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Rescuing the free-trade deals

June 17, 2015/in Washington Post

June 14, 2015
The Senate’s rejection of President Woodrow Wilson’s commitment of the United States to the League of Nations was the greatest setback to U.S. global leadership of the last century. While not remotely as consequential, the votes in the House last week that, unless revisited, would doom the Trans-Pacific Partnership send the same kind of negative signal regarding the willingness of the United States to take responsibility for the global system at a critical time.

The repudiation of the TPP would neuter the U.S. presidency for the next 19 months. It would reinforce global concerns that the vicissitudes of domestic politics are increasingly rendering the United States a less reliable ally. Coming on top of the American failure to either stop or join the Asian Infrastructure Investment Bank, it would signal a lack of U.S. commitment to Asia at a time when China is flexing its muscles. It would leave the grand strategy of rebalancing U.S. foreign policy toward Asia with no meaningful nonmilitary component. And it would strengthen the hands of companies overseas at the expense of U.S. firms. Ultimately, having a world in which U.S. companies systematically lose ground to foreign rivals would not work out to the advantage of American workers.

Both the House and Senate have now delivered majorities for the trade promotion authority necessary to complete the TPP. The problem is with the complementary trade assistance measures that most Republicans do not support and that Democrats are opposing in order to bring down the TPP. It is to be fervently hoped that a way through will be found to avoid a catastrophe for U.S. economic leadership. Perhaps success can be achieved if the TPP’s advocates can acknowledge that rather than being a model for future trade agreements, this debate should lead to careful reflection on the role of trade agreements in America’s international economic strategy.

Four points seem salient.
First, the era of agreements that achieve freer trade in the classic sense is essentially over. The world’s remaining tariff and quota barriers are small and, where present, less reflections of the triumph of protectionist interests and more a result of deep cultural values such as the Japanese attachment to rice farming. What we call trade agreements are in fact agreements on the protection of investments and the achievement of regulatory harmonization and establishment of standards in areas such as intellectual property. There may well be substantial gains to be had from such agreements, but this needs to be considered on the merits area by area. A reflexive presumption in favor of free trade should not be used to justify further agreements. Concerns that trade agreements may be a means to circumvent traditional procedures for taking up issues ranging from immigration to financial regulation must be taken seriously.

Second, there needs to be a balancing of the political costs of legislating trade agreements against those of other forms of internationalism. If a small fraction of the U.S. political capital that has been devoted to the Trans-Pacific Partnership had instead gone to support reform of the International Monetary Fund and adequate funding for international financial institutions and the United Nations, these objectives could have been attained — and with greater benefits than the TPP will deliver. Trade agreements are often defended on the grounds that commerce builds harmonious ties among nations. I suspect that a rebalancing of U.S. efforts toward supporting multilateral institutions that provide financial support for other countries, and away from intense negotiations that demand that those countries change their domestic policies, would help enhance U.S. prestige and influence in the world.

Third, there needs to be careful consideration going forward of the ramifications of trade agreements that include some countries while excluding others. Where the grouping is natural, such as with the North American Free Trade Agreement, or where it reflects a clear political strategy, as with the U.S.-Colombia or U.S.-Jordan agreements, the argument for this approach is much stronger than where there are no obvious criteria for which countries are included. Political necessity has in recent weeks led advocates to increasingly aggressive formulations about how the TPP enables us to gain advantage at the expense of China. We may come to regret this provocation. Certainly, it will be important down the road to consider China’s possible membership in the TPP on terms no different from those applied to others.

Fourth, the global economic challenge we face today is profoundly different than it was a generation ago. Then, just after the Cold War and the Latin American debt crisis, with Asia’s China-led renaissance in its early stages, the challenge was to enable new markets to emerge with the potential for profound benefits to their citizens and the global economy. Trade agreements that encouraged the adoption of market institutions in developing economies and enhanced those countries’ access to the industrial economies were crucial to creating a truly global economy.

Today, we have such an economy, and it has supported the greatest economic progress in the history of the world in emerging markets and is working spectacularly well for capital and a cosmopolitan elite that moves easily around the world. But being pressed down everywhere are middle classes who lack the wherewithal to take advantage of new global markets and do not want to compete with low-cost foreign labor. Our challenge now is less to increase globalization than to make the globalization we have work for our citizens.
None of this is to suggest an end to trade diplomacy. Rather, it is to suggest that such talks must be only one component of a broader approach that has as primary stakeholders not just global companies but also those concerned with economic equity, protection of the environment, opportunities for workers to migrate and financial stability. If the TPP is to be secured, there must be clear signals that international economic diplomacy will turn to these concerns.

Reform-minded Ukraine merits debt reduction

May 18, 2015/in Washington Post

May 17, 2015

Ukraine, the international community and its creditors will soon have to reach a conclusion about how to handle the country’s debt. The case for debt reduction is as strong as any that I have encountered over the past quarter century. How the issue is resolved will say much about the extent of international commitment to Ukraine and to resisting Russian aggression. Failure to achieve debt reduction would also confirm the view of those who believe that private financial interests disproportionately influence public policy.

Ukraine is in a state of quasi-war with Russia. Other former Soviet republics, as well as the nations of central Europe are watching anxiously. How this episode is regarded in history will depend as much on what is done for Ukraine as what is done to Russia.

This is especially true as Ukraine has its most reform-minded economic team since independence in 1991. It has shown real political courage in combating corruption and moving aggressively to curb energy subsidies that generated vast waste. Ukraine has done more in the past 12 months to reform its subsidies than most nations do in 12 years.

The moral, geopolitical, and economic case for the provision of strong support is compelling. The International Monetary Fund has done as much as can reasonably be asked with a programme totalling $17.5bn. While bilateral support from the US and Europe could be increased and the World Bank is missing a major opportunity, Ukraine’s viability ultimately depends on what happens to its debts.

The question of debt rescheduling or reduction is not a new one. When countries require assistance, it can always be argued that debt service obligations be delayed or partially cancelled. Usually — as in the case of European countries in recent years, or Asian countries during the 1997 financial crisis — this argument is rejected. The grounds are that with proper adjustment countries can meet their obligations, maintain access to markets and restore growth. Also, a world in which countries were willy nilly encouraged to default in order to meet budget obligations would be inimical to the effective flow of capital.

Over the years a number of international norms have evolved as to when it is appropriate to accept debt reduction. The most important is when a country’s debts are sufficiently large and its prospects sufficiently poor that there is no realistic prospect of repayment. Things become clearer when debt reduction would not be a source of systemic risk to the financial system or license widespread defaults.

All of this suggests a compelling case for debt reduction for Ukraine. The IMF has made clear that for its finances to be sustainable Kiev needs to reduce its current debt service payments and to avoid an excessive build-up of debt over the next five years. On even optimistic assumptions of Ukrainian economic performance and the avoidance of further conflict, this is not possible without debt reduction. Ukraine’s debt is not nearly large enough for a reduction to pose a threat to the world financial system. And why not set a precedent that if you lend money at a high spread to a country that is then invaded, you should not expect the world’s taxpayers to ensure that you are paid back in full?

So Ukraine’s debt should be reduced. Will it happen? Despite the merits, it is not clear. Ukraine’s creditors — led by the investment firm Franklin Templeton, but also with the support of a number of major US fund managers, who are sufficiently embarrassed by their selfish and unconstructive position that they avoid public identification — are playing hardball and refusing any write-offs. Understandably, if there are a substantial group of such free riders, other debt holders including the Russians will not accept writedowns.

It should be unacceptable to taxpayers around the world that their money be put at risk on loans to Ukraine in order that plans be made to pay back creditors in full. The IMF and national authorities should call out the recalcitrant creditors on their irresponsible behaviour. If necessary, Ukraine should be prepared to go into default and not meet its obligations, while at the same time the international community should make clear that it will continue to provide support to Kiev. In the context of these steps, creditors will have little choice but to accept the economic reality of the situation.

There is much in Ukraine that the rest of the world cannot control. But we can make sure that the country’s scarce resources are put to use restoring its economy rather than paying off those who made loans they now regret. And we can seize the opportunity to make clear that the world financial system will be operated to support the global economy not the other way round.

