Archive for category: Washington Post

There is still time to follow the basic rules of project management

November 11, 2013

As the president has recognized, the failure on the part of his administration to deliver a functioning website that Americans can use to enroll in “Obamacare”, the Affordable Care Act, represents an inexcusable error. Having succeeded after more than a century of failed efforts in achieving the progressive dream goal of legislating universal health insurance in America, it is tragic to be falling short on the mundane task of allowing Americans to actually enroll in the healthcare exchanges.

Even if the goal of getting the health insurance exchanges working by November 30 is achieved, and this cannot be regarded by objective observers as a certainty, a shadow has been cast on the core competence of the federal government.

What should be learned from this episode? It is too soon to know with confidence but there are some preliminary judgments that we can make.

At a basic level the implications go to public management. The dismal track record of the implementing of large-scale information technology initiatives even in rigorous and focused corporate environments points to the difficulty. Unexpected obstacles always arise, deadlines are usually missed, and budgets usually over-run.

Maximizing the prospect of success requires providing for slack in the schedule and in the budget, structuring projects with very clear accountability and frequent checkpoints, and assigning responsibility for oversight not simply to general managers but to people with extensive IT experience.

Success requires trust but also verifying. A homeowner who hires a general contractor to build an extension to his house, discusses the specifications and then goes away for six months is usually unhappy with the result. The same is true for public managers who trust contractors to perform essential tasks but fail to rigorously oversee every step.

An additional requisite for success is steadiness and realism in the face of difficulty. Once a project gets off track there is an overwhelming temptation for everyone involved to circle the wagons and promise rapid repair so as to hold critics at bay. Yet the right response to such failures is to bring problems to the surface as rapidly as possible and to move deliberately and carefully rather than more quickly. The best football teams stick to their playbooks even when they appear to be losing. So also when projects fall behind, it is important to mobilize new resources and management but not to over-promise with respect to how soon and how good a fix will be possible.

One case of over-optimism will ultimately be forgotten and, or, forgiven. Repeated over-optimism should not, and will not, be excused.

These are old truths that those responsible for implementing the Affordable Care Act should surely have heeded. Yet fairness requires recognizing that there is an equally important and in some ways more fundamental factor behind the problems of implementing Obamacare – the systematic effort of President Barack Obama’s opponents to delegitimize and undermine the project.

Large-scale information technology projects in the private sector are hard enough even without an organized constituency for failure.

It is no exaggeration to say that it has been the prophecy and the hope of many of the opponents that the project will fail. They have been eager to seize on any problems, highlight any controversial judgments, and create an environment in which failure becomes the expectation.

It is hypocritical for those who held up the confirmations of key officials with responsibility for managing federal healthcare programs and whose behavior deterred many able people from coming into government to lash out at the incompetence of government management.

And it is indefensible to refuse to appropriate money to carry out a program and then attack it on the grounds that it is being under-resourced.

Many people regard it as an obligation when their country is at war – even a war they oppose – to support the troops. In the same way history will not judge kindly those who, having lost a political debate over policy, try to undermine programs when they are being enacted.

There is a danger here that goes far beyond delays in access to health insurance. The risk is a vicious cycle develops in which poor government performance leads on the one hand to overly bold promises of repair and on the other to reduced funding and support for those doing the work.

This then leads to unmet expectations and disappointment setting off the cycle once again. In the end, government loses the ability to deliver for citizens and citizens lose respect for government. Our democracy is the loser.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

July 7, 2013

Imagine a library where many books have been borrowed and are long overdue. There is a case for an amnesty to get the books back and move on. There is a case for saying that rules are rules and fines must be paid. But the worst strategy is to keep indicating that an amnesty may come soon without ever introducing it. And this is roughly where we are in our corporate tax debate.

No one is satisfied with the U.S. corporate tax system. Some argue the main problem is that, while corporate profits are extraordinarily high relative to gross domestic product, tax collections are relatively low. Many very successful companies pay little or nothing in taxes at a time when the budget deficit is a major concern, hundreds of thousands of defense workers are being furloughed and lotteries are being held to determine which children Head Start can no longer afford to help.

But others say the main problem is that the United States has a higher corporate tax rate than any other major country and, unlike other countries, imposes severe taxes on income earned outside its borders. This, they argue, unfairly burdens companies engaged in international competition and discourages the repatriation of profits earned abroad. The resulting patterns of investment are also said to benefit foreign workers at the expense of their U.S. counterparts.

With respect to tax reform, these perspectives seem to argue in opposite directions. The former points toward the desirability of raising revenue by closing loopholes; the latter seems to call for a reduction in corporate tax burdens. But while many can get behind the idea of “broadening the base and lowering the rate,” consensus tends to collapse over the means to broaden the base. A principal objective of many business-oriented reformers seems to be narrowing the corporate tax base by reducing the taxation of foreign earnings through movement to a territorial system.

