By John L. Chapman
What policies best ensure a growing and prosperous economy? And more specifically, does massive monetary and spending stimulus make sense to end recessions, or would the opposite approach, viz., a stronger dollar, lower tax rates on incomes and capital along with less government spending, be more conducive to economic growth? At a moment when rioting in the streets of London and the cities of Greece over proposed government austerity has followed unrest over concern about declining living standards around the globe — manifested in rising food prices and lack of jobs in disparate places from China to Egypt this year — it is abundantly clear that this is the decisive issue for American voters next year. All other topics, including health care reform, will be evaluated in the context of how they affect economic growth, job creation, and the public fisc.
Appropriately, the core point of contention in political economy, the government’s size and role in society, will be at the center of election-year debate. With rioting abroad as a real-time reminder of what happens with loss of spending discipline, the U.S. economy now faces the near arrival of a long-developing fiscal reckoning, and how it is handled will determine what kind of country we have in the coming century.
Stark facts underline the 2012 debate in the U.S.:
Job creation and personal income growth are moribund. The U.S. has entered an alternative universe not seen since the 1930s: in the eleven years since the dawn of the new millennium, the U.S. has seen zero growth in total nonfarm employment, even as the U.S. population has increased by thirty million since 2000. Eerily, this was also true of the 1929-39 period (although zero employment growth then was attained only by doubling the government workforce from 2.8 to 5.6 million); the next worst comparable equivalent period after 1940 was 1950-61, when “only” ten million jobs were created here, although at the time this represented a 23 percent growth in total employment. Between 1960 and 2000 U.S. nonfarm employment grew 140 percent, gaining more than 1.9 million jobs per year on average, and real per capita incomes in the U.S. grew at 2.4 percent per annum over those four decades. But since 2000, real income per capita has grown at just 0.6 percent per year, or virtual stagnancy to match the stasis in job growth.
2000-2010: a lost decade for macroeconomic growth. To be sure, the loss of nearly nine million jobs in 2008-2009 wiped out the gains since 9/11 and the 2001-02 recession, and was accompanied by a fall in per capita incomes. And as President Obama says, two million new jobs in the last 18 months is welcome news (though even that number has not kept up with new labor force entrants in the same timeframe). But the Great Recession merely exacerbated decelerating growth in the U.S. ongoing since 2000: in the last eleven years, GDP growth has averaged less than 1.9% per year, after nearly doubling that growth rate across the 20th century.
Entitlement day of reckoning has arrived. Stagnant job and real income growth in the U.S. comes at an inauspicious time, as various estimates place the present value of total unfunded U.S. government liabilities for entitlement programs as between $62-100 trillion – and over $200 trillion if, as economist Laurence Kotlikoff rightly argues, all government cash flows including discretionary spending are considered. That’s scary, given that FDR conceived of social security at a time when the ratio of workers to retiree/beneficiaries was 16:1; today that ratio is nearing 3:1, and declining to 2.2:1 by 2050, with expanded entitlements now including health care as well as retirement income. For the first time ever, the Social Security Trust Fund went cash flow negative in 2010, meaning its pay-outs exceeded same-period receipts; the Medicare/Medicaid trust funds will witness the same turning point within a decade.
The core problem, as Kotlikoff points out, is that in just over a decade, 78 million baby boomers will be averaging $40,000 per year in transfer payments – that’s over $3.1 trillion per year, a huge envelope even at a time when the federal government will likely be spending $7-8 trillion annually. All of this implies one or a combination of three grim choices:  sharply higher taxes across the board to pay for it all, considerably stunting growth;  cuts to benefit pay-outs, which may include ObamaCare-style bureaucratic rationing – and the unfairness favoring the politically-connected that that always implies; or  a higher persistent inflation that unfairly harms all consumers, and especially those who are either creditors or living on fixed-incomes, as many elderly people do. .
