    China and India and the intensification of global competition. And
    there is little Democrats can do to reverse these trends.No matter
    which party you belong to, or which Big Idea or school of economic
    policy you subscribe to, one thing is clear: Globalization has
    overwhelmed Washington’s ability to control the economy. Whether you’re
    a Republican supply-side tax-cutter, a Wall Street deficit hawk of
    either party, or a Silicon Valley techie type, your preferred levers of
    economic policy just don’t work as well as they once did.As recently as
    10 years ago, the U.S. economy was still relatively self-contained.
    Then-Federal Reserve Chairman Alan Greenspan–often called the most
    powerful man in the world–could be sure that the U.S. economic machine
    would eventually respond when he called for higher or lower rates. Tax
    and spending decisions made in Washington could set the course for
    growth, while economic events in the rest of the world, such as the
    Asian financial crisis of the mid-1990s, were felt as minor bumps.That
    has changed. Since 1995 imports have risen from 12% of gross domestic
    product to about 17%. And foreign money finances about 32% of U.S.
    domestic investment, up from 7% in 1995. In other words, the U.S. is
    more open to the global economy than ever before, and the links run in
    both directions. Now many of the levers affecting the U.S. economy are
    located not in Washington but in Beijing, London, and even Mexico
    City.Greenspan and his successor, Ben S. Bernanke, have found this out
    the hard way. To restrain economic growth and cool the housing market,
    the two Fed heads have raised short-term interest rates 17 times since
    2004, for a total increase of more than four percentage points. But
    even as the Fed tightened up on the domestic money supply, foreign
    investors made up the difference.As a result, the interest rate on
    10-year government bonds today is 4.6%, exactly where it was in 2004,
    when the Fed started raising rates. Good news for home buyers who want
    mortgages. Not so good news for the policymakers trying for a soft

    a similar problem. His huge tax cuts poured hundreds of billions into
    the economy and kept output rising at a decent clip. Nevertheless, the
    fiscal stimulus generated far fewer jobs than anyone expected, as more
    and more production headed overseas. “Traditional macro policies are
    less effective than they used to be,” says Robert S. Shapiro, a top
    economic adviser to President Bill Clinton who now runs a Washington
    economic consulting firm. “We don’t know how to ensure strong job
    creation and strong wage growth anymore.”Pelosi and the congressional
    Democrats, who embraced fiscal restraint as their pre-election mantra,
    shouldn’t expect much better economic results by pulling the
    deficit-cutting lever. On the campaign trail, Pelosi promised to
    contain the budget deficit, telling one Washington audience that “if
    American families are expected to balance their checkbooks, so, too,
    should the Congress of the United States.” While that commitment may
    resonate politically, there’s growing economic evidence that reducing
    the budget deficit won’t do much to jazz up business investment and
    growth. A new study from the Federal Reserve Bank of New York, as
    nonpolitical an organization as you will find, reports that “investment
    has exhibited only a tenuous response to fiscal policy changes.”Even
    the Big Idea of devoting more tax dollars to research and development
    to make the U.S. more competitive–an idea repeatedly advocated by such
    tech leaders as John T. Chambers of Cisco Systems Inc.CSCO and John
    Doerr of venture capital giant Kleiner Perkins Caufield & Byers–is
    beginning to look economically and politically troublesome. True,
    increased funding for r&d appears to be a rare area of agreement
    between the two parties: Pelosi and the House Democrats came out with
    their “Innovation Agenda” last November, and Bush followed with his
    innovation-based “Competitiveness Initiative” in the January State of
    the Union speech.But in the brave new world of the global economy,
    where companies move factories and facilities around the world like
    game pieces, it’s no longer a given that U.S. workers benefit directly
    from U.S.-funded research. One worrisome example: Despite federal
    outlays of over $125 billion for medical research over the past five
    years, the U.S. has a large and growing trade deficit in advanced
    biotech and medical goods. “The era in which we could assume that
    increased U.S. public investment in r&d automatically generates
    domestic growth is over,” says Jeff Faux of the liberal Economic Policy
    Institute.Policymakers now face the unenviable task of managing the
    economy in the face of an overwhelming flow of goods and money back and
    forth across national borders. “The federal government affects the
    economy only on the margins,” says Charles R. Black Jr., Republican
    consultant and outside adviser to President Bush. Adds Timothy J.
