ECONOMY AUGUST 5, 2011
-
Read Later
READ LATERAvailable only to subscribers. SUBSCRIBE TODAY
-
Listen
ARTICLE AUDIO
- Font Size
Last Sunday, legislators and the president, convinced that the United States was facing an imminent risk of default and their sound decisions were needed to wrest global well-being from the jaws of collapse, purportedly scrambled to announce a deal on the debt ceiling hours before the Asian markets opened. Instead of cheering the deal, however, global markets thumbed their nose and turned down within hours of the announcement. Indeed, the most striking response to the “successful” conclusion of the United States debt ceiling cacophony on Sunday was the sharp fall in global stock markets the next day. Then, on Thursday, the Dow plunged over 500 points, the biggest single-day loss since December 1, 2008, at the height of the financial crisis. Why the painful downturn?
The failure of markets to rally around the purported good news reflects the far deeper troubles our global economy faces. The chaotic conclusion to the U.S. debt ceiling debate, meanwhile, only makes the future look bleaker, because it signals that U.S. politicians, like their European and Japanese counterparts, may be incapable of responding in a timely fashion to these momentous issues.
The overriding problem that most wealthy nations face is they have promised far more in public sector spending than they are currently willing to pay for in taxes. In the United States, the federal government spends 1.7 times its total revenues, leaving the country with a 9-10 percent 2011 GDP budget deficit, and little route to a solution if, as the Republicans demand, no further revenues are raised. It remains unclear how anyone decided that the federal government must not collect revenues exceeding 18 percent of GDP, irrespective of what happens as the society ages, but influential Republicans are pushing for a constitutional amendment that would set this limit in stone. Even tax reforms that would raise revenues, while lowering distortions, are apparently out of the question.
In Europe, the European Union ignored the profligate spending of the periphery, along with their reckless banks, only to wake up in recent months and call for rapid and deep austerity and change. In Japan, the government continues marching onward with large deficits and a climbing public sector debt to GDP ratio which, properly measured, is now the highest in the world.
None of the current policy stances in the United States, Japan, or Europe is sustainable. The most immediate problems are located in the euro area, where Greece’s upcoming default may ultimately lead to a series of defaults and debt restructurings across the periphery. European leaders are proving incapable of dealing with the issue. It was just 15 months ago that they claimed to have resolved Greece’s problems with a bailout program in May 2010. They have vowed no sovereign defaults would occur on European soil, yet this is exactly what is now underway.
Yet the newly prescribed Greek default will not solve Greece’s problems: It still has too much debt and too large a budget deficit. Nor is it credible that Ireland or Portugal can avoid default under current circumstances. The willingness to let defaults occur is already spurring flight from Italian and Spanish bonds. According to JP Morgan, the Italian treasury only has enough cash on hand to finance itself into September, meaning Europe’s third largest nation, with 1.6 trillion euros of sovereign bonds outstanding, is on the verge of a major financing crisis.
Japan’s problems, on the other hand, are longer term but similarly incontrovertible. Their population is aging rapidly, and the number of workers is now in decline. Instead of planning for the coming demographic challenges, however, the political leadership has run large budget deficits, ramping up their debts just as the tax-paying population begins to fall. If they stay on the current trajectory, a few lonely taxpayers will be responsible for massive debts. The solution to Japan’s problems (advocated both by the IMF and the Bank of Japan, as well as many in Japan’s Ministry of Finance) is harsh but simple: They need to increase the sales tax substantially to close the budget deficit. Despite this, successive Japanese governments have failed to deal with the problem. Instead, they continue to build up debt in an unsustainable manner.
In this context, the debate in the United States seems par for the course. The U.S., unlike Europe but like Japan, does not face imminent collapse. Yet the country’s fiscal issues are daunting. Even if we accept the Congressional Budget Office’s optimistic economic growth forecasts, on our current policy track America’s net debt will increase to 100 percent of GDP by 2020. This is up from just 40 percent of GDP at the end of 2008.
Even these optimistic forecasts were dealt a serious blow last week when the Bureau of Economic Analysis reported that first quarter GDP in the United States grew at a paltry annual rate of 0.4 percent, revised down from the already disappointing level of 1.9 percent. Second quarter growth has been estimated at just 1.3 percent. These figures are well below the 3 percent average annual rates assumed by the CBO in their budget forecasts to 2020. If growth averages 1 percent lower then the estimates, then America’s debt to GDP ratio would likely rise by an additional 14 percentage points by 2020. The impact of such modest changes in growth forecasts swamp the spending cuts that were just agreed to in the culmination of the debt ceiling debate.