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

Time US leadership woke up to new economic era

April 5, 2015/in Washington Post, Global Economics

April 5, 2015

This past month may be remembered as the moment the United States lost its role as the underwriter of the global economic system. True, there have been any number of periods of frustration for the US before, and times when American behaviour was hardly multilateralist, such as the 1971 Nixon shock, ending the convertibility of the dollar into gold. But I can think of no event since Bretton Woods comparable to the combination of China’s effort to establish a major new institution and the failure of the US to persuade dozens of its traditional allies, starting with Britain, to stay out of it.

This failure of strategy and tactics was a long time coming, and it should lead to a comprehensive review of the US approach to global economics. With China’s economic size rivalling America’s and emerging markets accounting for at least half of world output, the global economic architecture needs substantial adjustment. Political pressures from all sides in the US have rendered it increasingly dysfunctional.

Largely because of resistance from the right, the US stands alone in the world in failing to approve the International Monetary Fund governance reforms that Washington itself pushed for in 2009. By supplementing IMF resources, this change would have bolstered confidence in the global economy. More important, it would come closer to giving countries such as China and India a share of IMF votes commensurate with their new economic heft.

Meanwhile, pressures from the left have led to pervasive restrictions on infrastructure projects financed through existing development banks, which consequently have receded as funders, even as many developing countries now see infrastructure finance as their principle external funding need.

With US commitments unhonoured and US-backed policies blocking the kinds of finance other countries want to provide or receive through the existing institutions, the way was clear for China to establish the Asian Infrastructure Investment Bank. There is room for argument about the tactical approach that should have been taken once the initiative was put forward. But the larger question now is one of strategy. Here are three precepts that US leaders should keep in mind.

First, American leadership must have a bipartisan foundation at home, be free from gross hypocrisy and be restrained in the pursuit of self-interest. As long as one of our major parties is opposed to essentially all trade agreements, and the other is resistant to funding international organisations, the US will not be in a position to shape the global economic system.

Other countries are legitimately frustrated when US officials ask them to adjust their policies — then insist that American state regulators, independent agencies and far-reaching judicial actions are beyond their control. This is especially true when many foreign businesses assert that US actions raise real rule of law problems.

The legitimacy of US leadership depends on our resisting the temptation to abuse it in pursuit of parochial interest, even when that interest appears compelling. We cannot expect to maintain the dollar’s primary role in the international system if we are too aggressive about limiting its use in pursuit of particular security objectives.

Second, in global as well as domestic politics, the middle class counts the most. It sometimes seems that the prevailing global agenda combines elite concerns about matters such as intellectual property, investment protection and regulatory harmonisation with moral concerns about global poverty and posterity, while offering little to those in the middle. Approaches that do not serve the working class in industrial countries (and rising urban populations in developing ones) are unlikely to work out well in the long run.

Third, we may be headed into a world where capital is abundant and deflationary pressures are substantial. Demand could be in short supply for some time. In no big industrialised country do markets expect real interest rates to be much above zero in 2020 or inflation targets to be achieved. In the future, the priority must be promoting investment, not imposing austerity. The present system places the onus of adjustment on “borrowing” countries. The world now requires a symmetric system, with pressure also placed on “surplus” countries.

These precepts are just a beginning, and many questions remain. There are questions about global public goods, about acting with the speed and clarity that the current era requires, about co-operation between governmental and non-governmental actors, and much more. What is crucial is that the events of the past month will be seen by future historians not as the end of an era, but as a salutary wake up call.

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

A deal worth getting right

March 9, 2015/in Washington Post, Global Economics

March 8, 2015

Over the next few months, the question of U.S. participation in the Trans-Pacific Partnership trade deal is likely to be resolved one way or the other. It is, to put it mildly, a highly controversial issue. Proponents believe a deal is essential to both our economic and geopolitical interests; opponents fear that it will primarily benefit corporations and the wealthy at the expense of middle-class living standards.

Definitive judgement is not possible because the parties are still negotiating and we have not yet seen a final agreement. Our negotiators should never forget that those who “need” agreements get less-good ones than those who do not. The U.S. economy is certainly capable of prospering without a deal. And lack of global profit opportunities for corporations headquartered in the United States is not one of our economy’s most pressing problems. Nonetheless, I believe that the right TPP deal is very much in the U.S. national interest.

First, in considering what is most fundamental — the interests of American workers — it is essential to distinguish between the effects of trade and the effects of trade agreements. The combination of changing patterns of trade, in which more activity takes place with low-wage economies, and new research has altered economic thinking on trade. The consensus view now is that trade and globalization have meaningfully increased inequality in the United States by allowing more earning opportunities for those at the top and exposing ordinary workers to more competition, especially in manufacturing.

But increases in the extent of U.S. trade are driven largely by technology and by the increased sophistication of developing economies, not by trade agreements. The United States, for example, has had no new trade agreements or arrangements with India for 20 years. Yet the dollar volume of trade between the two countries has increased ninefold.

Arrangements such as the TPP have the potential to tilt the gains from trade toward the American middle class. This is due to the fact that the United States has been a very open market for a long time. This means that properly negotiated trade agreements bring down foreign barriers and promote exports to a much greater extent than they reduce U.S. barriers and benefit imports. They also reduce pressure for outsourcing because when barriers fall the incentive to invest abroad in order to avoid paying tariffs is attenuated.

Crucially, the TPP is necessary to allow U.S. producers to compete on a level playing field, given the proliferation of arrangements that do not include the United States. Currently, for example, Japanese and Southeast Asian producers get better terms in each other’s markets than does the United States. Only through the TPP do we have the chance to manage international competition in ways that can benefit U.S. workers through binding arrangements in areas such as labor and environmental standards.

So the TPP should be judged not against the hypothetical past in which U.S. workers did not face foreign competition but in the context of a world in which trade integration in Asia is already happening — with or without the United States. Its merit will depend on U.S. negotiating priorities.

Some matters pushed by the business community have little or nothing to do with the interests of the vast majority of U.S. workers and should not be emphasized. These include pressuring other countries to change health and safety regulations, extend and strengthen patent protections and deregulate financial services. In these areas, on grounds of fairness, it is reasonable for us to strive for the principle of national treatment — no discrimination against foreign firms — but not to use inherently scarce negotiating power to alter other countries’ basic choices.

Conversely, it is appropriate in the TPP talks, and our international economic diplomacy more generally, for us to use the substantial leverage we possess in areas that do bear directly on middle-class living standards. These include the prevention of inappropriate producer subsidies — including through manipulated exchange rates or distorted state enterprise accounting — and, more generally, cooperation to ensure that a world in which the greater mobility of capital and companies does not become one in which governments lose the ability to protect their citizens. If global integration means local disintegration, it will be a failure.

Any international agreement must be judged not just against our aspirations, but also against our alternatives. No plausible TPP deal will achieve all that we want. But it should be possible to negotiate an agreement that is much better than the alternative of growing trade shaped only by agreements that exclude the United States. I hope and expect that when it is presented for approval, the TPP will meet this test.

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

Only raise US rates when whites of inflation’s eyes are visible

February 9, 2015/in Washington Post

February 8, 2015

Aborting recovery and risking a further slowing of price rises is potentially catastrophic

I cannot recall a moment when the gap between what markets expect the US Federal Reserve to do and what the Fed itself has forecast it will do has been as large. Markets predict that the Fed will raise rates only to 1.6 per cent by the end of 2017; the Federal Open Market Committee’s average forecast is 3.5 per cent.

Such a divergence raises the risk of volatility and poses a communications challenge for the Fed. More important, it raises the question of what should guide future policy.

Especially after Friday’s very strong employment report, there can be no doubt that cyclical conditions are normalising. The unemployment rate now is at its postwar average level, and continues to fall. Job openings are above their historic average. Other indicators such as the insured unemployment rate suggest a normal or rapidly normalising economy. All of this taken in isolation would suggest that interest rates should not remain at zero much longer.