Despite the tension between perspectives, the debate has landed us in so perverse a place that win-win reform would be easy to achieve. The central issue is the taxation of global companies. Under current law, U.S. companies are taxed on their foreign profits — with a credit for taxes paid to other governments — only when they repatriate these profits. Right now, U.S. companies are holding nearly $2 trillion in cash abroad. Businesses argue, with some validity, that current rules make it expensive to bring money home while not raising much revenue for the government. Tax relief, they assert, would help them bring money home, at a minimum benefiting their shareholders but also possibly leading to an increase in investment.

Critics counter that companies that have used what might politely be called aggressive accounting practices to locate income in low-tax jurisdictions should not be given further relief.

In the meantime, what’s a corporate treasurer to do? With the possibility of some kind of relief looming, there is every reason to delay repatriating earnings to the United States even if the company has no good use for the cash abroad. And so the debate encourages exactly what all sides can agree is desirable to avoid: corporate cash kept abroad to the detriment of companies and to no benefit for the U.S. fiscal situation.

A clear and unambiguous commitment that there will be no rate reduction or repatriation relief for the next decade would be an improvement over the current situation because companies would know that they will have to pay taxes on their foreign profits if they wish to make them available to shareholders and would no longer have an incentive to delay.

But this would not be the best outcome. As a very general rule, improvement is possible anytime tax rules are experienced by taxpayers as a substantial burden without generating substantial revenue for the government. Having taxpayers be burdened less and pay more can make them better off and help the fiscal situation. The United States should eliminate the distinction between repatriated and unrepatriated foreign corporate profits for U.S. companies and tax all foreign income (after allowances for taxes paid to other governments) at a fixed rate well below its current corporate rate, perhaps in the range of 15 percent.

A similar tax should be imposed on past accumulated profits held abroad.

Such a proposal could easily be designed to raise revenue relative to the current baseline, encourage the repatriation of funds and reduce the competitive disadvantage faced by U.S. multinationals operating abroad. It is about as close to a free lunch as tax reformers will ever get.

May 6, 2013

The economics commentariat – and no small part of the political debate – has been consumed in the past few weeks with controversy surrounding a piece of research by my Harvard colleagues (and friends) Carmen Reinhart and Kenneth Rogoff. The article, published in 2010, had been widely interpreted as showing that economic growth is likely to stagnate in a given country once the ratio of its government debt to gross domestic product exceeded a threshold of 90 per cent. But scholars at the University of Massachusetts have demonstrated – and the duo have acknowledged – that the two professors accidentally omitted some relevant data in forming their results, thanks to a coding error. Questions have also raised with respect to how they weighted observations and which data they used.

Many have asserted that the debate undermines the claims of austerity advocates around the world that deficits should be reduced quickly. Some have gone so far as to blame Profs Reinhart and Rogoff for the unemployment of millions, asserting that they were crucial intellectual ammunition for austerity policies. Others believe that, even after review, the data support the view that deficit and debt burden reduction is important in most of the industrialised world. Still others say the controversy has called into question the usefulness of statistical research on economic policy questions.

Where should these debates settle? First, the whole experience should change the way we approach economic and statistical research. Profs Rogoff and Reinhart are rightly regarded as careful, honest scholars. Anyone close to the process of economic research or financial markets will recognise that data errors such as the ones they made are distressingly common.

Indeed, an internal investigation by JPMorgan into the $6bn loss it made last year on the “London whale” trade found mistakes not unlike those made by Profs Reinhart and Rogoff. Simple errors in a model meant that the bank dramatically underestimated the risks that it was running. In future, authors, academic journals and commentators need to devote more effort to replicating significant research results before broadcasting them widely.

More generally, no important policy conclusion should ever be based solely on a single statistical result. Policy judgments should be based on the accumulation of evidence from multiple studies done with differing approaches. Even then, there should be a reluctance to accept conclusions from “models” without an intuitive understanding of what is driving them. It is right and understandable that scholars want their findings to inform the policy debate. But they have an obligation to discourage and, on occasion, contradict those who would oversimplify and exaggerate their conclusions.

Second, all participants in policy debates should retain a healthy scepticism about retrospective statistical analysis. Trillions of dollars have been lost and millions have been unemployed because the lesson was learnt from 60 years of experience between 1945 and 2005 that “American house prices in aggregate always go up”. This was not a data problem or misanalysis. It was a data regularity – right up until it wasn’t.

The extrapolation from past experience to future outlook is always deeply problematic and needs to be done with great care. In retrospect, it was folly to believe that with data on about 30 countries it was possible to estimate a threshold beyond which debt became dangerous.