Careful politicians who assess risks appropriately would not base today’s budgets on such rosy future outlooks. We know that both households and indebted corporations will likely continue to save and pay down loans rather than spend or invest. Emerging markets will grow faster, but they can increasingly produce sophisticated goods more cheaply at home, so our scope for export growth is limited as well. Responsible fiscal policy requires that we gradually reduce budget deficits and prevent the current risk of a deleterious spike in public debt levels. But talk of “death panels” has scared all politicians from discussing the obvious—health care costs for the United States are not under control (for the private sector as well as for the public sector); within 20 years, it is clear to every observer that this will be a main source of fiscal crisis if nothing is done.
As in Japan and Europe, the American political process has proved incapable of dealing with this issue resolutely. The final agreement announced late Sunday evening offers no credible solutions to control healthcare costs, nor did it face the question of sensible ways to boost revenues. In order to even get a deal, economic projections were based on far more rosy scenarios than most in Washington truly believe are plausible. If one simple decision and relatively small deal take such crisis mongering and brinkmanship, how will America deal with the far more serious decisions to come?
When faced with daunting problems, politicians in industrialized countries are struggling to adapt to their new realities in which their borrowing becomes finite. So far, not one is proving remotely capable of dealing with this task.
Peter Boone is a principal at Salute Capital Management and non-resident senior fellow at the Peterson Institute for International Economics (PIIE). Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at MIT’s Sloan School of Management and Senior Fellow at PIIE.
22 comments
It's the political institutions, stupid. We can't live in a country where secret holds keep economic appointees from being confirmed, the filibuster allows a determined minority to block economic relief, and a major party hosts a crazed wing that brooks no compromise on its addled goal of reducing the federal deficit by cutting spending programs for poor people while refusing to raise taxes. Either those things have to go when the next Congress convenes, or we need a Federal Fiscal Reserve that is in charge of our debt and manages our deficits over the short- and medium-terms, independent of Congressional pressures on taxes and spending. Since the latter is basically anathema to the Constitution, I think we could profit from compulsory voting, because I'm pretty sure the 60% of people who didn't vote in 2010 weren't disillusioned or discouraged because Obama wasn't inflicting economic pain on them fast enough by cutting government spending.
- chaitless
August 5, 2011 at 1:14am
Or, we need a system that allows the voters to throw the bums out summarily. Can we recall the entire Congress and maybe the President? The spectacle of the debt ceiling crisis was appalling. Republican absolutism on taxes is appalling, it is so beyond stupid one struggles to find sufficient adjectives to describe it. I hope they are pleased the results of their absurd, irresponsible behavior.
- Sophia
August 5, 2011 at 2:30am
The stock market declines are prelude to a second recession. This will be happening to an already weakened economy and at a time when the government has very few tools that can still be used. I don't think that it has fully dawned on us, how much trouble we are in.
- paskunac
August 5, 2011 at 6:19am
American taxpayers resist tax increases for a good reason: they have been bearing regular tax increases for over 25 years and, yet, deficits continue to grow and take-home pay continues to stagnate or even decline. What regular tax increases? Payroll tax increases, adopted during the Reagan administration and phased-in over 20 plus years, tax increases that are so large that almost 80% of working Americans now pay more in payroll taxes than income taxes. Yet, we have very smart people like these two contributors who express dismay that American taxpayers aren't willing to accept tax increases to deal with a structural deficit attributable to tax policies favoring the wealthy adopted during the Bush administration and an aging population. It's no answer that nobody is suggesting more payroll tax increases, not to working Americans who have already absorbed an additional $2.7 trillion in payroll taxes so that wealthy American could enjoy an income tax cut, not to a middle class many of whom bear a marginal tax rate higher than the wealthiest Americans, as the result of payroll tax increases. Of course, I'm not blaming these two very smart contributors for a poorly-conceived tax policy adopted almost 30 years ago. But there are consequences to bad tax policy, including the unintended consequence of turning the middle class into tax protestors.
- rayward
August 5, 2011 at 7:00am
I'm reminded of an article about early medicine when they did not believe in bacteria as a cause of disease and hospitals were the best place to go to die, until someone asked the doctors to wash their hands before surgery and the results were impressive. We tried low taxes for 10 years with terrible results at great cost and we tried a 15% lower rate on capital gains and dividends. Why be innovative and take risk in small business when the best tax rate is in the stock market?
