Why Larry Summers sees danger ahead for the economy

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Like British Prime Minister David Cameron, Larry Summers sees warning lights flashing on the world’s economic dashboard. Summers, who served through 2010 as President Obama’s top economic adviser and was Treasury Secretary under Bill Clinton, said America should be acting now to shore up its economy, instead of celebrating its status as the healthiest patient in the global economic sick ward.

For starters, Summers said in an interview Tuesday: We should invest in public infrastructure, including energy infrastructure. Including oil pipelines.

Does that include the Keystone XL oil sands pipeline, a project that the Senate is voting on Tuesday — and one that has drawn little enthusiasm from the White House?

Yes, he said. “I suspect we should do the Keystone pipeline if it is still the relevant pipeline — which is very much in doubt. We certainly should not stand in the way of the Keystone pipeline,” Summers said. “We should be trying to use this moment to maximize use of our energy resources.”

Summers has voiced support for Keystone before, including in a September speech at the Brookings Institution. But building oil pipelines isn’t the only thing Summers thinks we should be doing. We should be lifting decades-old restrictions on energy exports, he said, and building up our ports to handle the traffic. We should be updating an air traffic control system that, he said, “runs on vacuum tubes.”

“There is an enormous amount of work that needs doing,” Summers said, to “put people to work in the short run and raise the efficiency of the economy in the medium and the long run.”

“What we need is a focused a growth strategy that recognizes the importance of generating healthy demand rather than a strategy that either accepts the lack of demand or tries to generate demand by driving down interest rates beyond extraordinary lows,” Summers said.

When told that he sounds frustrated with both Democratic policymakers and Republican ones, Summers said: “That was the way I intended to sound.”

For at least a year — long before Cameron warned of another looming economic disaster in Monday’s Guardian newspaper — Summers has been ringing alarm bells about the need for national governments, including the U.S. government, to prop up demand and stimulate economic activity.

With Europe stagnant, China cooling and Japan, Russia and Brazil dogged by recession, Summers — who removed himself from the running for Federal Reserve chairman last year — argues that we should forget about the national debt and start taking advantage of abnormally low interest rates to borrow and spend on worthwhile investments that will boost growth now and in the future.

That idea is unlikely to gain much traction on Capitol Hill, where resurgent Republicans are still focused on cutting spending. But Summers says we should be doing other things, too, such as promoting immigration and overhauling the business tax code, ideas with bipartisan support.

Why? Because, he warns,  if Europe falls into the same kind of prolonged slump that has plagued Japan for the past 20 years — a real possibility, economists say — America’s ability “to maintain enough demand to support the global economy will be very much in doubt.”

Japan, which slipped back into its fourth recession in six years on Monday, hasn’t had “a moment of dramatic crisis,” Summers said. Instead, it’s had a generation of “prolonged sluggish and disappointing performance. And that’s the risk that may be ahead for large blocs of the global economy.”

Why China won’t keep growing fast forever

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The Upshot, The New York Times
October 26, 2014

There has been plenty of discussion lately about signs that China’s economy is slowing down, focused on details of a possible housing bubble and vast sums of bad loans that the country will have to reckon with. But put aside the challenges China faces this quarter, or next year, and there is one view that is overwhelming: China is a long-term economic juggernaut that will stand astride the global economy in another generation’s time.

I know this because, for years now, major magazines and editorials and books have told me about the Chinese Century, in which we are apparently now living. Leading foreign policy journals have devoted copious ink to exploring what China’s rise will mean for global economics and politics, often taking as a given that China will be the dominant power of the coming century. (“Can the Liberal System Survive?” Foreign Affairs asked in 2008.)

Official forecasts — from international agencies like the Organization for Economic Cooperation and Development and the World Bank, and from United States intelligence circles — envision China continuing to grow rapidly over the next couple of decades, its economy eventually becoming much larger than that of the United States. Robert W. Fogel, a Nobel laureate in economics, forecast in 2010 that in 2040, Chinese economic output would be $123 trillion, about seven times the current size of the American economy (and three times his forecast for the United States in 2040).

But what if it’s all hogwash?