    Penny, a former Democratic representative from Minnesota who is now at
    the University of Minnesota: “Washington is far less relevant than it
    used to be. You don’t have to be an economics professional to see the
    evidence.”And get this: We don’t even know how to measure whether we as
    a country are succeeding or failing. The traditional metrics for
    economic security and prosperity are capturing impressive signs of
    life. Unemployment, inflation, and interest rates are low by historical
    standards. The stock market is rising, and household wealth is higher
    than it was at the peak of the 1990s boom, even after adjusting for
    inflation. To a large extent, this is thanks to the global economy,
    which has been fueling the U.S. expansion with cheap goods and cheap
    money. Yet real wages are down over the past five years, the trade
    deficit is enormous, and there are widespread worries about America’s
    continued ability to compete.Washington has responded to these
    concerns, in large part, with a series of small fixes, like tinkering
    with the pension system. But what’s needed is a new Big Idea for
    economic policy–or two or three competing Big Ideas–that accounts for
    the verities of the global economy.The first step is to get a better
    handle on what’s really happening to U.S. workers and businesses in
    today’s economy, where wealth is as important as income, and where
    events in Shanghai are as important as events in Chicago. If the value
    of a family’s home goes way up, but its income dips a bit, is the
    family better or worse off? If a U.S.-based company opens up an r&d
    facility in India or China, does its employment of American workers go
    up or down–and, does its overall contribution to U.S. growth increase
    or decrease? We don’t have the statistics needed to answer these
    questions.Second, we need to take hold of the main unused lever of
    economic policy: health care. Politicians and economists have mainly
    thought of health care as a cost that is dragging down competitiveness.
    Health-care spending is the main source of long-term federal, state,
    and local budget deficits, the prime gobbler of national savings, and
    one of the biggest tax distortions, in the form of the tax exemption
    for company-provided health insurance.All these things are true. But
    health care is also a huge source of private sector jobs, one of the
    most technologically advanced sectors of the economy, and frankly, the
    provider of a service people can’t get enough of. It can even be
    thought of as an investment, to the degree that better health allows
    Americans to work longer and to better enjoy their lives. We have to
    view health care as a force for growth, rather than an
    impediment.Finally, a Big Big Idea–probably too big to even consider
    right now–would be the creation of global institutions for governing
    the world economy. History tells us that market economies are prone to
    financial crises, to which the only solution is a strong central bank.
    During the Asian financial crisis of the 1990s, for example, the Fed
    played that role.But with the explosive growth of China and India, that
    sort of role for the Fed is no longer feasible, and no new institution
    has arisen to take its place. As former Treasury Secretary Robert E.
    Rubin, now a top official at Citigroup, recently said: “There’s no
    policy mechanism for bringing together the countries that really matter
    in the global economy.” The best solution would be some sort of global
    central bank with real powers–but that’s not going to happen until
    there’s a big enough financial crisis to truly scare people.

    that we understand it today, is a comparatively recent invention. It
    started with John Maynard Keynes in the 1930s. He put forth the Big
    Idea that governments had the ability to soften a downturn. Keynesian
    economics, as it was termed, calls for reducing interest rates, cutting
    taxes, and hiking government spending to ease the worst effects of
    recession.Today, Keynes’s prescriptions could be called Policy Classic,
    since even diehard free marketeers agree that fighting recessions is
    the right thing for governments to do. What’s more, Policy Classic
    still works in the modern global economy, up to a point. When a fire
    starts in your house, you should still try as hard as you can to douse
    it with water, even if your hose is leaky.Consider how Washington
    responded to the recession of 2001. One could quibble with the exact
    timing of Greenspan’s rate cuts, and the Democrats weren’t particularly
    happy with the Bush tax cuts. But there’s no disputing that massive
    amounts of fiscal and monetary stimulus made the 2001 downturn one of
    the mildest on record. And the recovery hasn’t been half bad, either.