- Nusholtz
August 5, 2011 at 8:22am
The absence of political courage is endemic in non-totalitarian systems. of course US 1Q2011 GDP was revised down to 0.4% Not one pundit seems to remember that half the country was shovelling snow for those three months. The media's negative contribution to loss of confidence in political systems is part of the problem. Take the cameras off the noisy minorities and start teaching people how the economy actually works. Ignore the BLS employment model and focus on ADP actual payroll increases. The current DJIA/S&P drops are factoring in a 50/50 chance of a double dip recession that means lower eps.
- K2K
August 5, 2011 at 9:13am
Wrong, wrong, wrong. The developed countries of the world used to make stuff. The undeveloped countries used to be incredibly poor. Tin shacks and mud huts and all that. There are now 300 million Chinese and Indians who have lifted themselves out of those mud huts and tin shacks (and countless more in other formerly undeveloped countries) with the skillsets and infrastructure with which to make the stuff we used to pay people good money to make "here." So there's a massive outbound wealth transfer going on and people in the developed world are shifting to $10/hr grocery bagging.
- Mikelawyr22
August 5, 2011 at 9:26am
The second economic crash the Republicans have been praying for to get Obama out of office is coming. But it may backfire on them. K2K has a good idea about teaching people how the economy works, but they wouldn't stand for it. They're too caught up in escapism. The human race only learns something after a disaster. The voters put Obama in the White House after the Republican-induced crash of 2008, and then they put Republican Tea Party wackos in control of our government in 2010! In 2012 our economy may be so bad that people will wake up (for 10 minutes or so) and ask government to start employing them. Corporate America is making record profits, with $2.5 trillion in the bank, and there are historically low interest rates in place. It is clear that the Republican economic model is a joke. Small business will never save us. Right now, only government can. We need a massive amount of infrastructure-repair jobs for a start and then the return of manufacturing in America. Government working with business and employees in the national interest is the only possible model for America's economic survival in the 21st Century. But Republicans say that model is the work of the devil. That model is helping Germany, with the strongest unions in history, to kick America's butt. Go figure, Republicans.
- magboy47.
August 5, 2011 at 12:15pm
Obama said it himself...if he can't fix this in 3 years he's a one term president. In 6 months he hits the 3 year mark. Now Nader's team is sniffing around... Rayward, you list off a bunch of things that underscore some serious gaps in knowledge. 1. Taxes on top 1% were much lower during Reagan than they are today (>5% in terms of effective tax rates), and under Clinton ('99) they were just 2% higher. But of course the government was significantly smaller under Clinton too. I think everyone would go back to Clinton ratios: Modestly higher taxes, and significantly smaller government. 2. Taxes on the middle class today today ARE in fact lower today than ever. At the end of Bush's term, middle class effective tax rates fell to the low 14's, while under Clinton they were 16-17%, under Reagan then were 17-18% 3. EU taxes are significantly higher on the middle class, with effective tax rates ranging from 20% (Canada) to 40% (Nordics). Yes, double and triple what our middle class. Note these are effective tax rates, whcih means this is serious, serious money--10's of thousands of dollars--to a middle class earner. 4. For all whining over Bush tax cuts on the wealthy, that is $70B a year in revenue. We are looking at a $1.5T shortfall. 5. Bush tax cuts on the non-wealthy, inlcuding the middle class--are roughly $230B/year. That is getting significant. 6. Our government size (federal and state combined) is already on par with many EU countries, and given current trajectories will surpass even more of them in a few years. Our federal spending is roughly $3.8T, our state spending is roughly $1.3T, and our local spending is roughly $1.6T. Combined, that is a lot of government. You see what is happening here don't you? Our revenue problem is not due to the wealthy not paying enough. Sure, they can pay more, but it doesn't change the calculus. Our problem is overwhelmingly due to the middle classes not paying enough. If we want EU style programs, the middle class and working poor will need to pay a lot more to fund them, just like they do in Europe. When you are asking for more government, you are indirectly asking for higher taxes on the working poor and middle class. There is no other way around this.
- seattleeng
August 5, 2011 at 1:14pm
Much of the US Debt is debt based upon promise to repay in dollars. Since the US can print those dollars, we should be able to avoid default, by just giving out fresh dollars. Right? Sure, it will result in inflation, but inflation is a common way to get rid of that debt and private debt as well, which is a great burden for this economy. Of course we need to avoid crazy rates of printing like in the Weimer German regime. What's wrong with this, Mr/Ms. Economist?
