Sunday, November 23, 2014

America’s Constrained Choice

NEWPORT BEACH – The conventional wisdom about the November presidential election in the United States is only partly correct. Yes, economic issues will play a large role in determining the outcome. But the next step in the argument – that the winner of an increasingly ugly contest will have the luxury of pursuing significantly different policies from his opponent – is much more uncertain.

By the time the next presidential term starts in January 2013, and contrary to the current narratives advanced by the Obama and Romney campaigns, the incumbent will find himself with limited room for maneuver on economic policy. Indeed, the potential differences for America are elsewhere, and have yet to be adequately understood by voters. They center on the social policies that would accompany a broadly similar set of economic measures; and, here, the differences between the candidates are consequential.

Whoever wins will face an economy growing at a sluggish 2% or less next year, with a nagging risk of stalling completely. Unemployment will still be far too high, and almost half of it will be hard-to-solve, long-term joblessness – and even more if we count (as we should) the millions of Americans who have dropped out of the labor force.

The financial side of the economy will also be a source of concern. The fiscal deficit will continue to flirt with the 10%-of-GDP level, adding to worries about the country’s medium-term debt dynamics. The banking sector will still be “de-risking,” limiting the flow of credit to small and medium-size companies and undermining hiring and investment in plant and equipment. And the household sector will be only partly through its painful de-leveraging phase.

The policy front will be equally unsettling. Having dithered and bickered for too long, the US Congress will find it increasingly difficult to postpone action on these challenges. Meanwhile, the Federal Reserve’s unusual activism, including an ever-expanding list of experimental measures, will yield fewer benefits and entail growing costs and risks.

The US economy will also be operating in a more difficult global environment. In the next few months, Europe’s debt crisis will most likely worsen. With emerging economies (including China) slowing, and with meaningful multilateral policy coordination remaining inadequate, protectionist pressures will mount as major trading powers compete for a stagnant pie.

So, whether President Barack Obama or Mitt Romney prevails in November, the next president will be constrained by the twin need for urgent economic stabilization and longer-term reforms. And, with headwinds from Europe and a synchronized global slowdown, the candidates will have no choice but to pursue, at least initially, similar economic policies to restore dynamic job creation and financial stability.

In striking the right balance between immediate economic stimulus and medium-term fiscal sustainability, the most urgent step will be to counter properly the looming fiscal cliff, as temporary tax cuts expire and deep, across-the-board spending reductions kick in automatically. Failure to do so would significantly increase the risk of an outright American recession.

Serious medium-term budget reforms are needed to deal with the legacy of repeated congressional failures. And, if provided with realistic numbers, the next president will soon recognize that the right mix of tax and spending reforms falls into a much narrower range than today’s competing political narratives suggest. It is certainly not an either/or proposition.

Fiscal reforms work best in a dynamic economy. To this end, Obama and Romney will need to lift the impediments to growth and job creation. Here again – in areas like housing, the labor market, credit intermediation, and infrastructure – there is less room for maneuver than most politicians would like us to believe.

But this does not mean that there is no scope for differences. There is, and they reflect the fact that general economic tendencies will be accompanied by multi-speed dynamics at many levels. From persistent differences in unemployment rates depending on skills and education to record-high income and wealth inequalities, each economic decision will be accompanied by the need for social judgment – whether explicit or, more likely, implicit – regarding its distributional impact.

After an “age” of excessive leverage, debt creation, and credit entitlement that culminated in the 2008 global financial crisis, America still faces the tricky challenge of allocating cumulative losses that continuously inhibit investment, jobs, and competitiveness. Until now, Congress’s excessive political polarization has translated into an approach that has pushed more of the burden of adjustment onto those who are less able to bear it.

In an ideal world, America’s next president would rapidly embark on a two-step approach to restoring job dynamism and financial soundness. First, he would devise a comprehensive set of economic-policy initiatives that are both feasible and desirable – and, again, the scope for major differences here is limited. Second, he would accompany this with an explicit set of social policies – and here the potential differences are profound – that addresses the need for equitable burden-sharing.

