Desperate times do not always call for desperate measures

By Guest Contributor
September 10, 2010

FINANCIAL BANK OF AMERICA

This is a guest post by R. Glenn Hubbard, dean of the Columbia Business School and former Chairman of the Council of Economic Advisers under President George W. Bush, and Peter Navarro, a professor of economics at the Merage School of Business at the University of California-Irvine. They are the authors of “Seeds of Destruction: Why the Path to Economic Ruin Runs Through Washington, and How to Reclaim American Prosperity.”

These seem like desperate times, particularly for incumbent politicians facing re-election. Here, we have an economy slowing once more below a 2% annual growth rate, even as the unemployment remains persistently high.

In response, a beleaguered White House wants yet another fiscal stimulus, while the Federal Reserve wants more easy money. This desperate fiscal and monetary policy response is, however, the very definition of insanity — using the same stimuli over and over and expecting a different result.

The fundamental flaw in Washington’s stimulus logic is the incorrect assumption that America’s current economic woes began with the 2007 recession. In fact, the roots of our slow-growth problem date back at least a full decade.
From 1946 to 1999, GDP grew annually at 3.2 percent, but since then, we’ve only averaged about 2.5%.  On a cumulative basis, this seemingly small difference adds up to about 10 million jobs we failed to create.

What these statistics add up to is not a short term cyclical downturn, but rather longer-term trouble driven by four major structural imbalances in America’s GDP “growth driver equation.”

Overconsumption:

From 1946 to 1999, consumption averaged 64 percent of GDP but over the last decade, that share jumped to 70 percent. This increase was fueled not by rising wages, but rather by a housing bubble and a mortgage refinancing wave that turned American homes into ATM machines. This overconsumption has been mirrored in a low saving rate and a second major structural imbalance – underinvestment.

Underinvestment:

Business investment in research and development, technological innovation, and the new productive capacity required for the job creation process has been the single most important missing ingredient in our economic recovery – and for renewed long-term prosperity. Yet the current administration seeks only to raise the regulatory and tax burdens of business.

Chronic trade deficits:

These have been equally destructive. During the 2000s, our current account deficit more than doubled and likely reduced our annual GDP growth rate by a half a percent or more.

Excessive government spending:

This spending has provided some short-term stimulus. However, an overfed Uncle Sam represents the ultimate seed of destruction through upward pressure on taxes and interest rates and a stark future of sharp cuts in defense, education, and infrastructure spending.

Given America’s four major structural imbalances, it should be clear there is no single “magic policy bullet” that can be fired to get America back on a robust and sustainable long term growth path. Instead, any policy blueprint must focus on longer-term structural reforms.

On the tax front, America’s complex income-based system discourages saving and investment. It handcuffs American exporters even as it promotes a cult of fiscal irresponsibility within the Beltway. Any real reform must broaden the tax base, reduce marginal tax rates, and remove tax biases against saving, investment, entrepreneurial risk-taking, and exports.

To reduce our trade deficit, we must increase national saving and constructively engage with the country that accounts for almost half of our deficit — China. The stark reality here is that America’s “Chinese import dependency” problem is rooted in both our own inadequate national saving, a set of protectionist and mercantilist Chinese practices that make it very difficult for American businesses to compete on a level, free trade playing field.

We must also wean ourselves from the idea that we can stimulate our way to prosperity. Accordingly, instead of more easy money, the Fed should turn its emphasis away from discretionary fine-tuning and firmly embrace a policy that has as its goals price stability and sustainable long-term growth.

Over the long — and short — term, in implementing any stimulus, we should favor tax cuts to stimulate business investment as the best way to stimulate job creation. Reducing the fiscal burden of entitlement programs is also essential to restoring prosperity.

These are realistic, sustainable policies we can and must pursue. To succeed, both parties need to broaden their positions: For Republicans, “tax cuts” can’t be the answer to every question. For Democrats, more short-term stimulus and a larger government can’t be the cure-all.

Photo caption: Automated teller machines at a Bank of America branch in Chicago’s Loop June 30, 2005, by John Gress.