- NR149264
August 5, 2011 at 1:50pm
Megaboy47 writes: "We need a massive amount of infrastructure-repair jobs for a start and then the return of manufacturing in America" The US is manufacturing more than ever. Today, we have nearly double the output of 1975 in constant dollars. The problem is that manufacturing has become so highly automated. The jobs are not coming back. Ever. But if they do, they will require less skill than is currently needed to secure a job at 7-11. I am regularly on factory floors in Asia. The workers there push buttons, and move product from one location to another and do menial assembly tasks. The zenith of US manufacturing was in the day when manufacturing required football field sized warehouses of highly skilled machinists making parts, backed by waves of lesser skilled people assembling those parts. Computers killed our manufacturing. You couldn't do a job that people do in Asia. Not because you don't have the skill. But because it is even more menial than picking lettuce. And the march is ruthless. The pace is incredible. And the task is so simple its maddening.
- seattleeng
August 5, 2011 at 2:15pm
I have to agree with Seattle on the question of manufacturing jobs. Some subset of the global manufacturing will remain high value - Germany generally, and some US, Korean and Japanese companies continue to exploit these - but most stuff is manufactured by humans doing idiot jobs to keep machines running. Manufacturing will not alone be the engine that fixes the American economy. Which raises a much bigger question - if it now takes only one of every 10 or so workers to grow our food and make our stuff, what in the hell do we do with the rest of the population. I don't know the answer - I know, however, that the answer is not to fantastically overpay a small subset of the population for financial manipulation and risk taking, and incrementally overpay knowledge workers like me, in order to keep 75% of the population in menial service and button pushing jobs.
- IowaBeauty
August 5, 2011 at 3:30pm
Seattle likes to talk about taxes. He doesn't like to talk about after-tax income shares, or the relationship, both actual and normative, between taxes and income shares. Today, after-tax income shares are enormously skewed to the wealthiest, far more than in 1980 when Reagan took office and more than any time in nearly a century. THAT is the real issue. Nominal income tax rates are a supply-side talking point, nothing more. A great deal of our increasingly automated manufacturing is due to foreign competition. To compete with low wage rates abroad, US firms have to substitute capital for labor. The result is both fewer US jobs and lower US wages, a significant part of the reason why our income shares have become more skewed to the wealthy. However, our tax system, which should mitigate this effect, has, since Reagan, been exacerbating it. An unstable economy is one result. More later. Now I have to attend a local campaign meeting to help kick Republican asses this November in our local elections. We have been a bellwether in part because we have balacned enrollment. If the Republicans do well here in November, Obama watch out. If we gain on them, indicator of rising Democratic fortunes nationally.
- roidubouloi
August 5, 2011 at 3:44pm
Germany and Japan blow apart the myth of "US wage rates are not competitive". De-linking medical insurance from employment would help (oops, that was McCain's idea in 2008) "Computers killed our manufacturing." is one part of the de-industrialization. Wall Street paradign of ever-growing quarterly earnings, on steroids after the high inflation/interest rates of 1970's and 1980's. Monetization of industrial assets through leveraged buyouts. I was there for the first one in 1978 when American Can spun-off all fiber-based assets into what became James River, worked through the destruction of the too-high price for RJR Nabisco, and, at the end of my career, saw how Wall Street destroyed a spin-off from James River, cleverly structured to also spin-off most of JR's debt. I would also factor in the stupidity of turning to finance and marketing whizzes instead of engineers to manage industrial companies. AmCan hired hundreds of MBAs at HQ after 1975. When I was rotated in for exposure to HQ, I still remember the Harvard MBA who pumped me for info on the three-piece can plants. I finally asked him if he had ever visited one. A look of horror on his face as he said that was beneath his whatever. (2-piece can mfg for beer and soda was designed as highly automated in the 1970's, before computers.) In case no one has noticed, it has been liberal Democrats pushing for the post-industrial service economy for more than thirty years.
- K2K
August 5, 2011 at 7:17pm
There are big changes afoot in the world and we are now just one player among many. We need to become as lean and organized as Germeny if we are to prosper but that is highly unlikely. Our politics perfectly mirror a confused, grossly overweight, ignorant and frightened people. Just look around. We are totally fucked.
- paskunac
August 6, 2011 at 7:10am
yeah, waking up to an S&P downgrade really works up an appetite for more. wtf???? paskunac: the German system has been in development since the 1880's when Bismarck co-opted the socialists by offering the world's first social safety net. The educational system supports serious vo-tech, something that latte liberals continue to disdain here. I never got over Mayor Mike Bloomberg's assault on vo-tech when he shut down the hguely successful auto-repair program at two Bronx High Schools. (Still easier to get excellent car repair than find a functional lawyer in the Bronx)
- K2K
August 6, 2011 at 8:35am
"In case no one has noticed, it has been liberal Democrats pushing for the post-industrial service economy for more than thirty years." This is the complete inversion of the truth. It is the right that has been hell-bent since 1980 to exert as much downward pressure on wages as possible by whatever means, including de-industrialization. Liberal Democrats have resisted, but only feebly and fitfully. The claim that it is liberals who have wanted to substitute low-paid service jobs for well-paid manufacturing jobs is a canard. It is on a par with claiming that Republicans want more fiscal stimulus but liberals stand in their way.