Even if such a threshold existed, why should it be the same in countries with and without their own currency, with very different financial systems, cultures, degrees of openness and growth experiences? And there is the old chestnut that correlation does not establish causation. Any tendency for high debt and low growth to go together might reflect the way that debts can rapidly accumulate as a consequence of slow growth.

Third, while Reinhart and Rogoff’s work, even before the recent replication efforts, did not support the claims made by prominent figures on the right in the US and UK regarding the urgency of deficit reduction efforts, the joy taken by some on the left from their embarrassment is inappropriate.

It is absurd to blame Reinhart and Rogoff for austerity policies. The political leaders advancing austerity measures made their choice of policy first, and then cast about for intellectual buttresses. While there may be no threshold beyond which debt becomes catastrophic, and while the British and US experiences both suggest that fiscal contraction in a slack economy where interest rates are near zero is inimical to growth, it is a grave mistake to suppose that debt can or should be accumulated with abandon.

On all but the most optimistic forecasts, further actions will be necessary almost everywhere in the industrial world to assure that debt levels are sustainable after economies recover.

This is not the time for austerity, but we forget at our peril that debt- financed spending is not an alternative to cutting other spending or raising taxes. It is only a way of deferring those painful acts.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

March 17, 2013

In economic policy what is good for one is not good for all

Europe’s economic situation is viewed with far less concern than was the case six, 12 or 18 months ago. Policy makers in Europe far prefer engaging the US on a possible trade and investment agreement to more discussion on financial stability and growth. However, misplaced confidence can be dangerous if it reduces pressure for necessary policy adjustments.

There is a striking difference between financial crises in memory and financial crises as they actually play out. In memory, they are a concatenation of disasters. But as they play out, the norm is moments of panic separated by lengthy stretches of apparent calm. It was eight months from the South Korean crisis to the Russian default of 1998, six months from Bear Stearns’ demise to Lehman Brothers’ fall, and there were several 30 per cent stock market rallies between 1929 and 1933.

Is Europe out of the woods? Certainly a number of key credit spreads, particularly in Spain and Italy, have narrowed substantially. But it is far from clear that market conditions have improved. Investors are still limited. Restrictions limit the ability of pessimistic investors to short European debt. Regulations enable local banks to treat government debt as risk free. This allows them to access funding from the European Central Bank on non-market terms. And there is the suspicion that, in extremis, the central bank would come in strongly and bail out bond holders. Remissions are sometimes followed by cures and sometimes by relapses.

A worrisome indicator in much of Europe is the tendency of stock and bond prices to move together. In healthy countries, when sentiment improves stock prices rise and bond prices fall, as risk premiums decline and interest rates rise. In unhealthy economies, as in much of Europe today, bonds are seen as risk assets, so they move just like stocks in response to changes in sentiment.

Perhaps it should not be surprising that Europe still looks to be in serious trouble. Growth has been dismal, with eurozone gross domestic product still below its 2007 level. Forecasts predict little if any growth this year.

For every Ireland, where there is a sense that a corner is being turned, there is a France, where the sustainability of current policy is increasingly questionable.

The controversy surrounding the decision by European authorities to conduct a bail-in that imposes levies on Cypriot bank depositors gives an indication of the degree of fragility in Europe. The idea that converting a small portion of deposits into equity claims in an economy with a population barely over 1m could be a source of systemic risk suggests the current situation rests on a hair trigger.

All of this is compounded by political uncertainty. Italy’s election was inconclusive even by its own standards. Scandals and staggeringly high unemployment are taking their toll in Spain. France is much calmer about its situation than are many outside observers. And Germany’s primary concern is avoiding turmoil before federal elections in September. There is little doubt that, given a choice, all eurozone countries would prefer almost any kind of macroeconomic unorthodoxy to the breakdown of monetary union. But this is insufficient. There is the serious risk that as nations pursue parochial concerns, the political and economic situation will deteriorate to a point that is not remediable.

Structural reform in the most troubled economies is essential, and the work of building a stronger institutional foundation for monetary union must go on. But the key to success will be the recognition that in economic policy – as in life – what is good for one is not good for all.

It is true, as German policy makers constantly point out, that fiscal consolidation and structural reform were key to Germany’s rise from being the “sick man of Europe” to its current position of strength. What they do not recognise is that there cannot be exports without imports. Germany’s export growth and huge trade surplus were enabled by borrowing by the European periphery. If the debtor countries of Europe are to follow Germany’s path without economic implosion there must be a strategy that assures increased external demand for what they produce. This could come from a German economy that was prepared to reduce its formidable trade surplus, from easier monetary policies in Europe that spurred growth and competitiveness, or from increased deployment of central funds such as those of the European Investment Bank.

Invocation of necessity is not a strategy. As any student of Germany’s experience of the 1920s knows, requiring a nation to service large debts by being austere in a context where there is no growth in demand for its exports is far from being a viable strategy.