Many of the most bullish forecasts of China’s economic future are based, more or less, on extrapolation. For more than three decades, its economic output per person has been rising at an extraordinary annual rate of 6 to 10 percent, climbing rapidly toward levels in the richest nations. If that continues for a couple of decades, the bullish forecasts will prove accurate.

But if you look at the long arc of economic history, such performance would be a remarkable aberration. That’s the argument that the Harvard economists Lant Pritchett and Lawrence H. Summers make in a new working paper. In short, past performance does not predict future results. What tends to happen, rather, is “reversion to the mean”: Countries having long periods of abnormal growth tend to revert to something around 2 percent growth, closer to the long-term global average.

“China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind,” with sustained super-rapid growth for more than 32 years, they write. “Why will growth slow? Mainly, because that is what rapid growth does.”

There are plenty of other China pessimists out there, who note everything from aging demographics to years of politically driven investment that may offer poor returns, to an economy trying to make the perilous transition away from investment spending and toward consumers. Just last week, a Conference Board report argued that China’s economy would slow as a credit and investment bubble deflated.

But part of what makes the argument from Mr. Pritchett and Mr. Summers interesting is that they don’t trouble themselves with those gory details of why growth may slow; they say just that the historical evidence suggests it is likely. Maybe concerns about debt levels and bad investments in China will prove justified. Or maybe not. Regardless, we should think that a change is more likely than not.

“China is a huge economy and a profoundly different economy than it was a generation ago,” Mr. Summers, the former Treasury secretary, said in an interview. “But it would be ahistoric to extrapolate and assume with any high degree of confidence that China will enjoy such extraordinary growth rates over the long term. Economists, strategic analysts, business planners and nervous neighbors should all recognize that a very wide spectrum of economic outcomes is possible over the next generation and that the most likely outcomes involve a very substantial slowing of growth.”

The paper’s authors put it in baseball terms. “If a hitter has a hot streak with a batting average up 50 points over the past 20 at-bats, then we would forecast a return to the average batting average over the next 20 at-bats,” they write. “If pressed to say why the batting average would be lower, one could speculate about why it currently is so high and predict those factors will diminish or predict future events will causally explain the lowering, but mainly, this is just what happens.”

The strongest arguments that they may be wrong, by contrast, focus on details of why China (as well as India, which they also analyze) has the potential to keep growing rapidly for many years to come.

I asked Jim O’Neill, the former Goldman Sachs strategist who coined the term “BRIC” for the large emerging economies of Brazil, Russia, India and China, to critique the Pritchett-Summers paper.

“In the case of China and India, the core driver of why a more positive path is likely to continue is the simple process of urbanization,” Mr. O’Neill wrote in an email. “If and when each get close to 70 percent urbanized, I’d have more sympathy with their findings, but this is a long way off.” (Just more than half of Chinese and a third of Indians live in cities. When people move from rural areas to cities, their economic output tends to rise sharply).

In other words, a China bull can look at the details of the country’s situation — the great potential of its people to keep increasing their productivity, a political system that has proved resilient through the challenges of the last few decades — and see plenty of reasons for optimism. The reversion-to-the-mean view says simply, “We don’t know what will go wrong, but history suggests that something will.”

If the pessimistic view is right, there are enormous implications for the global economy’s future. If China’s per capita G.D.P. kept growing from now until 2033 at the same rate as it has in recent decades, the country’s annual economic output would rise by $51.1 trillion over current levels in present-day dollars. By contrast, if growth reverts to the mean, the size of the Chinese economy will have increased only $11.2 trillion by 2033, or a difference of about $40 trillion. To put that in context, the current gross domestic product of the United States is about $17 trillion.

For decades, economists have been building models to try to understand the mysteries of what drives growth. Is economic destiny shaped by culture? By government institutions? By patterns of industrialization?

But those debates have been inconclusive. Consider some of the economic success stories of the last generation — China, India, Mexico, Poland, South Korea and Turkey, to name a few. All have different cultures, government institutions and economic development strategies.

Years of work on growth theory suggest that there is no secret recipe for a developing nation to achieve prosperity. As it turns out, a simplistic reversion-to-the-mean approach explains economic growth about as well as some more complex approaches to predicting which countries’ economies are poised to boom or shrink.