On the other hand, the available inflation data suggests little cause for concern. The core consumer price index has averaged 1.1 per cent over the past six months; if housing costs were stripped out it would be zero. Wages actually fell in December and over the past year employment costs have risen 2.25 per cent which, in conjunction with productivity growth of only 1 per cent, suggests inflation of below 2 per cent. Perhaps most troubling: market indications suggest inflation is more likely to fall than rise .

The Fed has rightly made clear that its decisions will be data dependent. The further key point is that it should allow the flow of information on inflation rather than on real economic activity to determine its timing in adjusting interest rates. And it should not raise rates until there is clear evidence that inflation, and inflation expectations, are in danger of exceeding its 2 per cent target. Here are four important reasons why.

First, real wages for most workers have been stagnant. Median family incomes are down by 4.5 per cent over the past five years and the economy is about $1.5tn — or $20,000 for the average family of four — below pre-recession estimates of its 2015 potential.

In such circumstances efforts to reduce demand and growth require a compelling justification. Yet the idea that below normal unemployment will necessarily lead to accelerating inflation as suggested by the so called Phillips curve is very uncertain. Contrary to such predictions, inflation did not decelerate by much even a few years ago when unemployment was in the range of 10 per cent. Nor was there much evidence of accelerating inflation in the 1990s when the unemployment rate fell below 4 per cent.

Second, if inflation were to accelerate a bit this would be a good thing. It is now running and is expected to run below the Fed target. Prices are about 4 per cent below where they would have been if 2 per cent inflation had been maintained since 2007. So there is a case for some inflation above 2 per cent to catch up to the Fed’s price level target path. There may also be a case for inflation a little bit above 2 per cent for the next few years to allow real interest rates low enough to promote recovery when the next recession comes.

Third, a plane that accelerates too rapidly as it takes off may cause passengers discomfort while a plane that accelerates too slowly may crash at the end of the runway. Historical experience is that inflation accelerates only slowly so the costs of an overshoot on inflation are small and reversible with standard tightening policies. In contrast, aborting recovery and risking a further slowing of inflation is potentially catastrophic — as Japan’s experience demonstrates. So in a world where economic forecasts are highly uncertain, prudence in avoiding the largest risks counsels in favour of Fed restraint in raising rates.

Fourth, the US has never been more intertwined with the global economy. Higher interest rates and the stronger dollar they would bring would mean greater debt burdens for debtor countries, a growing US trade deficit that damages manufacturing, and growing protectionist pressures.

There is already a danger given all the problems in Europe, Japan and emerging markets that safe haven flows will drive the dollar up to the point where the US economy could be significantly slowed. Raising rates without evidence of rising inflation could dramatically increase real rates and exacerbate these risks.

None of this is to say that rates should never be raised or that inflation indicators might not justify a rate increase before long. It is to say that the Fed could inject much needed confidence in the economy today and minimise future risks by announcing and following a strategy of not raising rates until it sees the whites of inflation’s eyes.

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

FT Video: Make the middle class a priority

January 20, 2015/in Washington Post, Global Economics, Secular Stagnation

Summers talked with FT editor, Lionel Barber, on January 19, 2015 about the Inclusive Prosperity report, why economic growth has been hampered and whether ECB action can lift middle-class incomes.

Focus on growth for the middle class

January 18, 2015/in Washington Post, Global Economics

January 18, 2015

The most challenging economic issue ahead of us involves a group that will barely be represented at this week’s annual Davos summit: the middle classes of the world’s industrial countries. As the Center for American Progress’s Inclusive Prosperity Commission, which I co-chaired with Ed Balls, the top economic official in Britain’s Labor Party, concludes in a new report, nothing is more important to the success of industrial democracies than sustained increases in wages and living standards for working families.

Amid the focus on global finance, geopolitics and the moral imperative to help the world’s poor, no one should lose sight of the fact that without substantial changes in policy, the prospects for the middle class globally are at best highly problematic.

First, the economic growth that is a necessary condition for rising incomes is threatened by the specter of secular stagnation and deflation. In the United States, 2014 was expected to be one of rising interest rates along with acceleration of growth, the end of quantitative easing and the approach of tightened monetary policy. In Japan, prices were to start rising again. In Europe, the year was to bring continued economic reform and normalization.

In fact, 10-year Treasury rates have fallen by more than 1 percentage point in the United States and are only half as high in Germany and Japan as they were a year ago. In a number of major countries, including Germany, France and Japan, short-term interest rates are now negative, with lenders to governments forced to pay for the privilege. Such low interest rates suggest a chronic excess of saving over investment and the likely persistence of conditions that make monetary policy ineffective in Europe and Japan, along with their possible reemergence in the United States. Market indicators almost everywhere suggest that inflation is expected to be well below the target rate for a decade.

The world has largely exhausted the scope for central bank improvisation as a growth strategy. Excess demand, inflation, excessive credit and the need for monetary tightening are the least of our concerns. Central banks still have to do their part, but it is time for concerted and substantial measures to raise both public and private investment.

Second, the capacity of our economies to sustain increasing growth and provide for rising living standards is not assured on the current policy path. The United States is often held out as a model, and indeed its performance has been strong by global standards. The United States has enjoyed growth of about 11 percent over the past five years. Of this, standard economic calculations suggest that about 8 percent can be regarded as cyclical, resulting from the decline in the unemployment rate. That leaves just 3 percent over five years as attributable to growth in the economy’s capacity. Even after our recovery, the share of American men age 25 to 54 who are out of work exceeds that in Japan, France, Germany and Britain.

Demand issues aside, growth prospects are worse in Europe and Japan, where adult populations are shrinking and ageing and economic dynamism is subsiding. A significant part of the sharp downward revisions in the estimated potential of industrial economies is a consequence of the recession conditions of recent years. In many ways, strong growth is itself the best structural policy for promoting growth as investment rises, workers gain experience and so forth. But more must be done.

Third, if it is to benefit the middle class, prosperity must be inclusive, and in the current environment this is far from assured. If the United States had the same income distribution it had in 1979, the bottom 80 percent of the population would have $1 trillion — or $11,000 per family — more. The top 1 percent would have $1 trillion — or $750,000 — less. There is little prospect for maintaining international integration and cooperation if it continues to be seen as leading to local disintegration while benefiting a mobile global elite.

The focus of international cooperative efforts in the economic sphere must shift. Considerable progress has been made in trade and investment. Less has been made in preventing races to the bottom in areas such as taxation and regulation. Only with enhanced international cooperation will the maintenance of progressive taxation and adequate regulatory protection be possible. And only if ordinary citizens see benefit in an ever more open global economy will it come about.

These three concerns — secular stagnation and deflation, slow underlying economic growth and rising inequality — are real. But they are not grounds for fatalism. The experience of many countries, including Canada and Australia in this century, and many eras shows that sustained growth in middle-class living standards is attainable. But it requires elites to recognize its importance and commit themselves to its achievement. That must be the focus of this year’s Davos.

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

Let this be the year when we put a proper price on carbon

January 5, 2015/in Washington Post, Global Economics

January 4, 2015

The fall in oil prices and declines in other energy prices make the case for a tax overwhelming

The case for carbon taxes has long been compelling. With the recent steep fall in oil prices and associated declines in other energy prices it is overwhelming. There is room for debate about the size of the tax and about how the proceeds should be deployed. But there should be no doubt that starting from the current zero tax rate on carbon, increased taxation would be desirable.

The core of the case for taxation is the recognition that those who use carbon-based fuels or products do not bear all the costs of their actions. Carbon emissions exacerbate the global climate change problem. In many cases they contribute to local pollution problems which immediately harm human health. Removing fossil fuels from the ground involves both accident risks and environmental challenges. And even with the substantial increases in US oil production we remain a net importer, so increases in consumption raise our dependence on Middle East producers.

When we drive our cars, heat our homes or use fossil fuels in more indirect ways, all of us create these costs without paying for them. It follows that we overuse these fuels. This is not some kind of government planning argument — it is the logic of the market: that which is not paid for is overused. Even if the government had no need or use for revenue, it could make the economy function better by levying carbon taxes and rebating the revenues to society.