European policy makers, the International Monetary Fund and external policy makers with a stake in the European outcome need to recognise that the history of financial crises is a history of missed opportunities. New business is always more exciting than unfinished business. And where matters are controversial, forced moves are easier for policy makers than unforced moves because they can be portrayed as moves of necessity rather than choice. So outsiders avoid confrontation and insiders embrace drift. The consequences could be grave.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

January 21, 2013

America must not lose sight of infrastructure, jobs and growth

In the two and a half months between the election and this week’s inauguration of President Barack Obama, America’s public policy debate has been focused on prospective budget deficits and what can be done to reduce them.

The concerns are partly economic – there is a recognition that debts cannot be allowed to grow indefinitely faster than incomes and the capacity to repay them. Then there is a moral dimension in terms of not unduly burdening our children. There is also the global and security dimension, with the concern that the excessive build-up of debt would leave the US vulnerable to foreign creditors and without the flexibility to respond to international emergencies.

Economic forecasts are, of course, uncertain. Yet there is a great likelihood that, in the next 15 years, debts will rise relative to incomes in an unsustainable way if no action is taken beyond the 2011 budget deal and the end-of-year agreement to prevent the nation tumbling over the “fiscal cliff”. So even without the risk of self-inflicted catastrophes – failure to meet debt obligations or government shutdown – it is entirely appropriate to focus on reducing prospective deficits.

Those who argue against a further concentration on prospective deficits on the grounds that – contingent on a forecast that assumes no recessions – the debt to gross domestic product ratio may stabilise for a decade counsel irresponsibly. Given all uncertainties and current debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.

Reducing prospective deficits should be a priority – but not an obsession that takes over economic policy. This would risk the enactment of measures such as pseudo-temporary tax cuts that produce cosmetic improvements in deficits at the cost of extra uncertainty and long-run fiscal burdens. It could preclude high-return investment in areas such as infrastructure, preventive medicine and tax enforcement that would, in the very long term, improve our fiscal position.

Economists have long been familiar with the concept “repressed inflation”. When concern with measured inflation takes over economic policy, and drives the introduction of price controls or subsidies to hold down prices, the results are perverse. Measured prices may not rise, so the appearance of inflation is avoided. But shortages, black markets and enlarged budget deficits appear. The repression is unsustainable and, when it is relaxed, measured inflation explodes as in the case of the Nixon price controls during the early 1970s.

Like repressing inflation, repressing budget deficits can be a serious mistake. Yet – just as corporate managements judged only on a single year’s earnings take perverse and ultimately harmful steps – government officials in the grip of a budget obsession repress rather than resolve deficit problems.

When arbitrary cuts are imposed, agencies respond by deferring maintenance, leading to greater liabilities later. Or compensation is provided in the form of promised retirement benefits that are less than fully accounted for, with the ultimate burden on taxpayers increased. Or measures such as the recent Roth Individual Retirement Arrangement legislation are enacted, encouraging taxpayers to accelerate their tax payment while reducing present value.

As important as avoiding the repression of the budget deficit is ensuring that focusing on it does not come at the expense of other, equally real deficits. Interest rates in the US and much of the industrialised world are now remarkably low. Indeed, in real terms the government’s cost of borrowing has been negative for as long as 20 years. No one who travels from the US can doubt that we have an enormous infrastructure deficit. Surely, even leaving aside any possible stimulus benefits, current economic conditions make this the ideal time to renew the nation’s bridges and roads. Such investments, borrowed at near-zero real rates of interest, need not increase debt ratios if their contribution to growth raises tax collections.

Infrastructure deficits are only the most salient of the deficits facing the US. Nearly six years after the onset of financial crisis, we are living with substantial jobs and growth deficits. Consider this: an increase of just 0.15 per cent in the growth rate maintained over the next 10 years would reduce the debt to GDP ratio in 2023 by about 2.5 percentage points. That is an amount equal to the much-debated end-of-year tax compromise. Increasing growth also creates jobs and raises incomes.

By all means, let us address the budget deficit. But let us not obsess over it in counterproductive ways – nor lose sight of the jobs and growth deficits that will ultimately have the greatest impact on the way this generation of Americans lives and what they bequeath to the next.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

October 28, 2012

The final full week of the US presidential campaign will see both candidates intensely debate the future of economic policy. But despite the rhetoric about its means, most experts agree on its ends. First, re-establishing economic growth at a rate that makes real reductions in unemployment possible; second, placing the nation’s finances on a stable footing by putting in place measures to ensure that the nation’s sovereign debt is declining relative to its wealth; and third, renewing the economy’s foundation in a way that can support steady growth in middle-class incomes over the next generation as well as work for all those who want it.