This work also offers a reminder: If you just extrapolate from the recent past to predict the economic future, you are likely to be wrong. Analysts predicted that the Soviet economy would soon surpass the American economy in the 1960s, that Japan’s would do the same in the 1980s and that the United States had achieved a new era of perpetual speedy growth in the late 1990s. None of these have come to pass.

In other words, when it comes to predicting nations’ fates over the long haul, we know a lot less than we like to admit.

The Economist: Even dragons tire

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The announcement this week that China’s economy had grown by 7.3% in the third quarter year-on-year was widely seen as marking the country’s “new normal” of slower growth, according to an October 25, 2014 Economist article. It was well below the roughly 10% pace China had averaged from 1980 until two years ago. Yet according to a new working paper by Lant Pritchett and Larry Summers of Harvard University, it is still abnormal: Chinese growth is likely to be lower still in future. Read more

Debt Management and Zero Lower Bound

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On September 30, 2014, Summers presented a co-authored paper titled, “Government Debt Management at the Zero Lower Bound,” at the Brookings Institute in Washington, DC.  Read more

Future of US Energy & Climate Security

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“I believe that the question of whether the United States should have a substantially more permissive policy with respect to the export of crude oil and with respect to the export of natural gas is easy,”  Summers told a Brookings Institute audience on September 9, 2014. “The answer is affirmative.” Read more

Secular Stagnation Q&A in The New Republic

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In a July 2014 interview with the New Republic, Summers discusses secular stagnation and says, the economy hasn’t grown rapidly “in a financially sustainable way” for a long time. Read more

The Economic Challenge of the Future: Jobs

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On the 125th Anniversary of the Wall Street Journal, Summers wrote an essay on July 7, 2014 on the economic challenge of the future: Jobs.  Summers said the economic challenge of the future will not be producing enough. It will be providing enough good jobs. The piece concludes, “the challenge for economic policy will increasingly be generating enough work for all who need work for income, purchasing power and dignity.”  Read more

Idle Workers + Low Interest Rates = Time to Rebuild Infrastructure

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If now is not the moment to rebuild, when is?

By Lawrence H. Summers 

The Boston Globe

April 11, 2014 — Are you proud of New York’s John F. Kennedy Airport? It’s a question I ask nearly every audience I speak to these days. JFK, after all, is the largest entry point for foreign visitors arriving in what sees itself as the greatest city on earth.

To a person, I’ve never heard anyone answer, “Yes.” Vice President Joe Biden took it one step further in a speech earlier this year, likening the airport down the road, New York’s LaGuardia, to being in “some third-world country.”

Yet the unemployment rate for construction workers in the United States is in the double digits. And the government can borrow — in the currency we print — at long-term rates of less than 3 percent. If now is not the moment to rebuild these airports, when will that moment ever come?

The American economy is not performing to the satisfaction of the American people. Total incomes are about $1.5 trillion less today — or $5,000 per person — than was anticipated in 2007 before the financial crisis began. The share of American adults working has increased only slightly since the recesssion’s trough, and more than 5 million fewer people are working than when employment was at peak levels in the mid-2000s. Median family incomes and hourly wages have remained essentially stagnant for more than a generation.

The single most important step the US government can take to reverse these discouraging trends is to mount a concerted, large-scale program directed at renewing our national infrastructure. At a time of unprecedented low interest rates and long-term unemployment, such a program is good economics but, more fundamentally, it is common sense.

Few Americans are impervious to the crumbling infrastructure in their everyday lives.

The country that brought the world the Internet and continues to lead the globe in information technology has an air traffic control system that relies on vacuum tubes and where sticky pieces of paper are moved around on bulletin boards to track flights. Even leaving aside the safety risks, the costs in extra fuel consumption and unneeded delays are measured well into the tens of billions of dollars. Can it possibly make sense to wait until every repair person capable of working with vacuum tubes has died off to complete the renovation of this antiquated system?

I travel constantly. Calls to my office on my iPhone are less likely to drop driving from Beijing to its airport or from Almaty in Kazakhstan to its airport than driving from the airport into Boston, New York, or Washington. I know I’m not alone in experiencing such problems. Surely, at a time when US companies are holding close to $2 trillion in cash, earning next to nothing for balance sheets, we should be investing in improving this frustrating deficiency.