Economic growth sharply diminishes in high-debt economies. In recent years, in the esteemed pages of the American Economic Review, in a full length book (This Time Is Different: Eight Centuries of Financial Folly), and in popular writings, economists Carmen Reinhart of the Peterson Institute of International Economics and Kenneth Rogoff of Harvard University have exhaustively described their path-breaking research showing the effects of debt and deficit-spending on economic growth and prosperity. Across data involving more than 40 countries going back 200 years in some cases for their statistical analysis, their seminal finding is one that should be enshrined as a canon of economic law: at ratios of gross national debt to GDP north of 90%, economic growth is sharply diminished. The U.S. has reached the 100% level, while for Japan, in the midst of economic torpor for the better part of 20 years, the ratio is approaching 200%. Greece, Italy, and Spain with its 20% unemployment are other countries among many now grappling with high debt.
Competing Visions Offered in 2012
Given the foregoing, the 2012 election will play out as a national discussion about the best answers to these challenges: what are the best policies to induce growth and job creation? How can entitlements and indeed, the entire federal budgeting process, be reformed so as to close the gap of unfunded liabilities, thereby avoiding a certain eventual collapse? And how will the American people resolve the trade-off between higher levels of prosperity, and social welfare programs that lower the gap in income distribution even as they lower the rate of economic growth?
In laying out his answer to these and at the same time offering us a remarkably candid glimpse of his vision for how an economy grows, Mr. Obama delivered a speech this past week at a Johnson Controls hybrid battery factory in Holland, MI., which was a recipient of government stimulus funds designed to promote “green energy”. In addition to more spending on new energy technologies and an extension of unemployment benefits in order to stimulate growth, the President hailed the success and growth of JCI’s government-aided battery business, which will supply electric cars:
….What also made this possible are the actions that we took together, as a nation, through our government –- the fact that we were willing to invest in the research and the technology that holds so much promise for jobs and growth; the fact that we helped create the conditions where businesses like this can prosper.
That’s why we’re investing in clean energy. That’s why I brought together the world’s largest auto companies who agreed, for the first time, to nearly double the distance their cars can go on a gallon of gas…… There are some in Congress right now who would rather see their opponents lose than see America win. And that has to stop…. Start passing some bills that we all know will help our economy right now….. I’ll give you some examples. You’ve got to tell them to extend the payroll tax cut, so middle-class families will continue to have more money to spend…. Tell Congress to send me a road construction bill so that companies can put tens of thousands of people to work right now building our roads and bridges and airports and seaports…. Send a message to Congress to come to an agreement on trade deals that will level the playing field and open markets to our businesses –- so we can sell more goods to countries around the world….
Tell Congress we need to reform the patent system…. Tell Congress we’ve got hundreds of thousands of bright, talented, skilled Americans who are returning home from Iraq and Afghanistan. And I’ve proposed connecting those veterans looking for work with businesses that need their skills…. Now, we do have to pay for these things. And in order to pay for these things… we need … a long-term plan to get our nation’s finances in order. That’s the only way we can invest in places like this. That’s how we can fund the research at the Department of Energy. That’s how we can fund the community college that trains folks to be able to work here. That’s how we can fund the infrastructure and the technology that will help us win the future — by doing what you do, what families do.
We can’t ask the people in this room — working families, middle-class families — to bear the entire burden….. Everybody has got to do their part….. That’s what all this fuss was about in Washington: Are we going to deal with our deficit in a way that’s fair? And that means closing tax loopholes for billionaires before we cut college loans for young people. That means ending government subsidies for oil and gas companies that are doing very well before you cut health care for seniors. It means making sure that the biggest corporations pay their fair share in taxes before we gut the investments in technology and clean energy that made this factory a reality.
All at once in this speech, Mr. Obama has clearly staked out his vision for economic growth:
- Continually renewed unemployment benefit payouts stimulate consumer spending, and thus aggregate demand and growth
- A payroll tax cut does the same, but other types of tax cuts, such as on corporate profits or marginal incomes of job-creating entrepreneurs, do not induce growth
- Government-directed green energy investments, fed in part by government-directed research at places like the Department of Energy, will pick “winners” and “losers” in industry; Johnson Controls is an example of a “winner”.