31 comments

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Basically there are 2 economic camps: The Kenysian camp believes that during serious economic downturns the Gov. must step in and provide substancial stimulus. The other camp believes Gov. should do nothing or better, to go into austerity measures (don’t know if this camp has a particular name). During the great depression President Hover’s administration did the austerity bit. This seemed to make the depression worse. FDR came in and applied Kenysian policies and this seemed to improve the economy. Currently business is in the doldrums. They wont hire, wont do research and they are waiting. waiting, waiting for things to improve. I believe that while it will increase the Fed. debt temporarily the only thing that will get the economy going and create jobs again is massive stimulus. The economy improves, people get jobs, spend money, the Gov. collects more taxes and pays down the debt. Doing nothing means we stay where we are for a long time. I’m recently unemployed. Jobs I thought I was going to get were closed. Meaning no one was hired. The companies interested in me decided now was the wrong time to hire any one. Obama’s Kenysian plan is the only hope for near term economic improvment!

Posted by Willyawontya | Report as abusive

The value added tax has been in use by other nations as a way to level costs of imports, exports, and as a curb to consumption. The VAT is an effective alternative to import duties, and can also be adjusted to curb consumption. Elimination of tax breaks that favor offshore accounts and manufacturing investment (eg. American Jobs Creation Act, 2004 — sic) would also benefit the U.S..

Posted by SanPa | Report as abusive

We surely don’t need more taxes and more regulations. We need to put a stop to this nonsence. I see a ground swell of violence happening in our country and I believe that it is caused by have an administration and a congress that can’t do anything because they are politicians and not leaders. We need action and if this festers long enough we might just have a real house cleaning in November.

Posted by fred5407 | Report as abusive

A large and growing percentage of Americans understand this problem and are fearful. The question seems to be how do we translate this concern into the political power to make the changes needed. Until a significant percentage of voters make it clear that they are not loyal to the traditional two parties, the political solution will not happen. Politicans must understand they have no significant political support unless they work to the middle and fix the problems. A die-hard party base only promotes the insane political system that got us into this mess. Politicians must fear for their futures like the rest of us.

Posted by actnow | Report as abusive

In the past, stimulus and tax cuts worked, because the money flowed around the USA, creating jobs and new innovations. But that structure has changed.

Stimulus money now largely flows right out of the country, straight to Asia. Tax cuts for wealthy Americans will follow the same route.

Extending unemployment doesn’t work either, because the job market that would eventually absorb our workers is now off shored. It is better to let millions of working Americans embrace biting poverty at the hands of our corrupt policy authors, because only then will we get ‘the change we need’, a change to a government for and by the people, not for the money and by the corporations.

Posted by theantibush | Report as abusive

Stimulus or lack thereof, easy or tight money, and higher or lower taxes are short term measures. The shock of a major U.S. economic depression or hyper-inflation must be avoided using them. Longer term, new product development and manufacturing success are the keys to the world’s strongest modern economies, that is if those economies aren’t fortunate enough to be sitting on huge quantities of raw materials that the world will pay dearly for. Note: the U.S. once was, but no longer is sitting in that position. Also emphasis on financial services instead of manufacturing indicates a declining economy. That was Great Britain 100 years ago and is the U.S. today. Only by manufacturing great products in great quantities that people the world over will gladly pay for (the finest and best priced computers, steel girders, medical devices, automobiles, plastics, chips, whatever) does a country add real value (that is, create real wealth for itself and its citizens). $100 worth of steel, reshaped into a valuable product, can then be sold for $200. $100 of real wealth has thus been created and can be spent for other products. Also, not only can that steel product now be sold for $200, but if it is manufactured here at home, U.S. labor..not foreign labor…will put nearly $100 of that total $200 price into its own pockets to spend right here at home, further boosting our economy, and “living the American dream” in the process. But to bring manufacturing back home for all of that, that is to say to put the US back at the top competitively in the world, as it once was in the ’50s, ’60s and ’70s, will require some painful sacrifices on all of our parts now and in the years just ahead. There is just no way around it. Here we are talking about temporarily lower pay levels (think lower living standards….and think politicians who just don’t get reelected pushing that agenda!). Our management and labor costs must be more in line with those of overseas manufacturers who successfully compete with the U.S. in today’s world. Note: We had little real competition from other countries in the ’50s, ’60s, and ’70s. We and our allies had flattened many of them during WWII and were then helping them rebuild following that war. We did such a good job of that, they now have become our all too capable competitors. A stretched out rubber band, pulled one way and then released, must then go in the opposite direction before finding its middle, “normal” position once again. Like that rubber band, we now must face and pay the hard price for our recent decades of overindulgence. During those most recent decades we, no longer as competitive in manufacturing as we once were, and who both publicly and privately, went into massive debt in the ’80s and beyond, in an effort to maintain those high living standards that had originally been built on real wealth creation in the decades just prior, but no longer were. We must now take the bitter pill of temporarily accepting lower standards of living. We must also save much more, and use those savings for investment in new manufacturing facilities (factories, laboratories, etc.), while driving down both our private and public debt. All of that must happen before we can begin to reestablish our leadership position in world manufacturing competitiveness, to once again be the world’s best wealth builders. We can do it and given some time and pain, eventually we will. Americans can be a very tough breed when they must be.