Where are the candidates on these three issues? Barack Obama has recognised the inadequacy of demand as the main barrier to growth and sought to bolster both public and private sector demand since becoming president. Recent work by the International Monetary Fund has confirmed the premise of his policies, namely that at a time when short-term interest rates are at zero, fiscal policies are especially potent as multipliers are larger than normal. The president has also respected the independence of the Federal Reserve as it has sought to respond creatively to the challenge of increasing demand. And he has put the economy on track to almost doubling exports over five years through a series of measures such as increasing government support for exporters. He has made clear his commitment to taking advantage of low interest rates to finance public investment and protect public sector jobs, to respect the independence of the Fed and to continue to promote exports.

Mitt Romney, in contrast, supports immediate efforts to sharply reduce government spending even as economic slack remains and Congress at the president’s behest has already legislated the most draconian cuts ever in domestic discretionary spending. Through some set of intellectual gymnastics he concludes that spending on new weapons systems by the government, or on luxury goods by the recipients of tax cuts, will create jobs but spending on fixing schools and highways do not. He also seems comfortable involving himself in monetary policy discussion on the side of reducing the supply of credit relative to current Fed policy. And his insistence that he will name China a currency manipulator on day one of his term even before his appointees have moved into their offices surely increases uncertainty by making a trade war possible.

President Obama has embraced the principles though not all the details embodied in the Simpson-Bowles commission report on budget deficits. Like the group of chief executives who made a major statement on deficit reduction last week he insists that achieving sustainable finances means both containing spending especially on entitlements and raising revenue. The budget he has put forward has been thoroughly audited by the Congressional Budget Office and puts the US debt to gross domestic product ratio on a declining path within this decade. And he has made clear that in talks with willing partners to conclude a deal, he is prepared to go beyond his budget proposals to ensure that debt accumulation is contained.
Mr Romney, meanwhile, has not suggested even a partial approach to the budget that has enough detail to be fully evaluated by independent experts. He has, however, insisted on the need for military spending of at least a trillion dollars more than recommended by Robert Gates, George W. Bush’s defence secretary, and for 20 per cent across the board tax cuts which independent estimates suggest would cost close to $5tn over the next decade. To offset these measures, he has spoken of “closing loopholes” without naming any specific items and in the face of repeated demonstrations that even the elimination of every tax benefit for those with incomes over $200,000 would raise far less than the totality of his proposals would cost.

From the Lewis and Clark expedition to the land grant colleges, to the transcontinental railway, to the interstate highway system, to the original research and development that led to the internet, the federal government led by either political party has always sought to lay a foundation for future prosperity. President Obama has continued this tradition while recognising the inevitability that in an uncertain world some investments will work out better than others. While audits have found many fewer problems with public investments than most expected over the past few years, much has been accomplished. Major efforts to measure and act on student achievement results are now in place in most states. Medical records are being systematically computerised. Domestic fossil fuels and renewable energy sources are meeting more and more of our energy needs. New financial protections are in place for consumers even as the capital reserves required of financial institutions have been substantially increased and student lending has been streamlined. These steps illustrate the kinds of progress that a second Obama administration would strive towards.

Mr Romney, on the other hand, has made clear a preference for using any available resources to reduce tax rates below their current level – in the hope that there are great investments companies are not already undertaking even in the face of sub 2 per cent interest rates and the lowest effective tax rates in generations. If this represents a foundation for prosperity it will be a very different one than America has enjoyed historically.

The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary

September 16, 2012

It is the mark of science and perhaps rational thought to operate with a falsifiable understanding of how the world works. So it is fair to ask economists a fundamental question: what could happen that would cause you to revise your views of how the economy operates and acknowledge that the model you had been using was flawed? As a vigorous advocate of fiscal expansion as an appropriate response to a major economic slump in an economy with zero or near-zero interest rates, I have for the past several years suggested that if the British economy – with its major attempts at fiscal consolidation – were to enjoy a rapid recovery, it would force me to substantially revise my views about fiscal policy and the macroeconomy.

Unfortunately for the British economy, nothing in the past several years compels me revise my views. British economic growth post-crisis has lagged substantially behind the US and the gap is growing. British gross domestic product has not yet returned to its pre-crisis level and is more than 10 per cent below what would have been forecast from the pre-crisis trend. The cumulative output loss from this British downturn in its first five years exceeds even that experienced during the 1930s. Forecasts continue to be revised downwards, with a decade or more of Japan-style stagnation emerging as a real risk.

Whenever policy is failing to achieve its objectives, as in Britain today, there is a debate as to whether the right response is doubling down – perseverance and intensification of the existing path – or recognition of error or changed circumstances and a change in course. In Britain today such a debate rages on the aggressive fiscal consolidation that the government has made its economic centrepiece. Until and unless there is a substantial reversal on near-term fiscal consolidation, Britain’s short and long-run economic performance is likely to deteriorate.

