MILAN – The world’s developed economies, of which the United States is by far the largest and systemically most important, face a range of difficult political and social choices. President Barack Obama’s proposed US budget acknowledges and addresses those choices and tradeoffs directly and fully for the first time in the post-crisis period.
Obama’s proposal is an important, honest, and politically courageous document. The debate that follows will largely determine whether the US shifts toward a strong, inclusive, and sustainable pattern of growth and employment, and how the burden of moving to such a path will be shared by Americans of various ages, educational levels, incomes, and wealth.
We know that powerful technological and global market forces have reduced dramatically the number of routine professional and blue-collar jobs, shifted employment options for the middle class toward the non-tradable side of the economy, and channeled growth in national income toward capital and high-end employment, with stagnating income elsewhere. Job creation remains weak, and employment continues to diverge from growth.
These trends cannot be blamed entirely on poor policy choices or shortsighted government. They arise mainly from an increasingly integrated global economy’s shifting technological landscape; but they have been exacerbated by a systematic pattern of public-sector underinvestment.
The lesson from many developed and developing countries is that underinvestment in infrastructure, human capital, institutions, and the economy’s knowledge and technology base reduces long-term growth. Short- and medium-term growth can be sustained for a while by substituting public and private debt for investment – that is, borrowing against future income and consumption. But this approach establishes a self-limiting pattern, because balance sheets are damaged, demand falters, and expectations have to be adjusted downward.
This brings us to the choices that Obama’s budget embodies. First there is the issue of how fast to reduce government deficits and the accumulation of public debt. Sudden fiscal contraction would reduce domestic aggregate demand faster than the economy’s deleveraging and structural shifts could replace it, thereby killing off growth and hiring, with adverse feedback effects on budget deficits. But delaying the debt reckoning for too long would undermine confidence in the US government’s capacity for fiscal discipline.
Deficits have to fall within a time horizon of 5-10 years. The alternative is either a sovereign-debt crisis, followed by a destructive spike in borrowing costs, or a growing burden for subsequent generations of taxpayers.
In an ideal world, where compromise is unnecessary, US fiscal policy would maintain the commitments embedded in the social-welfare system, even as demographic and other forces drive up costs (especially for health care). It would also maintain current consumptions levels and avoid tax increases, while redressing public-investment shortfalls in order to boost growth and expand employment options for today’s middle class and future generations. Finally, future generations would not be asked to bear the entire burden of rebalancing.
Obviously, it is impossible to reconcile all of these objectives. To be fair, some reforms – including tax, regulatory, and health-care measures – will help to restore balance without imposing large additional costs on the public sector. But these are not sufficient to rebalance the economy and restore its growth momentum. Simply put, one cannot sustain current levels of consumption and entitlements without crowding out public-sector investment, unless one believes that the state’s borrowing power is unlimited, and that the intergenerational burden shift is unimportant.
So choices have to be made. Gridlock, too, implies a choice – one that ensures that some version of the status quo will be the outcome. What would that look like?
Here some guess work is required. Entitlement programs would likely be reduced, but not enough to offset a substantial intergenerational burden transfer. Taxes might rise somewhat in the high-income ranges, with the proceeds going to fund entitlements and redistribution. The desire to avoid substantial tax increases (and to sustain consumption levels) will almost surely be reflected in a continuing shortfall of public-sector investment, in turn undermining long-term growth.
Obama’s proposed budget recognizes that all objectives and expectations cannot be met, and that growth is partly a distributional issue now and an intergenerational issue (and potentially one of inclusiveness and social stability) in the longer term. It is an invitation to the US Congress and the American public to acknowledge and address the choices and tradeoffs that are needed to establish a sustainable pattern of economic growth – and to ensure a fair distribution of the burden of getting there.
The choices are more extreme in countries where the imbalances are more severe and markets suffer more policy-induced impediments to the private-sector flexibility, mobility, and dynamism that continue to benefit the US. In Italy and Spain, growth is negative, and youth unemployment is 35% and 55%, respectively. To be sure, this is a moral issue, but it is also an issue of political and social stability.
Every country has its own version of a social contract that defines the rights and responsibilities of citizens, the role of the state, and the idea of inclusiveness. The most successful public policies and fiscal choices are those that are not only guided by the enduring values embedded in the social contract, but that are also adapted to changing demographic, technological, and global circumstances.
That sometime means making hard choices of the type that the US and many other developed countries are facing now. If we make these choices poorly, growth will suffer and future distributional choices will be far more painful.