As secretary of the Treasury during the Clinton administration, I used to visit a public school every time I went to a city outside Washington. I’ll never forget an occasion at an Oakland high school when I gave a speech extolling the importance of education. A young teacher came up to me and said, “Secretary Summers, that was a fine speech, and I agree with all of it. Just one thing — why should any of the students believe you when there is paint chipping off the walls of their classroom and when the first lunch period has to begin at 9:45 a.m. because this school is so overcrowded? There is no chipping paint at any bank. Maybe we think that is the most important thing.” She had a point I’ve never forgotten.

After 40 years of dangerous energy dependence, it is possible that within this decade the United States will become a major oil and natural gas exporter. Already, we produce more oil than Saudi Arabia. And there’s no denying that having America as the ultimate balancer in the world’s oil market will make it safer and more stable than the one we live in now. But that will not happen if we, as a nation, keep underinvesting in infrastructure to the point where trains and trucks — rather than pipelines — must play the primary role in moving energy resources around our country.

The terrible winter we’ve just suffered has no doubt left behind a legacy of potholes. The American Society of Civil Engineers estimates that driving on roads in need of repair costs the average Massachusetts motorist $313 annually. This is the equivalent of more than 50 cents a gallon. And yet gasoline taxes have not been raised in two decades, and as a country, we do not invest enough to maintain a transportation infrastructure, let alone to improve it.

There are many more examples. But beyond the power of examples, there is the reality that a substantial step-up in infrastructure investment would serve all of our major economic objectives. It is as close to a free lunch as economics will ever produce.

There is increasing concern that we may be in an era of secular stagnation in which there is insufficient investment demand to absorb all the financial savings done by households and corporations, even with interest rates so low as to risk financial bubbles. Raising demand through greater infrastructure investment is an antidote for such malaise as well as a source of better employment and economic growth.

Why? Investing in infrastructure offers the prospect of expanded economic capacity. With interest rates already near zero, incremental private outlays brought on by easier financial conditions are unlikely to have a very high return. On the other hand, the available evidence from the historical experience of the United States, in addition to cross-country comparisons and comparisons across US states, is that the social return to public infrastructure investment is very high.

We live in an ever more interdependent and competitive world. Savings can flow into any country. The fruits of research and development flow globally. Many iconic American companies now earn less than half their profits in the United States.

But one thing that is inherently immobile is our infrastructure. When we put money into strengthening our infrastructure, essentially all of what we spend stays in the United States. Once in place, all the benefits of the infrastructure go to Americans.

As an economic strategy, infrastructure investment also promotes fairness. The group in our society that has suffered most heavily from all of the structural change of the last generation is men with limited education. These men disproportionately work in construction, the core of infrastructure, and thus become the main beneficiaries of increased funding. Moreover, it is the majority of Americans, not the super-fortunate minority, who primarily benefit from improving public schools or airports or reducing potholes.

Finally, infrastructure investment is important for generational fairness. We live in a period when a — if not the — focus of economic policy has been on reducing government deficits and debts. These are important concerns, but they have been viewed too narrowly.

Infrastructure investments, even if not immediately paid for with new revenue sources, can easily contribute to reductions in long-term debt-to-income ratios because they spur economic growth, raise long-run capacity, and reduce the obligations of future generations. It is an accounting convention, not an economic reality, that borrowing money shows up as a debt, but deferring maintenance that will inevitably have to be done at some point does not. When maintenance or necessary investment is deferred, the bills climb much more quickly than the cost of federal borrowing at an average interest rate below 2 percent.

Where do we go from here? This should not be a partisan issue.

Democrats are correct that we need to commit more government money to measures like repairing highways and modernizing schools where there is no immediate cost recovery available. They are also right in their emphasis that a great nation cannot endure with its government operating on a shoestring. Even if we assume that entitlements are reformed, the rising share of the elderly in the population, health care costs that grow faster than the rest of the economy, and American international obligations mean that revenue increases are required if the United States is to invest adequately in its future.

