Wednesday, November 5, 2008

Moving beyond false dichotomies

Nov 4, 2008

By Robert E. Rubin & Jared Bernstein
AS ECONOMISTS and policy advisers try to sort out where we are, how we got here and where we must go for both the short term and the longer term, we are surrounded by polarising dichotomies: Fiscal recklessness versus fiscal rectitude, capital versus labour, free trade versus protectionism.

The next president of the United States, the prevailing wisdom goes, will have to choose between these polarities. But how real are these differences? Our view - and we come from pretty different analytical perspectives - is that in many important ways, they are false, and serve as more of a distraction than a map.

Fiscal rectitude versus stimulus and public investment

THE Bible got this right a long time ago (paraphrasing slightly): There's a time to spend, a time to save; a time to build deficits up and a time to tear them down. Though one of us (Rubin) is often invoked as an advocate of fiscal discipline, we both agree that there are times for fiscal discipline and times for fiscal largesse. With the current financial crisis, our joint view is that for the short term, our economy needs a large fiscal stimulus that generates substantial economic demand.

We also believe that fiscal stimulus must be married to a commitment to re-establish sound fiscal conditions with a multi-year programme that includes room for critical public investment, once the economy is back on a healthy track.

One of us (Rubin) views long-term fiscal deficits - in combination with a low national savings rate, large current account deficits and foreign portfolios that are heavily overweighted in dollar-dominated assets - as a serious threat to long- term interest rates and to the US dollar and, therefore, to America's economic future. The other views these economic relationships as much weaker.

At the same time, we both agree that America's economic future also requires public investment in critical areas such as education, health care, energy, worker training and much else. In our view, then, the next president needs to proceed on multiple tracks, with both the restoration of a sound fiscal regime and critical public investment in view.

First, under the US$700 billion (S$1 trillion) programme to support the financial system, the government will buy assets, whether in the form of equity injections or the purchase of debt from banks. And the real cost to the government is not the face value of those purchases but rather the budget authorities' estimate of the subsidy built into the price of those purchases, given the risks that are involved. That number will be some relatively limited fraction of the total amount paid.

Congress also included in the recent legislation an option for the next president to consider levying a fee on the financial services industry if the taxpayers' investment is not recouped.

Second, certain public investment can help the US meet its fiscal challenges. Most powerfully, the single largest factor in America's projected fiscal imbalances comprises the health-care entitlements of Medicare and Medicaid, underscoring the fundamental importance of health- care reform that expands coverage to more Americans yet constrains costs. While plans that would accomplish these goals have some cost, by pooling risk and stressing cost effectiveness, they could more than pay for themselves by reducing the growth trajectory of health- care spending, in both the private and public spheres.

One important policy question is what America's fiscal objectives should be in terms of deficits and of the ratio of the national debt to the gross domestic product. In times like these, larger than normal budget deficits will add to the national debt. In more stable times, a budget deficit equivalent to roughly 2 per cent of GDP will keep the debt-to-GDP ratio constant, a legitimate fiscal policy goal. In flush times, a smaller deficit would lower the debt ratio and that might be desirable. We both agree that individual income tax rates and other taxes for those at the very top could be moved back to the rates of the Clinton era. It's worth remembering that rates at this level helped finance deficit reduction and public investment that contributed to the longest economic expansion in US history.

In addition to restoring a sound fiscal regime, America could improve the personal savings rate and expand retirement security by establishing some kind of individualised account separate from Social Security, financed by an appropriate revenue measure. Also, it needs to work with other countries towards equilibrium exchange rates, as part of redressing US current account imbalances. But the idea that America can't be fiscally responsible while undertaking public investment at the same time is a myth.

Capital versus labour

HERE again, for all their alleged friction, America's dynamic and flexible capital and labour markets have combined to generate impressive productivity gains in recent years. The problem is that the benefits of this productivity growth have largely eluded working families. Though productivity grew by around 20 per cent from 2000 to last year, the real income of middle-class, working-age households has actually fallen by US$2,000, down 3 per cent.

One factor behind this outcome is the severely diminished bargaining power of many workers, and here the decline in union membership has played a key role. A true market economy should have true labour markets in which labour and business negotiate as peers. Many years ago, economist John Kenneth Galbraith argued that collective bargaining was necessary so that workers had the countervailing force they needed to bargain for their fair share of the growth they're helping to produce. To re-establish that force, workers should be allowed to choose to be unionised or not.

Tight labour markets, the kind we saw in the 1990s, are another source of bargaining power, helping to rebalance the claims of labour and capital on growth. Sound public policy, like public investment in education, health care, energy, infrastructure and basic research, financed by progressive taxation, can also drive strong growth and business confidence to invest and hire.

Moreover, the policies that are requisites for strong growth also increase wages by better equipping workers to succeed in a global marketplace and by encouraging businesses to create jobs.

Free markets versus regulation and protection

WE BOTH feel strongly that there are important lessons to be learnt from the disruptions in financial system, and that significant reforms are needed. The objective ought to be to optimise the balance between increasing consumer protection and reducing systemic risk, on the one hand, and preserving the benefits of a market-based system, on the other.

We know, too, that Wall Street and Main Street are intimately connected. The consequences of the financial market crisis are profound for Americans in terms of lost jobs, lower incomes and reduced retirement savings. Measures to reform and strengthen the financial system should be evaluated by this measure: Do they ultimately translate into improving the jobs, incomes and assets of working Americans?

With respect to trade, the choice is not trade liberalisation versus protectionism. Instead, as trade expands, we must recognise that protecting workers is not protectionism. We must better prepare our people to compete effectively and help those who are hurt by trade - not just dislocated workers, but those who find their incomes lowered through global competition. This means investing more of the benefits of trade in offsetting these losses, through more effective safety nets, including universal health care and pension coverage.

Beyond that, while we share a commitment to helping workers deal with our new global challenges, one of us (Bernstein) would advocate provisions in trade agreements that are intended to protect workers, both here and abroad, and the other would have considerable scepticism about the likely effectiveness of those provisions for workers. Public policy in all these areas - and a host of others - has been seriously deficient in recent years. It has led to a great increase in federal debt, inadequate regulatory protection against systemic risk and under-investment in people and infrastructure. Regressive tax policies have increased market-driven inequalities that could have been offset through progressive taxation.

False choices, grounded in ideology, have kept the US from effectively addressing all these issues. The next president must do his utmost to avoid being drawn into these Potemkin battles. At this critical juncture, Americans face both the most significant economic upheaval since the Depression and the long-term challenge of successfully competing in the global economy.

We have no choice but to move beyond such false dichotomies and towards a balanced pragmatism whose goal is broadly shared prosperity and increased economic security.

Robert Rubin, who was US treasury secretary from 1995 to 1999, is a director of Citigroup. Jared Bernstein is a senior economist at the Economic Policy Institute.


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