This is not really an election about such hotly-debated issues as outsourcing, tax increases versus entitlement reforms, government control of production versus unfettered private sector activity, or job creators versus free riders. It is much more about the accompanying concepts of social fairness, entitlement, equality and, yes, standards of behavior for a rich and civilized society.

This is an election about social responsibility – a society’s obligation to support those who are struggling, through no fault of their own, to find jobs and make ends meet. It is about protecting the most vulnerable segments of society, including by providing them access to proper health coverage. It is about reforming an education system that fails America’s young people (and about providing appropriate retraining to those who need it). Among the numerous issues of fairness and equality, it is about the rich giving back to a system that has brought them unimaginable wealth.

It is here where the differences between Obama and Romney are important. The sooner the campaign debate pivots to this, the greater the probability that Americans will make a more informed choice and, thus, buy into the collective effort needed to escape national malaise.

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    1. CommentedAlexander Antonov

      Reality of crisis-proof economy
      Alexander A. Antonov

      Economics as an exact science has not yet been developed. This is confirmed by the fact that the major economic phenomenon – economic crises – has no comprehensive explanation. This is accounted for by the lack of an appropriate mathematical description of economics, which is natural, because none of the mathematical tools used in economics allow giving such a mathematical description.
      Firstly, all of them are aimed at the investigation of mass phenomena, because the economic behavior of an individual is unpredictable. For instance, Sir Isaac Newton wrote on the issue that simulating human behavior is a more complicated task than predicting planetary motion. However, try to imagine the development of radio-electronics, if it refused to study the processes in radio-electronic components comprising all complicated radio-electronic systems due to the unpredictable behavior of single electrons.
      Secondly, the methods for analysis of economic situations widely used at present – graphical, statistical, econophysical – allow defining only states, and not processes.
      Processes are defined by differential equations, which have found quite restricted application in economics.
      This is why, using the term introduced by William Ross Ashby, economics can be referred to as ‘the black box’ and studied using the methods borrowed from the exact sciences. In particular, the term ‘the white box’ introduced by Norbert Wiener can be used; it corresponds to the object under investigation where processes identical in terms of their mathematical description to those in ‘the black box’ are observed. Moreover, mathematical description of the processes in ‘the white box’ is available. That is, basically, the analogy approach is used.
      Unfortunately, ‘the white box’ in the exact sciences has not yet been found for the current market economy. This is how complicated and unique economic phenomena are. Nevertheless, ‘the white box’ does exist for the economy reformed as suggested below.
      However, to begin with, let us find ‘the white box’ not for economics in general, but for the basic process, which is the ‘goods-money-goods’ process. The author demonstrates that this process is potentially oscillating and can be described with a second-degree differential equation with constant coefficients, similar to the mathematical description of the process in a radio-electronic oscillation circuit. That is, an electric oscillation circuit can be used as ‘the white box’ with regard to the ‘goods-money-goods’ process.
      However, such an oscillation process is unknown in the economy and has never before been implemented. The matter is that its implementation requires special conditions which cannot be created in a random way. Similarly, for instance, TVs and cars are not assembled at random, houses and bridges are not built in a random fashion, and food cannot get into a supermarket randomly, and so on. Any constructive activities always require certain knowledge, and economics is not an exception.
      In this respect, it is quite natural to ask whether economics needs these oscillation processes and the respective knowledge about them. Actually, it does, because only in this case money works all the time and most efficiently. Otherwise, there is always either shortage or surplus of money. As for oscillation processes, they are preferred and widely used not only in economics, but in nature and the exact sciences, as well. Here belong, for example, rotation of electrons around the nucleus and the revolution of planets about the Sun. Nothing can exist without the oscillation processes. Therefore, they should not be ignored in any science.
      However, due to ignorance of these circumstances, the actual economic process ‘goods-money-goods’ is described not with a linear differential equation with constant coefficients, but with a linear differential equation with variable coefficients, which is often referred to as the parametric differential equation. This is accounted for by the aforementioned unpredictability of human behavior, or the human factor, which was referred to as ‘the invisible hand’ by Adam Smith. For this reason, the coefficients of the parametric differential equation describing the real ‘goods-money-goods’ process are not just functions of time, but random functions of time. Therefore, these differential equations have no analytical solution. As for the market economy which is described by systems of these parametric differential equations, it is unpredictable; this is why economic crises in it are inevitable.
      Consequently, in order to be able to prevent economic crises, it is necessary to reform the economy. To this end, it is necessary to create the conditions providing for minimization of the human factor. The author suggests new economic tools enabling to solve the problem. Here belong business-interfaces, which provide for minimization of the internal human factor, and the new global information network free from the shortcomings of the Internet, which provides for minimization of the external human factor. The latter offers its users numerous business- and intellectually-oriented services.
      Socialist economy also provided for the successful suppression of the human factor (at that, contrary to business-interfaces, human rights and freedoms were suppressed, as well). Nevertheless, it was a prosperous economy. Therefore, business-interfaces must provide for linearization of the actual ‘goods-money-goods’ processes, i.e., for minimization of non-linear factors.
      The economy reformed as suggested above will become crisis-proof, and economics will become an exact science similar to the theory of electric circuits and systems, which is ‘the white box’ with regard to ‘the black box’ of economics.