Republicans are right that regulatory barriers hold back infrastructure investment. We need protections, but we need them to be administered more predictably and more rapidly. In 1903, it took Harvard less than 18 months to build Soldiers Field. Less than 18 months from when the stadium was conceived to when the first game was played — even without the benefit of modern construction equipment. It would take a decade today. In San Francisco, repairs to the Bay Bridge recently took nearly four times as long as building the original bridge in the 1930s.

And then there are the points that everyone should be able to agree on. Government needs to operate more efficiently. The Anderson Bridge connecting Cambridge and Boston has been under repair for nearly two years. I suspect that, with the right incentives, what was necessary could have been done in a matter of weeks rather than years. No doubt an important part of operating more efficiently will involve greater reliance on the private sector, but this must be done in a way that carefully protects taxpayer interests.

For all our problems, I would far prefer play the economic hand of the United States than that of any other major country. And while much more could be said with respect to tactics, I am confident that we as a nation will get them right if we can get behind the right basic principle: From the intercontinental railway to the interstate highway system to the Internet, American economic progress has depended on fundamental infrastructure investments. Our generation has not been doing its part. It is time for us to step up.

Lawrence H. Summers is a university professor and president emeritus at Harvard. He served as the secretary of the Treasury for President Clinton and the director of the National Economic Council for President Obama.

This article originally appeared in the Boston Globe.


‘Potemkin money’ is wrong way to help Ukraine

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March 9, 2014

The west should make modest promises and then strive to deliver more than the country expects

Events in Ukraine have underscored the importance of effective external support for successful economic and political reform. The international community is finally responding with concrete indications of support.

At one level the situation in Ukraine is unique – a product of the country’s sensitive location between Russia and Europe. At another, however, it is merely the latest example of a phenomenon that recurs all too often. A government that is illegitimate or at least highly problematic is brought down. The world community seeks to support economic reform. A new government, purportedly more democratic and legitimate, is installed in its place. Think, for example, of the transition that occurred after the Berlin Wall fell; or after the Arab uprisings; or in more isolated cases such as East Timor or Rwanda.

As a general rule, outsiders acted with the best of intentions in offering their support. But the results have often fallen short of their aspirations. I have seen close to a dozen cases over the past quarter-century where the precedent of the Marshall Plan was invoked. None was as successful as the original. This reflects the truth that functioning institutions cannot be imposed from the outside. Countries and their peoples shape their own destinies. Still, there are important lessons for the design of support programs.

First, immediate impact is essential. New governments will not last unless they deliver results that are felt on the ground. Outside support can be made conditional on progress towards reform but the conditions need to reflect political reality. Assistance must be delivered promptly so that its impact quickly becomes visible.

For example, social safety nets need to be strengthened before subsidies on items such as food and fuel are removed – not afterwards, as has too often been the case in the past. The international community needs to understand that, even when the conditions they impose are economically rational, they may be more than the political process can bear. It is no use for international agencies to blame the country they are trying to assist when this results in the adoption of bad policies. Such moments are surely a time for political concerns to trump technocrats’ fears.

Second, avoid “Potemkin money” – the tendency to announce huge assistance packages that grab the headlines but belie the inevitable truth that much of the cash will take time to arrive. The result is disappointment followed by disillusionment as recipients realise that not all assistance can materialise quickly or meet urgent local needs. It bears emphasis that the original Marshall Plan was announced without any figures or fact sheets. In Ukraine the west should make modest promises – and then strive to deliver more than the country has been led to expect.

Third, be realistic about debts. Ukraine’s debt-to-income ratio is low compared with those of the crisis countries of the European periphery. Honouring these obligations may be worthwhile, given the benefits of financial stability.

However, Ukraine’s private creditors have for some years received risk premiums of 500 basis points or more. Careful consideration should be given to rescheduling or restructuring the country’s debts.

Debt relief can provide a strong signal of political support – as it did in Poland in 1989. Countries in crisis should be wary of taking on debt to finance projects that will not generate the cash flows necessary to repay it. In such cases, donors should offer support in the form of grants rather than loans.

Fourth, honest management is as important as prudent policy. Policy makers have traditionally focused on the latter. But that is a mistake. Theft of public resources is a major source of poor economic performance.

The international community should do everything it can to recover ill-gotten gains from former Ukrainian officials and to put in place procedures that will prevent future skulduggery. The benefits would be political, as well as economic.