While the recent decline in energy prices is a good thing in that it has on balance raised the incomes of Americans, it does exacerbate the problem of energy overuse. The benefit of imposing carbon taxes is therefore enhanced.

On the other side of the ledger, there has always been the concern that raising carbon taxes would place an unfair burden on some middle- and low-income consumers. Those who drive long distances to work, say, or who have homes that are expensive to heat would be disproportionately burdened. Now these groups have received a windfall from the drop in energy prices so it would be possible to impose substantial carbon taxes without them being burdened relative to where prices stood six months ago. As an example, the price of petrol has fallen by over $1 per gallon. A $25 a ton tax on carbon that would raise over $1tn during the next decade would lift petrol prices by only about 25 cents.

Some worry that taxing fossil fuels will hurt the competitiveness of US industry and encourage offshoring. In fact a well designed tax would be levied on the carbon content of all imports coming from countries that did not impose their own carbon levies. The US should insist that its tax is compatible with World Trade Organisation rules. It would have the virtue of encouraging countries who wished to avoid the US tax to impose carbon taxes of their own, thereby further supporting efforts to reduce global climate change.

A US carbon tax would contribute to efforts to combat climate change in other ways. It would be a hugely important symbolic step ahead of the global climate summit in Paris late this year. It would shift the debate towards harmonised measures to raise the price of carbon use and away from the complex cap-and-trade type systems that in the EU and elsewhere have proven more difficult to operate than expected.

What size levy is appropriate? Here there is more danger of doing too little than too much. Once the principle of taxation is accepted its level can be adjusted. A tax of $25 a ton would raise well over $100bn each year and seems a reasonable starting point.

How should the proceeds be used? Here too it seems more important to reach consensus on the principle of taxation. My preference would be for the proceeds to be split between investments in infrastructure and pro-work tax credits. An additional $50bn a year in infrastructure spending would be a significant contribution to closing America’s investment gap in that area. The same sum devoted to pro-work tax credits could finance a huge increase in the earned income tax credit, a meaningful reduction in the payroll tax or some combination of the two.

Progressives who are concerned about climate change should rally to a carbon tax as the most important step for mobilising against it. Conservatives who believe in the power of markets should favour carbon taxes on market principles. And Americans who want to see their country lead on the energy and climate issues that are crucial to the world this century should want to be in the vanguard on carbon taxes. Now is the time.

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

Crumbling infrastructure is a sign of lost collective faith

December 7, 2014/in Washington Post

December 7, 2014

The only answer is prompt and aggressive responses to failure

Take a walk from the US Air Shuttle in New York’s LaGuardia airport to ground transportation. For months you will have encountered a sign saying “New escalator coming in Spring 2015”. Or take the Charles River at a key point separating Boston and Cambridge which is little more than 100 yards wide. Traffic has been diverted to support the repair of a major bridge crossing the river for more than two years, and yet work is expected to continue into 2016.

The world is said to progress but things that would once have seemed easy now seem hard. The Rhine river is much wider than the Charles yet General George Patton needed just a day to build bridges that permitted squadrons of tanks to get across it. It will take almost half as long to fix the escalator in LaGuardia as it took to build the Empire State building 85 years ago.

Is it any wonder that the American people have lost faith in the future and in institutions of all kinds? If rudimentary tasks such as keeping escalators going and bridges repaired are too much to handle, it is little surprise that disillusionment and cynicism flourish.

Political debates are often framed in terms of the respective roles of the public and private sector with progressives stressing the importance of private market failure and conservatives stressing the dysfunctionality of the public sector. The sad truth is that there is merit in both arguments.

The escalator that will take five months to repair is privately owned. Although it is in an airport, failure cannot be blamed on public authorities. Necessary maintenance had been delayed for years — with the escalator in question even being stripped for spare parts to support other escalators. Now the new owner has many priorities; the replacement of the escalator system is only one.

On the other hand, repair of the bridge across the Charles River is the responsibility of local governments. A combination of budgetary short sightedness, excessively rigid labour practices, and a failure to take account of the costs of traffic delays appears to account for the project’s remarkably long gestation period.

While much of the political debate takes place on a macro level, focusing on large scale changes in spending, tax or regulatory policies, I suspect that much of what frustrates the public happens on a more micro scale.

A government that has to install safety nets under bridges to catch failing debris will not inspire when it aspires to rebuild other nations.

When big companies are cannibalising their machinery for spare parts, it is hardly surprising that they are not trusted to embark on voluntary long run programmes to control greenhouse gases, promote diversity or develop new technologies.

What is to be done? First, the focus of infrastructure discussions in both the public and the private sector needs to shift from major new projects whose initiation and completion can be the occasion for grand celebration to more prosaic issues of upkeep, maintenance, and project implementation.

For example, before anyone contemplates spiffy new high-speed railway systems, careful consideration should be given to repairing existing rail lines and stations.

Second, accountants in the public and private sector need to develop methodologies for capturing deferred maintenance and showing this in the financial accounts for what it is — borrowing from the future. What is counted counts and so if maintenance deferrals were made transparent they would become much more expensive for decision makers.

Third, the public and the media on their behalf need to be much less accepting of institutional failure. It has been said that we do not want to know all to which we can become accustomed. A vicious cycle in which governments perform poorly and so are starved of resources and so perform worse is serious threat to healthy democracy.

Something similar can happen to business. If owners distrust management they will insist on taking cash out rather than permitting its use for long term investment. The only answer is prompt and aggressive responses to failure that ensure that it is shortlived.

More important than any specific remedy, there is a reason beyond the media and the public’s own economic problems why there is so much disillusionment with so many institutions. They do not seem to perform as well as they once did. We see it every day.

Fixing escalators and building bridges may seem like small stuff at a time of economic crisis and geopolitical instability. But it is time we recognise the importance of what may seem small to what is ultimately important — the faith of citizens in their collective future.

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

We play with fire if we skimp on public health

November 10, 2014/in Washington Post, Global Health

November 10, 2014

Epidemics and pandemics are like earthquakes. Tragic, inevitable and unpredictable. It starts as a random event. A virus jumps species from a bird, bat, or other animal to “Patient Zero” – who passes it on to other human beings. More likely than not, over the course of this century we will face an influenza pandemic similar to the one in 1918 that killed 50m people.

President Barack Obama’s first chief of staff, Rahm Emanuel, said in the wake of the global economic meltdown that “you never let a serious crisis go to waste”. Crises are opportunities to learn. They point to measures that will prevent the collapse of institutions when they are under extreme pressure.

While the focus is understandably on responding to the Ebola crisis, it is equally important that it serves as a wake-up call with respect to inadequacies that threaten not just tragedy on an unprecedented scale but the basic security of the US and other wealthy nations. As with climate change, no part of the world can insulate itself from the consequences of epidemic and pandemic.

The report of the Global Health 2035 commission, which I co-chaired, points up three crucial lessons. First, collective action must be taken to build strong health systems in every corner of the globe. In west Africa, Ebola was a “stress test” on national health systems, and in Sierra Leone, Liberia and Guinea the systems could not cope. There were too few trained health professionals; there was also too little equipment and too few supplies, and too little capacity for public health surveillance and control.

Nigeria’s containment of the virus after the first case was diagnosed in July is instructive. Its success, hailed by the World Health Organisation as a piece of “world class epidemiological detective work”, is explained by its aggressive, co-ordinated surveillance and control response. It already had a polio surveillance system, with skilled outbreak specialists who were quickly put to work tackling Ebola. While much of Nigeria’s health system, such as primary care services, remains very weak, on Ebola the surveillance and control system worked. Every country needs this kind of system. Prevention is cheaper than cure and leads to better outcomes.

Building these systems takes time and money. Our research, conducted with an international team of economists and health experts, and published last year in the medical journal The Lancet, suggests that the price of this “systems strengthening” would be about $30bn a year for the next two decades. The good news is that we have the financing to pay for this through a combination of aid and domestic spending. The cost represents well under 1 per cent of the additional gross domestic product that will be available to low- and lower-middle-income countries due to increased GDP growth over the next 20 years.