    2. CommentedThomas Haynie

      This is all well and good but to get ANYTHING done we need a Congress that is willing to play ball in ANY form if Obama gets it. The blatant obstruction to anything possibly beneficial is flat out shameful. Of course if Mitt’s policies turn out to be quite similar it will be all rainbows and sunshine.

    3. CommentedMark Pitts

      Sorry for the typo. That should have read "1/4 to 1/2 of 1% of annual GDP." The point is that any net benefit to the average citizen is de minimus.

    4. CommentedMark Pitts

      Mr. El-Erian misrepresents the nature of the competing tax proposals. A few facts to consider:

      Higher taxes for the truly wealthy may have sentimental and political appeal, but they have few practical effects. For example, the CBO estimated the annual taxes to be gained from the Buffet Rule. The resulting number was between ¼ and ½ of 1% of the annual deficit - hardly enough to matter.

      Increased tax revenue from Obama’s proposals will come primarily from those making less than $1million, most of whom live in high cost urban areas. This then is hardly a question of “the rich giving back to a system that has brought them unimaginable wealth.”

      The problem is one of growth, or more precisely, lack of growth. Economic problems will be solved by growth oriented economic policies, not by symbolic changes in social policies that lack a firm economic foundation to support them

        CommentedMark Pitts

        The amount to gained from the Buffet rule is about 4% of the deficit, but only about 0.4% of the debt or of GDP (please excuse my typo in the original post). This is hardly going to change anything for the middle class. It may get votes, but it changes nothing. Only resumed economic growth will change the trajectory of the middle class.

        CommentedMichael Nikolaou

        I am questioning your assertion that "increased tax revenue will have few practical effects".

        The nonpartisan Tax Policy Center
        estimates that "217,000 households would be subject to the Buffett rule. While the actual amount would vary enormously from person to person, those households would pay an additional $190,000 in taxes, on average".

        This is a total of about $42 billion. While this amount is unquestionably small - compared to a $1000 billion deficit - and will not wipe out the entire deficit in a single stroke,
        it will have a discernible effect on the deficit, which is an order of magnitude higher than your 0.25-0.5% estimate.

    5. CommentedTim Chambers

      I read Schumpeter's book thirty some odd years ago, and as I remember it, he defined creative destruction as the sloughing off, onto other countries, of production that can no longer be done at favorable ROI, as happened with consumer electronics in the 1960s, and garment work in the 1980s. It had nothing to do with the present day problem of companies seeking absolute advantage in labor costs through off-shoring.

      New investment would, in theory, take the place of moribund industries and labor would, supposedly, be retrained for better jobs. Schumpeter's theory may have been true at the time he wrote his book, but it hasn't been operable for the past several years, since massive amounts of work was needlessly outsourced overseas in pursuit of ever increasing profits, and production workers replaced by robots on the factory floor.

      One of the reasons for lack of demand is that robots don't make good consumers of anything but lubricant. Just try to build a consumer economy of that! I dare you!