    Since the economy peaked in the second quarter of 2001, economic growth
    has averaged a decent 2.8%.Yet the recovery could have been a lot
    stronger, given the amount of stimulus pumped into the economy.
    Consumers and businesses aren’t fools: They used their extra money to
    buy cheap imports rather than more expensive American-made goods and
    services. Between 2001 and today, imports rose by three percentage
    points as a share of GDP, one of the main reasons that job growth was
    so slow. By comparison, the import share rose by only one percentage
    point or so in the recoveries of the early 1980s and the early 1990s.In
    an open economy, Policy Classic loses its punch. The inability to
    create jobs after a recession is bad enough. What really should concern
    us all, though, is what might happen in the next recession. Foreign
    investors have been extraordinarily willing to put their money into the
    U.S. But let’s suppose, just for the sake of argument, that a recession
    here makes other countries look like a better bet. Then foreign
    investors pull out their money, pushing interest rates way up and the
    dollar way down. The higher rates slow the economy, and the lower
    dollar makes imports more expensive, triggering higher inflation.Poof!
    Instant stagflation. And what’s worse, Bernanke and the Fed will be
    forced to keep interest rates high to fight inflation.But enough of
    cataclysmic scenarios that might or might not happen. The question to
    ask is this: How does globalization affect the long-term policies for
    growth, both liberal and conservative, rolled out by the U.S. in recent
    decades? Probably the best known is supply-side economics, which
    originated in the 1970s and achieved prominence under President Ronald
    Reagan in the 1980s. Like all Big Ideas, the logic behind supply-side
    economics is clear: Lower tax rates give workers an incentive to put in
    more hours, encourage savings and investment by increasing the aftertax
    rate of return, and spur entrepreneurs to expand their businesses by
    allowing them to keep more of the profits.According to Kevin A.
    Hassett, director of economic policy studies at the American Enterprise
    Institute, globalization actually increases the pressure to cut taxes.
    If tax rates are too high, “corporate income is so mobile that the
    money just leaves,” says Hassett. “There’s an international tax
    competition, and everyone is playing.”Yet economists are hard-pressed
    to find evidence that tax cuts have a big effect on growth. Last
    summer, the Treasury Dept. released a study that looked at the
    long-term impact of extending President Bush’s tax cuts, which are due
    to expire at the end of 2010. The study concluded that extending the
    tax cuts indefinitely would boost GDP by only 0.7% over the long run.
    That’s less than a rounding error.It’s also clear that having a low tax
    rate is only one factor among many determining international
    competitiveness. It’s equally important to have an honest government,
    or an efficient health-care system, or an educated workforce. “There
    isn’t a single blueprint for a successful economy,” says Robert E.
    Hall, a Stanford University economist who was one of the main advocates
    of a flat tax in the 1980s.On to the next Big Idea: deficit reduction,
    a mirror image of supply-side economics that the Democrats have made
    the centerpiece of their political and economic agenda. “Fiscal
    responsibility is important for the long term,” says Bruce Reed,
    president of the Democratic Leadership Council. “The overall economy is
    going to pay a price if the country is going broke.”The case for
    deficit reduction as a long-term growth strategy is also
    straightforward. Smaller budget deficits are supposed to boost national
    savings, which leads to lower interest rates, smaller trade deficits,
    increased investment by businesses, and more job creation. And
    certainly that’s the way it worked in the 1990s, when Rubin was running
    economic policy under President Clinton–hence the name Rubinomics.But
    this line of reasoning doesn’t hold up so well in an economy that is
    far more exposed to global forces than it was in 1993, when Clinton
    took office. The financial markets have become far more seamlessly
    global, making the U.S. budget deficit a much smaller influence on
    interest rates. Today’s roughly $250 billion deficit would use up about
    14% of U.S. national savings. That’s a big deal, but it’s only 2% of
    global savings.The ease with which capital flows across national
    borders helps justify the Bush Administration’s relative lack of
    concern about budget deficits or even personal savings. “What starts to
    break down is the simple link between encouraging savings and