An effective policy approach to Britain’s economic problems must start with the recognition that the principal factor holding back the British economy over both the short and medium term is the lack of demand. It is true that Britain also faces important structural issues ranging from difficulties in promoting innovation to deficiencies in the system of worker training. Still, it is apparent from the relatively low level of vacancies, the reluctance of workers to leave jobs and the pervasiveness across industries of increased unemployment that it is lack of demand that is holding the economy back. Testimony from companies on their investment plans also supports this view.

During the depression, John Maynard Keynes compared Britain’s economic woes to a “magneto” problem, referring to the fact that a car might have many infirmities but if its electrical system did not work the car would not go. If that was fixed, the car would run, even with other problems. So it is today. Moreover, to a greatly under-appreciated extent in the policy debate, short-run increases in demand and output would have medium to long-term benefits as the economy reaps the rewards of what economists call hysteresis effects. A stronger economy means more capital investment and fewer cuts to corporate research and development. It means fewer people lose their connection to good jobs and become addicted to living without work. It means that more young people get first jobs and it means more businesses choose leaders oriented to expansion rather than cost-cutting. The most important structural programme for raising Britain’s potential output in the future is raising its output today.

The objection to this view comes in many forms but it is in essence that reversing course on fiscal expansion now would undermine credibility, backfire with respect to growth by risking a spike in capital costs and risk catastrophe down the road as debts became unsustainable. This line of argument is profoundly flawed. First, the behaviour of financial markets suggests that economic weakness rather than profligacy is the main source of concern about future credit problems. Why else would the tendency be for the costs of buying credit insurance on the UK to rise when overall interest rates fall? In a similar vein, a tendency has emerged in both the UK and US for interest rates to rise and fall with stock prices, implying that it is evolving optimism and pessimism about the future, not changing views about fiscal policy driving markets. Second, the reality is that the primary determinant of fiscal health in both the US and UK over the medium term will be the rate of growth. An extra percentage point of growth maintained for five years would reduce Britain’s debt-to-GDP ratio by close to 10 percentage points whereas austerity policies that slowed growth could even backfire in the narrow sense of raising debt-to-GDP ratios and turning debt unsustainability into a self-fulfilling prophecy.

Britain must change the pace of fiscal consolidation to stand a chance of avoiding a lost decade. Rather than starving public investment, now is the time to add to confidence by making plans for structural reforms to contain the growth of public consumption spending over time. It is also time to take overdue measures to promote exports and, after years of appropriately low investment, to restart housing investment. But when demand is needed for growth and the private sector is hanging back, the first priority must be for the public sector to stop exacerbating the contraction.

The writer is Charles W. Eliot university professor at Harvard.

July 15, 2012

Even if the process proves protracted, the American economy will eventually recover. Yet even as cyclical issues cease to dominate the economic conversation, it is likely that inequality will move to the forefront.

There is no question that income is distributed substantially more unequally than it was a generation ago, with those at the very top gaining a greater share as even the upper middle class loses ground in relative terms. Those with less skill – especially men who in an earlier era would have worked with their hands – are losing ground not just in relative but also in absolute terms.

These issues frame an important part of the economic debate in this election year. Progressives argue that widening inequality jeopardises the legitimacy of our political and economic system. They argue that a time when the market is generating more inequality is no time to shift tax burdens from those with the highest incomes to the middle class, as has taken place in the past dozen years. And while recognising that innovators such as Apple co-founder Steve Jobs earned their billions providing great value to consumers and making substantial contributions to the US and global economies, they assert that the social value associated with the activities behind many other fortunes, especially in finance, is less apparent.

Conservatives argue that, in a world where everything is increasingly mobile, high tax rates run more risk than they once did of driving businesses and jobs overseas. They highlight the central role of entrepreneurship in advancing economic growth and note that, since most new ventures fail, the returns on successful ones have to be very large if entrepreneurship is going to flourish. They take umbrage at the suggestion there is something wrong with success on a grand scale. And they worry that policy measures taken to combat inequality directly will have perverse side effects.

Unfortunately, the points on both sides of the argument have considerable force. While I support moves to make the tax system more progressive, the reality is that inequality is likely to remain high and continue to rise, even in the face of all that can responsibly be done to increase the burden on those with high income and redistribute the proceeds. Measures such as allowing unions to organise without undue reprisals and enhancing shareholders’ role in executive pay-setting are desirable. But they are unlikely even to hold at bay the trend towards increasing inequality.

Where does this leave the public policy agenda? The global record of populist policies motivated by inequality concerns is hardly encouraging. Equally, passivity in the face of dramatic economic change is unlikely to be viable. Perhaps the focus needs to shift from inequality in outcomes, where attitudes divide sharply and there are limits to what can be done, to inequalities in opportunity. It is hard to see who could disagree with the aspiration to equalise opportunity or fail to recognise the manifest inequalities in opportunity today.