The second lesson is that the lack of investment in public health is a global emergency. The WHO’s slow response to Ebola was not surprising, given its recent staff cuts. For that, we all share the blame. Since 1994, the WHO’s regular budget has declined steadily in real terms. Even before the Ebola crisis, it struggled to fund basic functions. The entire budget for influenza was just $7*7m in 2013 – less than a third of what New York City alone devotes to preparing for public health emergencies.

It takes just one infected airline passenger to introduce an infection into a country. We need the WHO more than ever. It alone has the mandate and legitimacy to serve as a health protection agency for all countries, rich and poor. Starving it of funds is reckless.

The third lesson concerns scientific innovation. When it comes to discovering and developing medicines, vaccines and diagnostic tests, we have been largely ignoring the infectious diseases that disproportionately kill the world’s poor. Consequently, we still have no medicines or vaccine for Ebola. All we can do is provide basic life support, such as fluids and blood pressure treatment . For prevention, we have to rely on old-fashioned measures such as quarantine.

Margaret Chan, WHO’s director-general, has explained the reason for this neglect. Doctors were “empty-handed”, she said, because “a profit-driven industry does not invest in products for markets that cannot pay”. Ebola affects poor African nations, so drug companies see no profit in working on it. No society will allow companies to reap huge profits when disease is spreading rapidly.

Rich governments and donors need to step up. Investing several billion dollars a year, less than 0.01 per cent of global GDP, could be decisive in preventing tragedy on the scale of world war.

Some issues are more important than recessions and elections. Ebola is a tragedy. Let us hope that it will also be a spur to taking the necessary steps to prevent the far greater one that is nearly inevitable on the current policy trajectory. The next Ebola is just around the corner.
The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary. Dr Gavin Yamey, University of California contributed to this piece.

Why public investment really is a free lunch

October 7, 2014/in Washington Post, Secular Stagnation

The IMF finds that a dollar of spending increases output by nearly $3

October 7, 2014

It has been joked that the letters IMF stand for “it’s mostly fiscal.” The International Monetary Fund has long been a stalwart advocate of austerity as the route out of financial crisis, and every year it chastises dozens of countries for their fiscal indiscipline. Fiscal consolidation – a euphemism for cuts to government spending – is a staple of the fund’s rescue programmes. A year ago the IMF was suggesting that the US had a fiscal gap of as much as 10 per cent of gross domestic product.

All of this makes the IMF’s recently published World Economic Outlook a remarkable and important document. In its flagship publication, the IMF advocates substantially increased public infrastructure investment, and not just in the US but much of the world. It asserts that when unemployment is high, as it is in much of the industrialised world, the stimulative impact will be greater if investment is paid for by borrowing, rather than cutting other spending or raising taxes. Most notably, the IMF asserts that properly designed infrastructure investment will reduce rather than increase government debt burdens. Public infrastructure investments can pay for themselves.

Why does the IMF reach these conclusions? Consider a hypothetical investment in a new highway financed entirely with debt. Assume – counterfactually and conservatively – that the process of building the highway provides no stimulative benefit. Further assume that the investment earns only a 6 per cent real return, also a very conservative assumption given widely accepted estimates of the benefits of public investment. Then, annual tax collections adjusted for inflation would increase by 1.5 per cent of the amount invested, since the government claims about 25 cents out of every additional dollar of income. Real interest costs, that is interest costs less inflation, are below 1 per cent in the US and much of the industrialised world over horizons of up to 30 years. So infrastructure investment actually makes it possible to reduce burdens on future generations.

In fact, this calculation understates the positive budgetary impact of well-designed infrastructure investment, as the IMF recognised. It neglects the tax revenue that comes from the stimulative benefit of putting people to work constructing infrastructure, as well as the possible long-run benefits that come from combating recession. It neglects the reality that deferring infrastructure renewal places a burden on future generations just as surely as does government borrowing.

It ignores the fact that by increasing the economy’s capacity, infrastructure investment increases the ability to handle any given level of debt. Critically, it takes no account of the fact that in many cases government can catalyse a dollar of infrastructure investment at a cost of much less than a dollar by providing a tranche of equity financing, a tax subsidy or a loan guarantee.

When it takes these factors into account, the IMF finds that a dollar of investment increases output by nearly $3. The budgetary arithmetic associated with infrastructure investment is especially attractive at a time when there are enough unused resources that greater infrastructure investment need not come at the expense of other spending. If we are entering a period of secular stagnation, unemployed resources could be available in much of the industrial world for quite some time.

While the case for investment applies almost everywhere – possibly excepting China, where infrastructure investment has been used a stimulus tool for some time – the appropriate strategy for doing more differs around the world.

The US needs long-term budgeting for infrastructure that recognises benefits as well as costs. Projects should be approved with reasonable speed. The government can contribute by supporting private investments in areas such as telecommunications and energy.

Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps. This may be possible through the expansion of the European Investment Bank or more use of capital budget concepts in implementing fiscal reviews.

Emerging markets need to make sure that projects are chosen in a reasonable way based on economic benefit.

What is crucial everywhere is the recognition that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions. The IMF, a bastion of “tough love” austerity, has come to this important realisation. Countries with the wisdom to follow its lead will benefit.

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

Bold reform is the only answer to secular stagnation

September 8, 2014/in Washington Post, Secular Stagnation

September 8, 2014

There may be supply-side barriers that hold the economy back before constraints on demand bind

By Lawrence H. Summers

The economy continues to operate way below any estimate of its potential made before the onset of financial crisis in 2007, with a shortfall of gross domestic product relative to previous trend in excess of $1.5tn, or $20,000 per family of four. As disturbing, the average growth rate of the economy of less than 2 per cent since that time has caused output to fall further and further below previous estimates of its potential.

Almost a year ago I invoked the concept of secular stagnation in response to the observation that five years after financial haemorrhaging had been staunched, the business cycle was cycling back to what had been previously thought of as normal levels of output.

Secular stagnation in my version, like that of Alvin Hansen, the economist who coined the term in the 1930s, has emphasised the difficulty of maintaining sufficient demand to permit normal levels of output.

But with a high propensity to save, a low propensity to invest and low inflation, this has been impossible. Nominal interest rates cannot fall below zero, as they would have to for real interest rates to be low enough to enable saving and investment to be equated with the economy producing at its full potential. Furthermore, even if potential output can be attained, it would require interest rates so low that they risk financial instability.

Given the factors operating to reduce natural interest rates – rising inequality, lower capital costs, slowing population growth, foreign reserve accumulation, and greater costs of financial intermediation – it seems unlikely that the American economy is capable of demanding 10 per cent more output than it does now, at interest rates consistent with financial stability. So demand-side secular stagnation remains an important economic problem.

But, as the work of Robert J Gordon has shown, there may now be supply-side barriers that threaten to hold back the economy before constraints on the ability to create demand start to bind. Two ways of looking at the current situation point up the difficulty.
First, while I have emphasised that levels of GDP are far short of what pre-crisis trends would predict, the unemployment rate at 6.1 per cent (down from a 10 per cent peak) has reverted most of the way back to even relatively optimistic estimates of its normal level. In other words, even while economic growth performance has been very poor, it appears that demand has been advancing rapidly enough to substantially reduce slack in the labour market. Weak growth, along with substantial decreases in slack, suggests significant weakness in the growth of potential output.

To be fair, there is room to cavil about the unemployment rate as a measure of slack in the labour market. But the extent of apparent normalisation is even greater if one looks at measures of job openings and vacancies, new unemployment insurance claims, or the short-term unemployment rate.

Second, with Friday’s relatively weak employment statistics job growth has averaged 200,000 jobs a month over the past six months. If this continues, what would it imply for movements in the unemployment rate?

This depends on what happens to labour force participation, which has been trending downwards because of population ageing and long-term structural trends, even as the unemployment rate has declined sharply. Assume (optimistically, given recent trends) that the labour force participation rate for workers of a given age remains constant, and that the economy creates 200,000 jobs a month. The unemployment rate would then fall to about 4 per cent by the end of 2016.