    encouraging investment,” says James S. Poterba, a Massachusetts
    Institute of Technology economist appointed by Bush to his tax reform
    commission in 2005. “If Joe in Pittsburgh saves, we can’t say that we
    benefit this factory in Harrisburg. The jobs we generate might be jobs
    somewhere else”–like overseas.So if globalization weakens the
    usefulness of tax cuts and deficit reduction as policy tools, what’s
    left? The New Economy boom of the 1990s was driven by technological
    change and innovation. The logical way to rekindle the magic, then, is
    to boost government spending for r&d and education. Just listen to
    Daron Acemoglu of MIT, the most recent winner of the John Bates Clark
    Medal, given to the best economist under the age of 40. “The U.S. is a
    frontier country,” says Acemoglu, meaning that its competitive
    advantage comes from being at the forefront of new technology. As a
    result, he says “if any policy is going to have a beneficial effect, it
    has to help the innovation sector.”This Big Idea was first suggested by
    Paul Romer, now at Stanford University, in the 1980s, and named New
    Growth Theory. That term fell out of favor after the tech
    crash–perhaps because it sounded too much like the New Economy–and
    the Big Idea now goes by the prosaic name “innovation policy.”The
    problem is that it’s tough to make a direct connection between federal
    r&d spending and the creation of high-tech jobs. Despite the U.S.
    prominence in medical research, the pharmaceutical, biotech, and
    medical devices industries have added only 19,000 workers in the past
    five years.

    and India are increasingly attractive places for companies to do
    research and development (using ideas, perhaps, that were originally
    developed using U.S. tax dollars). Money is following as well, with
    U.S. venture capitalists investing more than $400 million in Chinese
    and Indian companies in the third quarter alone, according to the
    National Venture Capital Assn. There’s a growing sense that at a time
    of scarce resources, the U.S. may not be getting enough bang for its
    buck from R&D spending. “The question about funding basic R&D
    for health care is the same as for funding other basic R&D,” says
    Robert B. Reich, Labor Secretary under Clinton and now at the
    University of California at Berkeley. “How long can and should the U.S.
    continue to subsidize the rest of the world?”This question becomes
    especially pressing if the newly resurgent Democrats carry through on
    their promise to put in place a “pay-as-you-go” budget system whereby
    new spending cannot be financed by increased borrowing. Who is going to
    vote an increase for science if it means raising taxes or cutting
    spending for children? The last bout of meaningful deficit reduction,
    during Clinton’s first term, did serious damage to R&D spending,
    which dropped by 3.9% in real terms.Education poses a different set of
    issues. Clearly, education is key to competitiveness. “If an educated
    population is the engine of change, then we’re doing a really, really
    lousy job,” says Claudia Goldin, a Harvard economist who is
    co-authoring a book about education and technology. “We have been
    un-subsidizing higher education for some time.”There are two problems.
    First, real wages for young Americans with a bachelor’s degree have
    declined by almost 8% over the past three years. Nobody knows the
    reason for sure, but some economists suspect that global competition
    has something to do with it.The other problem is that education is
    closely tied, in tricky ways, to the hot-button issue of immigration.
    Despite post-September 11 restrictions, foreign students with temporary
    visas still account for almost 40% of new graduate students in science
    and engineering. We still need to spend more on education, but in an
    era of labor mobility the decision about where to put our resources is
    not a slam-dunk.With the Big Ideas under assault by globalization,
    economists have responded by focusing on smaller goals. “Are there
    places where we can make sensible improvements that don’t require big
    philosophical changes in what we are doing?” asks Poterba of MIT. For
    example, the new pension bill encourages companies to automatically
    enroll new hires in 401(k) plans unless they opt out. Economists
    believe that will greatly increase savings by workers. Not as big a
    deal, perhaps, as full-scale tax reform, but a gain.Beyond that, the
    idea of a national economic policy may be fundamentally out of date in
    a world of global markets. Washington is no longer the center of the
    economic universe. That’s a basic fact that Democrats and Republicans
    alike will need to get their heads around.