Archive for December 19th, 2009

Fixing the Economy

“Unemployment is falling,” screams the headline at CNN’s business webpage.   A couple of quarters of GDP growth, assurances from officials that the worst is behind us, and promising data on unemployment have some people betting that this sharp recession is past it’s bottom, and we’ll see a return to growth, perhaps fully recovered by 2012.   The dollar is even of its lows, jumping from about $1.52 per Euro a couple weeks ago to $1.43 today.  Maybe, just maybe, things are getting better.

I hate to throw cold water on this optimism, but unless structural problems are addressed, any recovery will be short lived.  It’s being driven by the stimulus package and increased debt.   That in and of itself isn’t bad — the point of the stimulus was to spur on growth, and it seems to be working.   But, as I pointed out a month ago this crisis is in many ways worse than the Great Depression.   Ben Bernacke, whose academic work focused on the Great Depression, handled this crisis the way he and others no doubt believe could have prevented the Great Depression after the stock market crash.  He was probably right.   Quick action to reinvigorate the financial sectors and stimulate the economy is having a growing impact.   By the middle of next year those cursing Obama and Bernacke now may well be singing their praises.   Yet the crisis is no where close to over.

Remember, back in the eighties the Reagan Administration restimulated the economy through debt and government spending, leading to an illusion of prosperity (‘it’s morning in America,’) but built on a foundation of sand.   The manufacturing sector was dying and the prosperity was paid for by debt and increased trade deficits.   This helped inspire a stock bubble in the 90s, and the hyper-stimulation of the economy after 9-11 fueled a real estate bubble.   But each bubble burst.   Only a recovery that rebalances the economy — keeps our current account in balance and ultimately works to pay down debt, at least as a percentage of GDP — can be sustained.

And again — with the baby boomers about to retire and start withdrawing from rather than paying into the social security system, medicare system, 401K plans, etc., the strain on the economy will grow.   This suggests to me that it will be virtually impossible to ride yet another bubble or simply get back on track.   Yet things can get better.

I’ve come to the conclusion that an increase in the government’s role in the economy will be necessary to fix this.   Yet it can’t be something like bureaucratic socialism or an emphasis on government re-distribution of wealth.   Rather, the government will have to create conditions conducive for economic growth and structural change.   I do not believe the market can do this on its own, markets are not magic.

To libertarian minded readers who haven’t already clicked in disgust to some other website, I understand the danger.  Big government is inherently dangerous.   Governments wage wars, can stagnate the economy, and deny individual liberty.   However, without governments, markets give in to massive corruption and organized crime.  In this case governmental action caused the problem in a weird mix of too much government in terms of debt and spending, and too little in terms of regulation.   The result was a massive redistribution of wealth from the poor to the rich (the gap between the two is larger than ever since the 19th century), lack of regulative oversight over the financial sector, and an internationalization of capital that increased human exploitation and suffering.

To fix this, we have to embrace a few principles:  a) credit is good, but high debt to GDP ratios are bad; b) the current account should stay within 2 or 3% of staying in balance; c) private debt needs to be offset by higher saving rates and reasonable regulations on credit (especially credit cards); and d) net worth in terms of wealth is not the same as savings.

Specific policies:

a) Balance the budget through spending cuts, tax increases or (more likely) a mix of both.   This should start within a year, after a recovery begins to take off (timing it will be tough — you can’t start taxing more and spending less too early, that could also damage the recovery);

b) support through tax credits and even direct grants investment and R&D into productive businesses, especially those which align with our comparative advantage.   These include technology (especially green technology), alternate energy sources, and niche production.   Local farming and production should be aided too.   No help should go to service sector sources, as we have to shift towards production to get the current account in balance;

c) Engage in a massive overhaul of entitlements to assure they are viable for the influx of boomers retiring.   This may require means testing for social security, and a health care overhaul to assure the long term viability of medicare.

d) Health care reform must be expanded to cut costs through rationing care (based on need, not wealth), limiting payment to physicians, and dramatically curtailing support for prescription drugs; and

e) US Defense spending needs to be cut dramatically, with a shift away from being a “global power” towards being able to defend the country from external attack.   This means considering a withdrawal from NATO, a realist tripartite policy of working for stability with China and Russia, and removal of forces from Afghanistan and Iraq.

Moreover, the financial sector must not only be regulated, but the international system needs a “new Bretton Woods.”  The old Bretton Woods system, named after a resort in New Hampshire where top world economists met in July 1944 to start planning the post-war economy, was a success.   It engineered a shift towards freer trade, a stable monetary policy (fixed exchange rates pegged to a gold backed dollar until 1971), and functioning international organizations such as the World Bank and IMF.   However, globalization and the internationalization of capital have rendered this system obsolete.   Globalization has altered and weakened state sovereignty to the point that international regulations need to be stronger; states no longer are able to reign in “big money” on the world stage.

This organization will have to effectively create rules to regulate credit markets, provide environmental standards, aid in technology transfers to the third world, promote stable monetary policies (perhaps replacing the dollar with a new global ‘currency of last resort’) and rules on trade.   Free trade is the backbone of a global market economy, and capitalism does not function well without regulation and rule of law — history has taught us that much.   Part of the problem now is that with globalization the old regulation regimes are no longer adequate.    Another problem is that big business has so much power in the political systems of the industrialized West that regulation is resisted.   Even Social Democrats in Europe have embraced market capitalism and a partnership with big business.   Yet that government – business axis has created a different kind of monster, and unless we can defeat it, long term economic stability is unlikely.

We can prepare to move to a smaller carbon footprint, a new high tech energy society, a new generation of prosperity and production, and the ability to move ‘beyond oil’ as the backbone of the economy.    To do so, we need to first get government out of bed with business (they’re doing nasty kinky things) and then to undertake a rational policy of targeted budget cuts, tax increases, investments in business/R&G and global regime building.    Otherwise, we can probably have a “fools paradise” of apparent economic recovery until maybe 2015 or so, but it can’t last.

Finally, none of this will work unless people move away from being focused on consumerism and material stuff, and recognize the importance of family, community, and values.   The policies and debt are symptoms of a deeper cultural problem, and if we don’t change that, we won’t have the will to do what is necessary for the future.

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