By definition, the number of children not born in to the top 1 per cent who move into the top 1 per cent must equal the number of those born into the top 1 per cent who move out of it over their lifetimes. So a serious programme to promote equal opportunity must both seek to enhance opportunity for those not in wealthy families, and to address some of the advantages enjoyed by the children of the fortunate.

The most important step that can be taken to enhance opportunity is to strengthen public education. For the past decade we have focused on ensuring no child is left behind, and this must continue. But if we are to ensure everyone has a real chance of great success, we must also ensure every child in the public system can learn as much and go as far as their talent permits. This means judging schools on measures beyond the fraction of students who exceed some minimum. The leading universities have in the past 40 years, with the encouragement and support of the federal government, made a significant effort to recruit and support students from ethnic minorities. This should continue.

But as things stand a student from a minority group who has strong admission text scores is considerably more likely to apply, and be admitted, to a leading university than a low-income student. It is time the best institutions undertook the kind of commitment to economic diversity that they have long mounted towards racial diversity. It is not realistic to expect that schools and universities dependent on charitable contributions will not be attentive to offspring of their supporters. Perhaps, though, the custom could be established that, for each “legacy slot”, room would be made for one “opportunity slot”.

What about the perpetuation of privilege? Parents always seek to help their children, and it is not realistic to think privileged parents will do any differently. But there is no reason why the estate tax should decrease relative to the economy at a time when great fortunes are increasingly dominant. Nor should tax-planning techniques that are de facto tax cuts only for those with millions of dollars of income and tens of millions in wealth continue to be legal.

These are some ideas for advancing equality of opportunity. There are many more. It is an aspiration those of every political stripe should share.

The writer is Charles W. Eliot university professor at Harvard.

June 3, 2012

With the past week’s dismal US jobs data, signs of increasing financial strain in Europe and discouraging news from China, the proposition that the global economy is returning to a path of healthy growth looks highly implausible.

It is more likely that a pessimistic view is again taking over as falling incomes lead to falling confidence that leads to reduced spending and yet further declines in income. Financial strains hurt the real economy, especially in Europe, and reinforce existing strains. And export-dependent emerging markets suffer as the economies of the industrialised world weaken.

The question is not whether the current policy path is acceptable. The question is what should be done? To come up with a viable solution, consider the remarkable level of interest rates in much of the industrialised economies. The US government can borrow in nominal terms at about 0.5 per cent for five years, 1.5 per cent for 10 years and 2.5 per cent for 30 years. Rates are considerably lower in Germany and still lower in Japan.

Even more remarkable are the interest rates on inflation-protected bonds. In real terms, the world is prepared to pay the US more than 100 basis points to store its money for five years and more than 50 basis points for 10 years. Maturities would have to reach more than 20 years before the interest rates on indexed bonds become positive. Again, real rates are even lower in Germany and Japan. Remarkably, the UK borrowed money last week for 50 years at a real rate of 4 basis points.

These low rates even on long maturities mean that markets are offering the opportunity to lock in low long-term borrowing costs. In the US, for example, the government could commit to borrowing five-year money in five years at a nominal cost of about 2.5 per cent and at a real cost very close to zero.

What does all this say about macroeconomic policy? Many in both the US and Europe are arguing for further quantitative easing to bring down longer-term interest rates. This may be appropriate given that there is a much greater danger from policy underreacting to current economic weakness than from it overreacting.

However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative real interest rate. There is also the question of whether extremely low safe real interest rates promote bubbles of various kinds.

There is also an oddity in this renewed emphasis on quantitative easing. The essential aim of such policies is to shorten the debt held by the public or issued by the consolidated public sector comprising both the government and central bank. Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates – exactly the opposite of what central banks are doing. In the US Treasury, for example, discussions of debt management policy have had exactly this emphasis. But the Treasury alone does not control the maturity of debt when the central bank is active in all debt markets.

So, what is to be done? Rather than focusing on lowering already epically low rates, governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more not less. They can also invest in improving their future fiscal position, even assuming that no positive demand stimulus effects are likely to materialise. At a time of negative real rates, accelerating any necessary maintenance project and issuing debt leave the state richer not poorer; this assumes that maintenance costs rise at or above the general inflation rate.
As my fellow Harvard economist Martin Feldstein has pointed out, this principle applies to accelerating replacement cycles for military supplies. Similarly, government decisions to issue debt and then buy space that is currently being leased will improve the government’s financial position. That is, as long as the interest rate on debt is less than the ratio of rents to building values, a condition almost certain to be met in a world of government borrowing rates of less than 2 per cent.

