[Anonymous]

Can Anyone Steer This Economy?
Global
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
landing.

PRESIDENT BUSH ENCOUNTERED
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.

ECONOMIC POLICY, IN THE SENSE
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.

THE TRUTH IS, CHINA
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.

[Author]

November 16, 2006 at 12:17 PM