While such a low unemployment rate is conceivable, it seems much more likely that employment growth would slow at some point, because of rising wage costs or policy actions, or because employers have difficulty finding workers. Then, the economy would be held back not by lack of demand but lack of supply potential.

Why has the economy’s supply potential declined so much relative to the pre-2007 trend? This will be debated in the years to come. Part of the answer lies in the damaging effect of past economic weakness on future potential. Part is the brutal demographics of an ageing population, the end of the trend towards increased women’s labour force participation, and the exhaustion of the gains from an increasingly educated workforce. And part is the apparent slowing of at least measured productivity.

To achieve growth of even 2 per cent over the next decade, active support for demand will be necessary but not sufficient. Structural reform is essential to increase the productivity of both workers and capital, and to increase growth in the number of people able and willing to work productively. Infrastructure investment, immigration reform, policies to promote family-friendly work, support for exploitation of energy resources, and business tax reform become ever more important policy imperatives.

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

Ending presidents’ second-term curse

August 10, 2014/in Washington Post

August 10, 2014

Disillusionment with Washington has rarely run higher. Congress is unable to act even in areas where there is widespread agreement that measures are necessary, such as immigration, infrastructure spending and business tax reform. The Obama administration, rightly or wrongly, is increasingly condemned as ineffectual. What was once a flood of extraordinarily talented people eager to go into government has shrunk to a trickle, and many crucial positions remain unfilled for months or even years. Bipartisan compromise seems inconceivable on profoundly important long-term challenges such as climate change, national security strategy and the need to strengthen entitlement programs in a fiscally responsible way.

It is tempting and, surely to some limited extent, right to blame all this on a failure of leadership by top policymakers. And structural factors such as increased polarization of the electorate and the ever-growing role of money in politics surely contribute.

Yet it is worth putting current concerns in the context of a stunning American political regularity. Second presidential terms are almost without exception very difficult for the president and his team, for the government and for the country. Consider the history:

George W. Bush’s second term began with a futile effort to reform Social Security and was then defined by the debacle of Hurricane Katrina and the nation’s plunge into financial crisis. His most significant policy steps — large structural tax cuts, redefinition of the federal role in education, the introduction of prescription drug benefits to Medicare and reorientation of national security strategy toward the threat of terrorism — all took place during his first term.

Bill Clinton’s second term will be remembered for scandal and his impeachment by the House. His most important legislative accomplishments — such as major moves to balance the budget, reforming welfare to support work rather than dependency, expansion of health-insurance benefits — took place in his first term.

Ronald Reagan’s second term was marked by the Iran-Contra scandal and a sense of a president who had become remote from much of the work of his administration. While the Tax Reform Act of 1986 was important, his most significant legacies — big tax and spending cuts, deregulation and a major defense buildup — largely occurred during his first term.

Richard Nixon’s second term was not completed because of his resignation over Watergate. The most important policy measures of his administration — the opening to China, withdrawal from Vietnam, the establishment of a major federal role in environmental and other forms of regulation — took place in his first term.

Dwight Eisenhower’s second term involved the resignation of his chief of staff and, more important, a growing perception that the country was suffering from a stifling complacency. It is hard to point to anything to compare to first-term accomplishments such as the withdrawal from Korea and initiation of the interstate highway system.

Harry Truman’s second term was marked by the Korean War, scandal, gridlock and extraordinarily low public approval. His important legacies — the Marshall Plan, the containment strategy, the postwar focus on strengthening the economy with measures such as the G.I. Bill and federal housing support — were products of his first term.

Franklin Roosevelt’s second term was the least successful part of his presidency, as it saw the failure of his effort to pack the Supreme Court and a major economic relapse in 1938 and no accomplishment remotely comparable to the New Deal or his wartime leadership.

And second terms have what may well be a substantial added cost. A large part of what presidents do during their first terms, particularly in the latter half, is directed at securing reelection rather than any longer-term objective.

Would the U.S. government function better if presidents were limited to one term, perhaps of six years? The unfortunate, bipartisan experience with second terms suggests the issue is worthy of debate. The historical record helps makes the case for change.

Why the record is not dispositive, however, is suggested by the term “lame duck.” As the phrase suggests, leaders nearing the end of their time in office lose the ability to influence other actors by offering future rewards and punishments or by making deals in which they commit to future actions. If this is the main reason second terms are difficult, then removing the possibility of reelection could simply pull the problems forward into first terms.

This is why many scholars regard the current constitutional limit of two presidential terms as problematic. However, reviewing the fairly dismal experience of second terms, my guess is that problems caused by lame-duck effects are much smaller than those caused by a toxic combination of hubris and exhaustion after the extraordinary effort that a president and his team must exert to achieve reelection. But the issue requires much more study and debate.

The belief that this time will be different usually precedes trouble, and so it has been with second terms. On the night of their reelection, all reelected presidents expect to beat the second-term curse. At least since the Civil War, none has. And we have been governed by reelected presidents for close about 40 percent of the last century. National reflection on reform is overdue.

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

Put American foreign policy back on the pitch

July 6, 2014/in Washington Post

July 6, 2014

A failure to engage with global economic issues is a failure to mount a strong defense

By Lawrence H. Summers

Sports coaches know that there is nothing more dangerous for a team than retreating into passivity for fear of making a mistake. Whether it is due to a desire to sit on a lead, or because of nerves following a setback, failing to advance aggressively is almost always a strategic error.

What is true in athletic competition is all too true in the life of nations. While imprudence is always unwise, excessive caution in the name of prudence or expediency can have grave consequences. A nation will never have more power or influence than it has ambition to shape the global system. A sense of fatalism can become a self-fulfilling prophecy as adversaries are emboldened and allies move either to appease adversaries or to provide for their own security.

At a time of high tension in Europe with Russian adventurism in Ukraine, pervasive conflict and instability in the Middle East, and rising tensions within Asia as China makes its presence ever more strongly and widely felt, the choices the US makes will have far reaching consequences. It is no exaggeration to say that there is more doubt about our willingness to stand behind our allies, resist aggression and support a stable global system than at any time in decades.

Effective engagement at flash points is essential but crisis response is never as good as crisis prevention. Somewhat lost as the world focuses on global hotspots is the danger that the US will abdicate from the responsibility it has undertaken for 70 years since the second world war for supporting a more integrated, increasingly rule based and faster growing global economy. It is the success of this project that explains why history played out so differently after the second world war than after the first, and it is this project that won the cold war by demonstrating that capitalism rather than communism was the best way forward for the world’s people.

At a time when authoritarian mercantilism has emerged as the principal alternative to democratic capitalism, the US Congress is flirting with eliminating the Export Import Bank that, at no cost to the government, enables US exporters to compete on a more level playing field with those of competitor nations, all of whom have similar vehicles. Only by maintaining a capacity to counter foreign subsidies can we hope to maintain a level global trading system and to avoid ceding ground to mercantilists. Eliminating the Export Import Bank without extracting any concessions from foreign governments would be the economic equivalent of unilateral disarmament.

No one with any sophistication supposes that the world has seen the last big financial crisis or that we can prosper in a world in crisis. Yet the US, having pushed successfully for big increases in IMF resources and for important reforms in its governance, is now the lone nation blocking these measures from going into effect as Congress is unwilling to pass the relevant authorizing legislation. The IMF enables us to do in the economic area what we are unable to do in the security area: place most of the burden for supporting a functioning global system on all global stakeholders.

The vital strategic thrust proclaimed in US foreign policy over the past five years has been the pivot or rebalance towards Asia. This is entirely appropriate given the shift in the global economic centre of gravity. The reality though is that little has changed. The most important potential beneficial change in the next several years would be the achievement of the Trans-Pacific Partnership. Yet the combined prospect that a deal will be negotiated and that it will receive Congressional approval seems much too low for comfort and there is little evidence that the issue commands urgency beyond the relatively narrow international trade community. The prospects for a trade agreement with Europe seem even more remote.