These examples are the place to begin because they involve what is in effect an arbitrage, whereby the government uses its credit to deliver essentially the same bundle of services at a lower cost. It would be amazing if there were not many public investment projects with certain equivalent real returns well above zero. Consider a $1 project that yielded even a permanent 4 cents a year in real terms increment to GDP by expanding the economy’s capacity or its ability to innovate. Depending on where it was undertaken, this project would yield at least 1 cent a year in government revenue. At any real interest rate below 1 per cent, the project pays for itself even before taking into account any Keynesian effects.

This logic suggests that countries regarded as havens that can borrow long-term at a very low cost should be rushing to take advantage of the opportunity. This is a view that should be shared by those most alarmed about looming debt crises because the greater your concern about the ability to borrow in the future, the stronger the case for borrowing for the long term today.

There is, of course, still the question of whether more borrowing will increase anxiety about a government’s creditworthiness. It should not, as long as the proceeds of borrowing are used either to reduce future spending or raise future incomes.

Any rational business leader would use a moment like this to term out its debt. Governments in the industrialised world should too.

The writer is the Charles W. Eliot university professor at Harvard University and a former US Treasury secretary.

March 25, 2012

Economic forecasters divide into two groups. There are those who cannot know the future but think they can – and then there are those who recognise their inability to know the future. Major shifts in the economy are rarely forecast and often not fully recognised until they have been under way for some time. So judgments about the US economy have to be tentative. What can be said is that for the first time in five years a resumption of growth significantly above the economy’s potential now appears a substantial possibility. Put differently, after years when growth was more likely to surprise below expectations than above them, the risks are now very much two-sided.

As winter turned to spring in 2010 and 2011, many observers thought they detected evidence that the economy had decisively turned, only to be disappointed a few months later. Several considerations suggest that this time may be different. Employment growth has been running well ahead of population growth for some time now. The stock market level is higher and its expected volatility lower than at any time since 2007, suggesting that the uncertainty weighing on business has declined. Consumers who deferred purchases of cars and other durable goods have created pent-up demand that now seems to be emerging. At last the housing market seems to be stabilising. For years now, the rate of new families setting up households has been well below normal as more and more young people have moved in with their parents. At some point they will set out on their own, creating a virtuous circle of a stronger housing market, more “family formation” that boosts demand, further improvement in housing conditions and so on. And, assuming there is no punitive regulation, innovation in mobile information technology, social networking and newly discovered oil and natural gas seems likely to drive investment and job creation.

True, the risks of high oil prices, further problems in Europe and financial fallout from anxiety about future deficits remain salient. However, unlike the situation in 2010 and 2011, these risks are probably already priced into markets and factored into outlooks for consumer and business spending. There has already been a significant rise in oil prices. Europe’s situation is hardly resolved but is very unlikely to deteriorate as much in the next months as it did last year. And market participants report great alarm about the deficit situation. So even modestly good news in any of these areas could drive upward revisions in current forecasts.

What are the implications for macroeconomic policy? Such recovery as we are enjoying is less a reflection of the American economy’s natural resilience than of the extraordinary steps that both fiscal and monetary policy makers have taken to offset private sector deleveraging – a process that is far from complete. A convalescing patient who does not finish their course of treatment takes a grave risk. So too the most serious risk to recovery over the next few years is no longer financial strain or external shocks, but that policy will shift too quickly away from its emphasis on maintaining adequate demand, towards a concern with traditional fiscal and monetary prudence.

On even a pessimistic reading of the economy’s potential, unemployment remains 2 percentage points below normal levels, employment remains 5m jobs below potential levels and gross domestic product remains close to $1tn short of its potential. Even if the economy creates 300,000 jobs a month and grows at 4 per cent, it would take several years to restore normal conditions. So a lurch back this year towards the kind of policies that are appropriate in normal times would be quite premature.

Indeed, recent research suggests that, by slowing investment and increasing long-term employment, such policies could seriously damage the economy’s long-term performance. Brad Delong and I argued in a recent paper that premature and excessive fiscal contraction could even, by shrinking the economy, exacerbate budget problems in the long run.

How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the time it may take to return to normality in a world where policy credibility is essential? The right approach is to use contingent commitments – policies that commit to action to normalise conditions, but only when certain thresholds are crossed. So, for example, it might be appropriate for the Federal Reserve to commit to maintain the current Fed Funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a commitment that a financing mechanism such as a gasoline tax would be triggered when some level of employment or output growth has been achieved for a given interval. Tax reform legislation might propose that new rates be phased in at a pace that would depend on economic performance.

Contingent commitments have the virtue of giving households and businesses clarity as to how policy will play out. In areas where legislation is necessary, they can help to eliminate political uncertainty. They also allow policy makers to make a simultaneous commitment to near-term expansion and medium-term prudence – exactly what we require right now. In a volatile and uncertain world, there is always an element of contingency in policy. Recognising it explicitly is the way to provide confidence and protect credibility in a world whose future no one can gauge with precision.

The writer is former US Treasury secretary and Charles W. Eliot university professor at Harvard.