- Laws will be passed such as a doubling of CAFÉ fuel economy standards, and, voila, by government dictate, new investments and jobs will ensue, thanks to the government decree.
- More stimulus spending is needs to construct new roads and bridges and all types of infrastructure (implying the last few years of outsized federal spending did not tackle this).
- Free trade deals stalled in Congress should be passed (these would be helpful to growth, but deals such as those with South Korea, Columbia, and Panama have languished in Congress for three years and been ignored by this President).
- Other federal programs, such as programs to reform patent law or provide jobs for returning veterans, will be activated
- The deficits must be curbed, but we cannot cut necessary spending on things such as “community colleges” or “health care for seniors” and hence “everyone must pay their fair share”, including “billionaires” and “the biggest corporations”.
The Republican nominee is a long way from being determined, but with the exception of pursuing free trade deals that are unambiguously additive to growth – indeed, the Republicans have been disappointed in the multi-year stall on these of late – there will be radical differences in policy proposals offered next year. In the short run, nothing is higher on the Republican agenda than fundamental tax reform, as Columbia Business School economist Glenn Hubbard noted last week: a reform along the lines of Mr. Obama’s own Bowles-Simpson Commission (which he ignored), calling for dramatically lower and flatter marginal rates on all types of taxation in return for closing of loopholes, would ignite growth and begin a much-needed recapitalization of the entire US economy immediately. And some Republicans (though, sadly, not all) believe that fundamental monetary reform is needed as well: the dollar’s loss of 38% of its trade-weighted value in the last decade is concurrent with stagnating growth: indeed, there has never been an historical example of a growing economy sustained via a weak currency. During Japan’s boom decades of the 1960-90 hyper-growth era, for example, the yen/dollar exchange rate climbed from 360 to 80:1, belying the mistaken notion that a weak currency is needed to drive an export-centric economy.
Republicans will also offer sharp contrasts with Mr. Obama’s vision of government-picked winners, government-directed research, and government-run jobs programs, along with more “stimulus” spending. And of course they will offer more pronounced plans to stanch the entire federal spending trajectory, beginning with an attempted repeal of ObamaCare. They will additionally seek to roll back the regulatory excesses of Mr. Obama’s EPA or NLRB, which is embroiled in legal action against Boeing at the moment over a $2 billion plant in South Carolina that would create 1200 jobs at least – though all of them likely non-union there. Beyond being anti-capitalistic, such moves are nothing short of tragic, in the economy such as it is now, at near zero growth.
Mr. Obama had a friendly audience at Johnson Controls, which of course has been deigned to be one of the industrial “winners” in the Obama-led economy. But no better judgment of the Obama policy mix could be rendered than that of the $2 trillion in cash sitting on America’s corporate balance sheets. Microsoft, for example, is a company with $108 billion in total assets; $53 billion of it, nearly half, is in cash and immediately-liquid instruments. For Coca Cola, the idle cash stands at $14 billion, IBM, $12 billion, and Caterpillar, Inc., $11 billion. The modern theory of corporate finance holds that excess cash beyond reserve levels should be distributed to shareholders via dividends or share buybacks, if the firm cannot pursue investment projects at least equaling its cost of capital. That so many firms, including the icons of American business, will neither invest their cash nor distribute it at the moment shows the extraordinary burdens now placed upon them by the uncertainty of future tax and regulatory liabilities. This is capital that can and must be unlocked if prosperity is to be returned and sustained to the United States, and indeed, the global economy.
Pundits are fond of calling every election “the most important” in a generation, if not ever. But 2012 may well be justly described as such, because these two radically different visions for economic growth will be offered to voters; the cementing of one or the other would portend equally radically different growth trajectories for the long term.
Mr. Chapman is a director of research at Hill & Cutler Co., and chief economist at Alhambra Investment Partners.