Then there is the economic assistance dimension. When Latin America faced a profound debt crisis in the 1980s, when the Berlin Wall fell and the nations of central Europe and the former Soviet Union needed to transform their economies, when financial crisis struck Asia in 1997, when debt burdens stunted Africa’s growth around the turn of the century, the US working with its allies and the international financial institutions crafted strong if imperfect responses to restore growth and hope. No comparably large and generous effort is visible today with respect to the Middle East or Ukraine, even as China is emerging as a larger presence in much of Africa and Latin America than the US.

A failure to engage effectively with global economic issues is a failure to mount a strong forward defense of American interests. The fact that we cannot do everything must not become a reason not to do anything. While elections may turn on domestic preoccupations, history’s judgment will turn on what the US does internationally. Passivity’s moment has passed.

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

The rich have advantages that money cannot buy

June 8, 2014/in Washington Post

The differences between the rich and everyone else are about health and opportunity

By Lawrence H. Summers

June 8, 2014

With the popularity of Thomas Piketty’s book, Capital in the 21st Century, inequality has become central to the public debate over economic policy. Piketty, and much of this discussion, focuses on the sharp increases in the share of income and wealth going to the top 1 per cent, 0.1 per cent and 0.01 per cent of the population.

This is indeed a critical issue. Whatever the resolution of arguments over particular numbers, it is almost certain that the share of personal income going to the top 1 per cent of the population has risen by 10 percentage points over the past generation, and that the share of the bottom 90 per cent has fallen by a comparable amount.

The only groups that have seen faster income growth than the top 1 per cent are the top 0.1 per cent and top 0.01 per cent.

This discussion helps push policy in constructive directions. There is every reason to believe that taxes can be reformed to eliminate loopholes for the wealthy and become more progressive, while also promoting a more efficient allocation of investment. In areas ranging from local zoning laws to intellectual property protection, from financial regulation to energy subsidies, public policy now bestows great fortunes on those whose primary skill is working the political system rather than producing great products and services. There is a compelling case for policy measures to reduce profits from such rent-seeking activities as a number of economists, notably Dean Baker and the late Mancur Olsen, have emphasised.

At the same time, unless one regards envy as a virtue, the primary reason for concern about inequality is that lower- and middle-income workers have too little – not that the rich have too much.

So in judging policies relating to inequality, the criterion should be what their impact will be on the middle class and the poor.

On any reasonable reading of the evidence starting where the US is today, more could be done to increase tax progressivity without doing any noticeable damage to the prospects for economic growth.

It is vital to remember, however, that important aspects of inequality are unlikely to be transformed just by limited income redistribution. Consider two fundamental components of life – health and the ability to provide opportunity for children.

Barry Bosworth and his colleagues at the Brookings Institution have examined changes in life expectancy starting at age 55 for the cohort of people born in 1920 and the cohort born in 1940. They found that the richest men gained roughly six years in life expectancy, middle-income earners gained roughly four years, and those in the lowest part of the distribution gained two years. To put this in perspective, the elimination or doubling of cancer mortality would mean less than a four-year change in life expectancy.

Why these differences? They more likely have to do with lifestyle and variations in diet and stress than the ability to afford medical care – especially since the figures refer to relatively aged people, all of whom, once they reach 65, fall under Medicare.

Over the past two generations, the gap in educational achievement between the children of the rich and the children of the poor has doubled. While the college enrolment rate for children from the lowest quarter of the income distribution has increased from 6 per cent to 8 per cent, the rate for children from the highest quarter has risen from 40 per cent to 73 per cent.

What has driven these trends? No doubt there are many factors. But a crucial one has to be that the average affluent child now receives 6,000 hours of extracurricular education, in the form of being read to, taken to a museum, coached in a sport, or any other kind of stimulus provided by an adult, more than the average poor child – and this gap has greatly increased since the 1970s.

A famous literary spat between 1920s novelists F Scott Fitzgerald and Ernest Hemingway has been boiled down over time to a succinct, if apocryphal, exchange. Fitzgerald: “The rich are different from you and me.” Hemingway’s retort: “Yes, they have more money.”

These observations on health and the ability to provide opportunity for children suggest that the differences between the rich and everyone else are not only about money but about things that are even more fundamental: health and opportunity.

If society is to become more just and inclusive it will be necessary to craft policies that address the rapidly increasing share of money income going to the rich. But it is crucial to recognise that measures to support the rest of the population are at least equally important.

It would be a tragedy if this new focus on inequality and on great fortunes diverted attention from the most fundamental tasks of any democratic society – supporting the health and education of all its citizens.

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

UK austerity is no model for the world

May 4, 2014/in Washington Post

New York is more dependent on financial services yet its GDP is above its previous peak

May 4, 2014

By Lawrence H. Summers

The British economy is the standout member of the Group of Seven rich nations. Over the last quarter the UK had economic growth at an annual rate of more than 3 per cent. In the same period the US barely grew, continental Europe remained in the doldrums and Japan struggled to maintain momentum. No surprise then that many have seized on Britain’s strong performance as vindication of the austerity strategy pursued by the UK government since 2010, and as evidence to refute the idea of secular stagnation – that lack of demand is a constraint on growth.

Interpreting the UK experience correctly is important. As well as the domestic political stakes and the question of the country’s future economic policy, Britain is of much wider importance as it bears on economic policy debates around the world. Unfortunately for those who feel vindicated given the strategy that has been pursued, properly interpreted the British experience refutes austerity advocates and confirms JM Keynes’ warning about the dangers of indiscriminate budget cutting in the middle of a downturn.

Start with the current situation. While recent growth has been rapid, this is only because of the depth of the hole Britain dug for itself. Whereas in the US gross domestic product is well above its pre-crisis peak, in the UK it remains below previous highs and further short of levels predicted when austerity policies were first implemented. Not surprisingly given this dismal record, the debt-to-GDP ratio is now almost 10 percentage points higher than was forecast, and the date when budget balance will be achieved has been pushed back by years.

The most common excuse offered for such poor performance is an over dependence on financial services. Yet GDP in the New York metropolitan area, which is even more dependent on financial services than Britain, has comfortably outstripped its previous peak. While the euro area has performed poorly, trade statistics confirm that this cannot account for most of Britain’s poor growth as export declines account for only a small part of the deterioration.

The US economy grew at an annual rate of 9 per cent for a number of years after the trough of the Depression in 1933. Such rapid growth in peacetime is unheard of in the US experience. Why did it happen? Only because of the depth of the Depression. No one has ever taken the pace of the US recovery from the Depression as evidence for the austerity policies that helped to induce it. Likewise, part of the story of British growth is simply one of catching up after a major crisis. Historically, deeper recessions are followed by stronger recoveries. Again New York’s metropolitan area offers a powerful example: after falling relative to the rest of the US in 2008, it had more rapid growth thereafter.

Two additional points about the UK’s growth experience require emphasis. First, the acceleration in growth has less to do with austerity spurring expansion than it does to a slowdown in the pace at which policy became more austere. Whether one looks at the deficit itself, or the various structural deficit measures prepared by national and international organisations, the pace of fiscal contraction has slowed over the past two years.

This means that the brake on growth caused by fiscal policy is becoming more attenuated. So the turnround in growth over the past 18 months is as much evidence against austerity as it is pro-austerity.

Second, faced with the potential damage caused by the deficit reduction to demand and economic growth, the UK government has been forced to introduce a number of extraordinary measures to support lending. Most significant is the so-called Help to Buy programme to support property purchases. There are also programmes to reward banks for lending to small businesses and to get the central bank involved in export finance.

Especially in the case of Help to Buy, which manages to recapitulate most of the sins of the US government-sponsored enterprises, these programmes are highly problematic. The stated goal of the austerity drive was to improve confidence in Britain’s standing as a sovereign borrower. Yet there is the basic fact that guaranteeing mortgages en masse is creating a huge potential government liability, as do other loan guarantee programmes.

Moreover, subsidised credit for housing risks reigniting bubbles as house prices in London have risen much faster than GDP over the past year. And, of course, all programmes for the benefit of homeowners rather than renters have perverse distributional consequences.