- roidubouloi
August 6, 2011 at 9:21am
Roid writes: ". Today, after-tax income shares are enormously skewed to the wealthiest, far more than in 1980 when Reagan took office and more than any time in nearly a century." Roid, this is all new wealth that has been created. The middle class still have the same slice (a little more, actually, adjusted for inflation) that they did 5, 10 or even 50 years ago. But when NEW wealth is created, it does go to those that create it. When Facebook created $50 or $100B of NEW wealth, that wealth largely stayed with its founders and employees. Where would you like the NEW wealth to go for these new ideas? To the welder in Akron? CBO data says after-tax income in 2005 % for middle quintile was $41.5K in 1979, and $50.2K in 2005. In other words, the middle class family of 2005 has 25% more income than the 1979 family. That is huge. Roid writes: "A great deal of our increasingly automated manufacturing is due to foreign competition. " No. Our increasingly automated manufacturing is in response to the drive for higher quality and the drive for lower cost.
- seattleeng
August 6, 2011 at 11:50am
http://www.presidency.ucsb.edu/ws/index.php?pid=29607#axzz1UGfxyrVM Democratic Party Platform of 1980 who says there is no predictability in American governance....
- K2K
August 6, 2011 at 12:48pm
The de-coupling of health insurance coverage from employment/employers would be one of the single best things the U.S. could do. It would relieve business of a significant burden and would enable much more inter-job mobility as workers stop being scared that leaving a job means dropping health care with no certainty of regaining it. This is the one crucial area where the Affordable Care Act is testimony to wimping out on a substantial and future-shaping reform at the moment it could have been achieved.
- ironyroad
August 6, 2011 at 9:09pm
Yes, seattle, it doesn't matter whether wealth is new wealth or old wealth. When has the economy been static? But at least it is finally clear that you actually favor the skewed distribution of wealth -- because with your radical libertarian religion you believe that this is a "just" distribution -- and want the tax system to keep it as skewed as possible rather than mitigate it. Is new wealth for some reason supposed to be exempt from taxation? Why is that? Unfortunately, the side effect of the enormous skewness of income is inadequate consumer demand due to inadequate consumer income. The system tries to compensate with consumer credit, such as home equity mortgages, but this is not sustainable as debt rises relative to income and property values cannot increase indefinitely. Then you get a bust. Which we got in spades. So, even if one believed along with you that the market somehow produces uniquely just outcomes -- and I think this is utter poppycock quite on a part with creationism -- the reality of a modern market economy is that what you demand is a prescription for constant market failures, recession, and sooner or later depression. Do you think you could sell that stinking pile of horseshit to the American people on the ground that it is "just" or does it require constant lying and false claims that your disastrous faux economics is the path to prosperity? Income shares, not absolute dollars, are what is relevant to the stability of the economy because it is demand that sustains the economy. If there is inadequate consumption demand or unsustainable consumption demand due to lack of middle class income, you get crashes. Get it yet, seattle? Besides, wanna bet that if I look up your latest factual claims they are wrong? They invariably are. And, no, the substitution of capital for labor is not as you claim due to demand for quality. It is due to high wages. But how can wages be high when they are stagnant? They are rendered "high" in competitive terms by low-wage foreign competition. As ever, you are just making stuff up.
- roidubouloi
August 7, 2011 at 9:33pm
Oops, seattle. Did you adjust household income by quintile for the number of workers per household? No, and it has been rising. There is an economic phenomenon called "home labor," by which people consume the output of their own labor without trading in the market. It doesn't get counted in household income because GDP only counts market transactions. Unless you think that those who weren't doing market work in 1979 were playing tennis, a lot of what has occurred is that market income -- counted in GDP -- is now substituted for non-market income not counted. But the REAL income has not changed that much. When you cook your own dinner, that is income, but the labor is not in GDP. If you buy the same dinner, it is. Thus, the actual change for the middle quintile is a lot lower than you claim. The income of the top 1% is up 150% in the same period. A lot of this wealth was created only through theft, the sale of bogus financial instruments subsequently bailed out by the government.
- roidubouloi
August 7, 2011 at 10:16pm