Fifth, countries need to pursue broad policies in a way that benefits Ukraine. For example, Congress needs to demonstrate that the US is as committed as the rest of the world to providing full funding for the International Monetary Fund. America should also move to allow crude oil and natural gas exports to flow more freely. Over time, this would contribute to Ukraine’s autonomy and economic strength. All of this goes for Europe, too – which is far closer to Ukraine and has an even greater stake in the country’s future prosperity. The possibility of a closer partnership with the EU is a North Star that can guide Ukrainian reformists.

Respect for these principles does not ensure success. But ignoring them almost guarantees failure. Given what is at stake with Russia in Crimea, that gloomy outcome must be strenuously avoided.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary. Follow on Twitter @LHSummers

America Risks Becoming a Downton Abbey Economy

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February 16, 2014

Inequality will have to be addressed, with free markets playing a pivotal role

Inequality has emerged as a major issue in the US and beyond. A generation ago it could reasonably have been asserted that the overall growth rate of the economy was the main influence on the growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.

The share of income going to the top 1 per cent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy. It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.

President Barack Obama is right to be concerned. Those who condemn him for “tearing down the wealthy” and engaging in un-American populism are, to put it politely, lacking in historical perspective. Presidents from Franklin Roosevelt to Harry Truman railed against the excesses of a privileged few in finance and business. Some have gone beyond rhetoric. Confronted with rising steel prices, John Kennedy sent the FBI storming into corporate offices and is widely thought to have ordered the authorities to audit executives’ personal tax returns. Richard Nixon used the same weapon in 1973, announcing tax investigations “of the books of companies which raised their prices more than 1.5 per cent above the January ceiling.” All were reacting in their own way to a phenomenon that Bill Clinton has described best: “Although America’s rich got richer . . . the country did not . . . the stock market tripled but wages went down.”

Given the widespread frustration with stagnant incomes, and an increasing body of evidence suggesting that the worst-off have few opportunities to improve their lot, demands for action are hardly unreasonable. The challenge is knowing what to do.

If income could be redistributed without damping economic growth, there would be a compelling case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom. Unfortunately this is not the case. It is easy to think of policies that would have reduced the earning power of Bill Gates or Mark Zuckerberg by making it more difficult to start and profit from a business. But it is much harder to see how such policies would raise the incomes of the rest of the population. Such policies would surely hurt them as consumers by depriving them of the fruits of technological progress.

It is certainly true that there has been a dramatic increase in the number of highly paid people in finance over the last generation. Recent studies reveal that most of the increase has resulted from an increase in the value of assets under management. (The percentage of assets that financiers take in fees has remained roughly constant.) Perhaps some policy could be found that would reduce these fees but the beneficiaries would be the owners of financial assets – a group that consists mainly of very wealthy people.

It is not enough to identify policies that reduce inequality. To be effective they must also raise the incomes of the middle class and the poor. Tax reform has a major role to play. The current tax code is so badly designed that it is very likely to be having the effect of reducing economic growth. It also allows the rich to shield a far greater proportion of their income from taxation than the poor. For example, last year’s increase in the stock market represented an increase in wealth of about $6tn, of which the lion’s share went to the very wealthy.

It is unlikely that the government will collect as much as 10 per cent of this figure. That is because of a host of policies that favour the rich, such as the capital gains exemption, the ability to defer tax on unrealized capital gains, and the fact that gains on assets passed on at death are not taxed at all. Similarly, the corporate tax system allows value to flow through it like a sieve. The ratio of corporate tax collections to the market value of US corporations is near a record low. The estate tax can be more or less avoided with sophisticated planning.

Closing loopholes that only the wealthy can enjoy would enable taxes to be cut elsewhere. Measures such as the earned income tax credit can raise the incomes of the poor and middle class by more than they cost the Treasury, because they give people incentives to work and save.

It is ironic that those who profess the most enthusiasm for market forces are least enthusiastic about curbing tax benefits for the wealthy. Sooner or later inequality will have to be addressed. Much better that it be done by letting free markets operate and then working to improve the result. Policies that aim instead to thwart market forces rarely work, and usually fall victim to the law of unintended consequences.

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