    6. CommentedFrank O'Callaghan

      The choice is designed to be narrow. The American problem is of inequality. The evidence is clear: great inequality is inefficient. America has redistributed wealth in the wrong direction.

    7. CommentedJohn A Werneken

      Suppose we stand this on its head and continue the Bush tax rates, or better, limit all deductions on a progressive basis beginning at the AVERAGE income and reaching ZERO at $250,000.00, with a flat rate income tax; repeal the non-entitlement spending cuts but go take the entitlement cuts, and take them much farther: FUND retirement by a combination of "Retirement Savings Accounts" with tax privileges, increasing the retirement age gradually but over no more than 10 years to 70, fixing the COLA adjustments; limit Medicare and Medicaid to current levels plus a COLA no larger than the rate of inflation; require all additional entitlement spending to either cease or be VAT funded.

      SURE we get a recession. We might also get a stable currency, liquidation of debt overhang, and a restoration of growth.

      My own income is closer to a full time minimum wage than any other broadly grasped number, but those are the policies I favor. To hell with equity, lets have progress and opportunity.

    8. CommentedRobert Winter

      It is always interesting to read a carefully balanced and thoughtful analysis of the constraints upon the candidates and the issues they should be confronting. The author states "This is not really an election about such hotly-debated issues as outsourcing, tax increases versus entitlement reforms, government control of production versus unfettered private sector activity, or job creators versus free riders. It is much more about the accompanying concepts of social fairness, entitlement, equality and, yes, standards of behavior for a rich and civilized society.

      CommentsThis is an election about social responsibility – a society’s obligation to support those who are struggling, through no fault of their own, to find jobs and make ends meet."

      The author presumably having had months to consider the views of the candidates, it would have been of interest to get his perspective upon how the candidates are approaching the issues he sees as central. And, whether he sees any differences in their approach worth commenting upon.

        CommentedSid Knight

        Hey, c'mon. Take what you can get. This is pretty good coming from Wall Street.

    9. CommentedLuke Ho-Hyung Lee

      Unfortunately, without being aware of it, we have developed numerous “job-killing machines” in the real market (or supply chain process) through the use of IT and networking technology over the last 20 to 30 years of the Modern Information Age. In this situation, structurally, the market as a whole cannot self-generate enough businesses and jobs to keep consumer spending at the desired level, no matter how powerful expansionary or stimulus economic policies are adopted.

      Please see: “Job-Killing Machines in the Modern Information Age”

      I believe our leaders and economic experts should consider this very seriously in their ruminations about the economy.

        CommentedProcyon Mukherjee

        The ability of markets to self-generate enough employment opportunities that can take care of the destruction of jobs that stem from innovation in the IT and networking technology gets tested through one single metric, which is GDP growth; an overall growth that is indifferent to the current spate of activities in the IT sector plays truant to the theory of creative destruction, in which case destruction must balance out. Unfortunately this is never a measured and controlled activity and we have a phase lag and the extent of the time gap cannot be estimated in advance as innovation and its disruptive habits are never predicated by firm evidence. It is therefore important to supplement through the machinery of government spending, a job creation process that acts as a catalyst or a complementary function; the reluctance of the polity to accept this as an efficient denouement is another question.

        Procyon Mukherjee

        Portrait of Ryan Shyu

        CommentedRyan Shyu

        There is an important distinction between unemployment as a result of inadequate economic stimulus, and the so-called "job-killing machines" you mention.

        Economic growth has always been predicated on technological advances, and technological advances inevitably render sectors of the economy outdated. This process does imply a temporary loss of jobs, but in the long run consumers benefit from lower prices and the labor force can flow into more productive fields. This is the "creative destruction" championed by Schumpeter as a defining characteristic of capitalism.

        On the other hand, inadequate economic stimulus is a pure loss in the sense that our economy is currently exhibiting a shortfall of demand--the ongoing banking-sector and household deleveraging mentioned by El-Erian are two causes of this. In this situation expansionary policies can provide an unambiguous boost to the economy--there is no broader purpose to the jobs lost from a too-weak stimulus.