Britain’s growth thus reflects a combination of the depth of the hole it found itself in, the moderation in the trend towards ever-deeper austerity and the effects of possibly bubble-inducing government loans. It may be better for the citizens of Britain than any alternative. It certainly should not, however, be seen as any kind of inspiration to other companies or countries.

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

‘Potemkin money’ is wrong way to help Ukraine

March 9, 2014/in Washington Post, Global Economics

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

February 16, 2014/in Washington Post, Financial Times, Global Economics

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

Washington must not settle for secular stagnation

January 5, 2014/in Washington Post, Secular Stagnation

January 5, 2014

By Lawrence Summers

We may, as I argued last month in the Financial Times, be in a period of “secular stagnation” in which sluggish growth and output, and employment levels well below potential, might coincide for some time to come with problematically low real interest rates.

Since the start of this century, annual US gross domestic product growth has averaged less than 1.8 per cent. The economy is now operating nearly 10 per cent – or more than $1.6tn – below what was judged to be its potential as recently as 2007. And all this is in the face of negative real interest rates for terms of more than five years and extraordinarily easy monetary policy.

It is true that even some forecasters who have had the wisdom to remain pessimistic about growth prospects for the past few years are coming around to more optimistic views in 2014 – at least in the US. This is encouraging but should be qualified by the recognition that, even on optimistic forecasts, output and employment will remain well below previous trend for many years. More troubling, even with today’s high degree of slack in the economy, and with wage and price inflation slowing, there are signs of eroding credit standards and inflated asset values. If we were to enjoy years of healthy growth under anything like current credit conditions, there is every reason to expect we would return to the kind of problems we saw in 2005-07 long before output and employment returned to trend or inflation picked up again.

So the secular stagnation challenge is not just to achieve reasonable growth but to do so in a financially sustainable way. There are, essentially, three approaches.

The first would emphasise what is seen as the deep supply-side fundamentals – labour force skills, companies’ capacity for innovation, structural tax reform and assuring the long-run sustainability of entitlement programmes. All of this is appealing – if politically difficult – and would indeed make a great contribution to the economy’s health in the long run. But it is unlikely to do much in the next five to 10 years. Apart from obvious delays – it takes time for education to operate, for example – our economy is held back by lack of demand rather than lack of supply. Increasing our capacity to produce will not translate into increased output unless there is more demand for goods and services. Training programmes or reform of social insurance may, for instance, affect which workers find jobs but they will not affect how many find jobs. Indeed, measures that raise supply could have the perverse effect of magnifying deflationary pressure.

The second strategy, which has dominated US policy in recent years, is lowering relevant interest rates and capital costs as much as possible and relying on regulatory policies to assure financial stability. The economy is far healthier now than it would have been in the absence of these measures. But a strategy that relies on interest rates significantly below growth rates for long periods of time virtually guarantees the emergence of substantial bubbles and dangerous build-ups in leverage. The idea that regulation can allow the growth benefits of easy credit to come without the costs is a chimera. It is precisely the increases in asset values and increased ability to borrow that stimulate the economy that are the proper concern of prudential regulation.

The third approach – and the one that holds most promise – is a commitment to raising the level of demand at any given level of interest rates, through policies that restore a situation where reasonable growth and reasonable interest rates can coincide. This means ending the disastrous trend towards ever less government spending and employment each year – and taking advantage of the current period of economic slack to renew and build up our infrastructure. If the government had invested more over the past five years, our debt burden relative to our incomes would be lower: allowing slackening in the economy has hurt its potential in the long run.

Raising demand also means seeking to spur private spending. There is much that can be done in the energy sector to unleash private investment on both the fossil fuel and renewable sides. Regulation that requires the more rapid replacement of coal-fired power plants will increase investment and spur growth as well as helping the environment. And in a troubled global economy it is essential to ensure that a widening trade deficit does not excessively divert demand from the US economy.

Secular stagnation is not an inevitability. With the right policy choices, we can have both reasonable growth and financial stability. But, without a clear diagnosis of our problem and a commitment to structural increases in demand, we will be condemned to oscillating between inadequate growth and unsustainable finance. We can do better.

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

Why stagnation might prove to be the new normal

December 15, 2013/in Washington Post, Secular Stagnation

December 15, 2013

In the past decade, before the crisis, bubbles and loose credit were only sufficient to drive moderate growth

Is it possible that the US and other major global economies might not return to full employment and strong growth without the help of unconventional policy support? I raised that notion – the old idea of “secular stagnation” – recently in a talk hosted by the International Monetary Fund.

My concern rests on a number of considerations. First, even though financial repair had largely taken place four years ago, recovery has only kept up with population growth and normal productivity growth in the US, and has been worse elsewhere in the industrial world.

Second, manifestly unsustainable bubbles and loosening of credit standards during the middle of the past decade, along with very easy money, were sufficient to drive only moderate economic growth.

Third, short-term interest rates are severely constrained by the zero lower bound: real rates may not be able to fall far enough to spur enough investment to lead to full employment.

Fourth, in such situations falling wages and prices or lower-than-expected are likely to worsen performance by encouraging consumers and investors to delay spending, and to redistribute income and wealth from high-spending debtors to low-spending creditors.

The implication of these thoughts is that the presumption that normal economic and policy conditions will return at some point cannot be maintained. Look at Japan, where gross domestic product today is less than two-thirds of what most observers predicted a generation ago, even though interest rates have been at zero for many years. It is worth emphasizing that Japanese GDP was less disappointing in the five years after the bubbles burst at the end of the 1980s than the US GDP has since 2008. In America today, GDP is more than 10 per cent below what was predicted before the financial crisis.

If secular stagnation concerns are relevant to our current economic situation, there are obviously profound policy implications. But before turning to policy, there are two central issues regarding the secular stagnation thesis that have to be addressed.

First, is not a growth acceleration in the works in the US and beyond? There are certainly grounds for optimism: note recent statistics, the strong stock markets and the end at last of sharp fiscal contraction. One should also recall that fears of secular stagnation were common at the end of the second world war and were proved wrong. Today, secular stagnation should be viewed as a contingency to be insured against – not a fate to which we ought to be resigned. Yet, it should be recalled that the achievement of escape velocity has been around the corner in consensus forecasts for several years and we have seen several false dawns – just as Japan did in the 1990s. More fundamentally, even if the economy accelerates next year, this provides no assurance that it is capable of sustained growth at normal real interest rates. Europe and Japan are forecast to have grown at levels well below the US. Across the industrial world, inflation is below target levels and shows no signs of picking up – suggesting a chronic demand shortfall.

Second, why should the economy not return to normal after the effects of the financial crisis are worked off? Is there a basis for believing that equilibrium real interest rates have declined? There are many a prior reasons why the level of spending at any given set of interest rates is likely to have declined. Investment demand may have been reduced due to slower growth of the labor force and perhaps slower productivity growth. Consumption may be lower due to a sharp increase in the share of income held by the very wealthy and the rising share of income accruing to capital. Risk aversion has risen as a consequence of the crisis and as saving – by both states and consumers – has risen. The crisis increased the costs of financial intermediation and left major debt overhangs. Declines in the cost of durable goods, especially those associated with information technology, mean that the same level of saving purchases more capital every year. Lower inflation means any interest rate translates into a higher after-tax rate than it did when inflation rates were higher; logic is supported by evidence. For many years now indexed bond yields have been on a downward trend. Indeed, US real rates are substantially negative at a five year horizon.

Some have suggested that a belief in secular stagnation implies the desirability of bubbles to support demand. This idea confuses prediction with recommendation. It is, of course, better to support demand by supporting productive investment or highly valued consumption than by artificially inflating bubbles. On the other hand, it is only rational to recognize that low interest rates raise asset values and drive investors to take greater risks, making bubbles more likely. So the risk of financial instability provides yet another reason why preempting structural stagnation is so profoundly important.

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

https://larrysummers.com/wp-content/uploads/2025/04/clear-2.png 0 0 Larry Summers https://larrysummers.com/wp-content/uploads/2025/04/clear-2.png Larry Summers2013-12-15 14:25:002025-04-21 18:03:44Why stagnation might prove to be the new normal