Posted by wpmccarty | Report as abusive

This “GLobal Economy” is a Fiction, wrought from “free trade” agreements and the dropping of federal tarrifs on imports.

Every single good from China should be paying our government a hefty import duty, enough that the cheap junk in every store has comparable cost to domestically produced goods. No more offshoring. As for the H1 visas, you are all exactly right, no more cheap foreign labor imported to destroy the middle class, and especially no more illegal aliens forcing wages down.

To give you an idea, a contractor employing illegal labor can underbid any domestic company by a Minimum of 30% simply through saving the tax money that the rest of us are legally obligated to pay -which drives legitimate American workers into the bread line.

End NAFTA and all other so-called “free trade” agreements, bring back tarrifs -so what if it hurts our exports -all we export is military hardware and Hollywood anyway, so where is the loss? We can produce and sell domestically. Also, let’s look at the Clean Air act, which places unfair burdens on any industry within the states -the government should be encouraging companies to find a productive use for their waste -not simply punishing their bottom line for creating it.

Bottom line, we have been sold out, steadily and unceasingly ever since Millhouse Nixon killed the last vestiage of the gold standard and the Fed began printing straight-up Monopoly money. Hang on to your Krugerrands, we are in for a wild inflationary ride as the nation is Zimbabwe-fied and turned into a Weimar Republic where we will end up bringing home paychecks of Federal Reserve Notes in a wheelbarrow.

Posted by TreadOnThis | Report as abusive

theantibush wrote: It is better to let millions of working Americans embrace biting poverty at the hands of our corrupt policy authors

Violent civil wars and/or the toppling of governments rarely lead to periods of enlightened government; nor are they always successful. The American and French Revolutions were the exception, but they were rather bloody, and the French had to suffer through a few dictators afterward. Just ask Spartacus and other Roman slaves in 73-71 BC, Russians in 1917, Germans in 1933, Chinese in 1949, Cubans in 1959, Cambodians in 1975, and Persians in 1979.

Posted by saucymugwump | Report as abusive

“Over the long — and short — term, in implementing any stimulus, we should favor tax cuts to stimulate business investment as the best way to stimulate job creation. Reducing the fiscal burden of entitlement programs is also essential to restoring prosperity.”
A rather quick 2 sentence paragraph. Listen, tax cuts will stimulate corporations to reap more profit here by outsourcing jobs and operations to other countries with cheaper labor. Reducing social security programs? Why? Just have the government pay back what they borrowed from the trust fund in the first place. social security funds were never intended for anything other then the original intent (aka: a trust fund). Get it thru your head. the analogy is the average Americans wages, 401k funds, pensions, savings is being rung dry, like a wash rag by the top corporate robber barons.

Posted by Jonesy | Report as abusive

comments on few points..discussed on this thread

1 The Products manufactured in China/ Asia. The American companies should make that Change and not the consumer. The consumer will go for Low cost. Example..If I buy a Apple Product..Ipod ..It is made in China .why cant they make in US.

2 We should stop Jobs going abroad and not stopping the temps into US to do work. Most of us came from Other countries to work inthe US and once you are in US and able to get a job ..that means you pay taxes, rent a home, spend money for your day to day livings and most of the money is within US..( Yes ..some will go out).Many landed into the US for work.

Bottom line ..Get the American compaies to start the factories here ..have a proper balance of trade..Generate job here in the US and get people to pay their taxes..

Posted by sun14 | Report as abusive

Gee, I didn’t think any body got it. Our manufacturing base is sorely lacking. We can’t depend on construction and automaking alone. Thanks John. That was perfect!!!

Posted by Tom_MacKnight | Report as abusive