Posted by: dstieglitz | February 25, 2010

Digging Out of the Economic Hole

    What lasting impact will this recession have on families, businesses, and government? How can the economy recover? What is the best way to return to full employment? For three reasons, the only honest answer is that we don’t know! First of all, economic forecasts are notoriously inaccurate because they are blind to major turning points and interactions among concurrent changes. Second, the connectedness of the global economy is unlike anything we’ve ever seen before, so the lessons of history are, at best, only marginally useful. And third, the future depends on economic choices the president and Congress will make (or not make).

      The financial wherewithal of families has declined markedly. Home values have plummeted; retirement savings accounts have been battered; and unemployment and under-employment are at 30-year highs. For more than a decade, U.S. households stimulated the economy by spending more than they earned and borrowing to fill the gap. But the era of easy credit is over. Banks have tightened lending criteria and are pushing borrowers to repay the money they borrowed in the past. Families are spending less and saving more. Clearly, it is unlikely that consumer spending will lift the economy out of this recession.

      Similarly, businesses seem to be unable or unwilling to lead the recovery. They are reacting to criticisms from Washington and consumer frugality by curtailing hiring, keeping inventories low, and making only essential investments. With households and businesses on the sidelines, only two sources of demand remain: government spending and exports.

      The Federal government stepped in to fill the spending void with the $700 billion Troubled Asset Relief Program, the $878 billion Economic Recovery Act, and $3+ trillion budgets for 2010 and 2011. This prolific spending coupled with declining tax revenues blew a gaping hole in the budget. The 2009 deficit was nearly 10 percent of the GDP and the 2010 deficit may be larger. The spending has shifted the debt burden from households to the Federal government. So far, the Treasury Department has had no problem selling bonds (even to the Chinese) because investors consider the U.S. government to be among the most creditworthy institutions on earth. In the near future, however, they will force the government to implement a workable strategy for reducing annual deficits.

      The biggest threat to long term economic health is misdirected spending. Successive extensions in unemployment insurance reduce the recession’s pain, but unemployment payments are like putting dying patients on heart-lung machines – it keeps them alive but doesn’t help the recovery. Large infrastructure investments (e.g., repairing roads and building nuclear power plants) are more effective because something gets built while the money is channeled to unemployed workers. Furthermore, once such projects are finished, they no longer drain the budget! On the other hand, permanent spending increases in areas like health care are high risk because they must be funded by equally permanent tax increases or spending reductions.

      During an interview with Oprah Winfrey, the president generously awarded himself “a solid B-plus” for his first-year performance. He must have been evaluating himself on a bond-rating scale where the top grade is a triple-A. Following his historic election, President Obama had a boatload of political capital. He spent a chunk of it endorsing a stimulus package that failed to reduce unemployment and was widely seen as a pork barrel. More of his capital evaporated when, instead of dealing with 10 percent unemployment, he pushed a health care reform package that many voters don’t want. Many were appalled by the intrusion of government into management of the auto industry, the financial services industry, and the home mortgage industry. Still others are angry about soaring annual deficits. Recent Republican successes in Massachusetts, Virginia, and New Jersey show that President Obama is nearly bankrupt relative to political capital.

      In his State-of-the-Union address, the president said that doubling our exports over the next five years may be the best bet to revive the U.S. economy and create new jobs. I agree! Growth in exports is a viable, long-term solution, or at least a major part of one. Our negative balance-of-trade (currently $500 billion per year) represents a withdrawal from the economy – we send millions of jobs overseas when we import more than we export. The U.S. exported $1.3 trillion in goods and services last year, which produced nearly 10 million jobs. Each $1 billion of exports equates to about 7,000 jobs. To return to full employment, the U.S. should improve both sides of the balance-of-trade equation. Oil imports in half (nearly $400 billion per year) could be cut n half in the next five years by drilling our own natural gas and off-shore oil, and pursuing alternative energy sources.

    But will the president and Congress have the stomach to make the policy changes that will cause a substantial increase in exports?  Will they:

(1) Ratify the free-trade agreements with Colombia, Panama, and South Korea to expand U.S. exports to those markets

(2) Reform the tax code to enhance U.S. competitiveness instead of taxing U.S. operations overseas

(3) Liberalize regulations that limit U.S. exports supposedly for security and foreign policy reasons

(4) Pressure the Chinese to value their currency fairly.

Of these four policy changes, tax reform is the most controversial. Instead of raising corporate and personal income taxes, Congress could institute a value-added tax, a national sales tax, a carbon tax, or all three! Such taxes could be rebated on exports when they leave the U.S. and added on imports when they enter the U.S. Positive Congressional actions in these areas would create 7,000 jobs for each $1 billion increase in exports – and not cost taxpayers “one single dime” as President Obama likes to say. It’s time for him to talk turkey instead of peacock on matters of job creation, increasing exports, taxes, and budget cuts!

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